Did Austrian Libertarians Read The Forgotten Depression: 1921: The Crash That Cured Itself Properly?

The libertarian blogosphere has been spruiking a recent book by James Grant called The Forgotten Depression: 1921: The Crash That Cured Itself (2014) for some time now.

Right now libertarian blogs are gushing over how the book has won the Hayek Prize of the Manhattan Institute. Well, it is not surprising that the conservative/libertarian Manhattan Institute gave a prize named after Hayek to the book, and, quite frankly, I couldn’t care less.

But what does interest me is this: have the Austrians who are spruiking Grant’s book actually read it properly?

The Austrian libertarians are adamant that US monetary policy did not play a significant role in the recovery from this 1920–1921 recession, which lasted from January 1920 to July 1921. (That, incidentally, was a period of 18 months, which is not particularly short as compared with the average length of recessions in the post-WWII era.)

But right on p. 179 of Grant’s The Forgotten Depression: 1921: The Crash That Cured Itself, there is this statement:

“Public policy made one signal contribution, at least, to the improvement in American finances. This was in the all important matter of interest rates. It was welcome news when the Federal Reserve Bank of Boston cut its main discount rate to 6 percent from 7 percent, effective April 15. It was the first easing move by any Federal Reserve bank since the previous spring. The Federal Reserve Bank of New York followed on May 4 with a reduction to 6.5 percent from 7 percent. This move the market correctly interpreted as the beginning of the end of the era of ultrahigh interest rates (high enough in nominal terms, extra lofty when adjusted for the declines in prices and wages).” (Grant 2014: 179).

Although Grant points to the inflow of gold as a more important factor (in his view) for the recovery in the passage that follows this (Grant 2014: 179–180), he clearly does acknowledge the role of Federal Reserve monetary policy too.

The key element in monetary policy in 1921 was interest rates, and there was a clear sea-change in Federal Reserve rate policy from May 1921 before the start of the recovery in July 1921, when in May they signalled that the high rate policy had ended and began to lower rates. The rate cuts beginning in May 1921 had a great influence on the economy by way of expectations and business confidence – especially by helping to create confidence and expectations of continuing rate cuts and looser monetary policy in the future, as indeed did happen.

Even Grant seems to admit this. But Austrians still deny it – at the same time they point to the book as if it vindicates their views. Let’s see: what would be an appropriate expression for this?… Hoist with your own petard, perhaps?

Anyway, if you want an analysis of the recession of 1920–1921 free from Austrian mythology and ignorance, I refer you to my posts on the subject below:

“The US Recession of 1920–1921: Some Austrian Myths,” October 23, 2010.

“There was no US Recovery in 1921 under Austrian Trade Cycle Theory!,” June 25, 2011.

“The Depression of 1920–1921: An Austrian Myth,” December 9, 2011.

“A Video on the US Recession of 1920-1921: Debunking the Libertarian Narrative,” February 5, 2012.

“The Recovery from the US Recession of 1920–1921 and Open Market Operations,” October 4, 2012.

“Rothbard on the Recession of 1920–1921,” October 6, 2012.

“The Recession of 1920–1921 versus the Depression of 1929–1933,” February 2, 2014.

“Debt Deflation: 1920–1921 versus 1929–1933,” February 3, 2014.

“US Wages in 1920–1921,” February 10, 2014.

“The Causes of the Recession of 1920–1921,” February 11, 2014.

“The ‘Depression’ of 1920–1921: The Libertarian Myth that Won’t Die,” October 31, 2014.

“US Monetary Policy and the Recession of 1920–1921,” December 5, 2014.

BIBLIOGRAPHY
Grant, James. 2014. The Forgotten Depression: 1921: The Crash That Cured Itself. Simon & Schuster, New York and London.

More Fake History of the Great Depression

I refer readers to this post by Robert P. Murphy:

Robert P. Murphy, “Does Anyone Deny That There Were Unprecedented Credit Stimulus Policies During Hoover Administration?,” 27 September.

Here is Murphy’s question to Keynesians:

“In my book on the Great Depression [Murphy 2009 – LK], I quote Lionel Robbins saying (I think in 1934) that central banks around the world had tried unprecedented measures to stimulate a recovery through cheap credit, and that this was a complete reversal of traditional central bank doctrine. ….

But I’m asking, do you [sc. Keynesians – LK] agree with Robbins, Hayek, and the random Joes writing letters to the NYT, who at the time were claiming that the central banks of the world were fighting the downturn differently from how things were handled in previous crises?

Note well, I’m speaking here in absolute terms, not in a Sumnerian view whereby the Fed–by definition–has been ‘tight’ the last few years because NGDP is below trend. Rather, I’m asking (for example) if it’s true that central banks in the early 1930s were actively trying to ease credit (by lowering interest rates, setting up special asset purchases or loan programs, etc.) when they had never done things like this in earlier crises?”

First the issue of Lionel Robbins.

Here is what Lionel Robbins said:

“Now in the pre-war [viz. pre-WWI – LK] business depression a very clear policy had been developed to deal with this situation. The maxim adopted by central banks for dealing with financial crises was to discount freely on good security, but to keep the rate of discount high.

Similarly in dealing with the wider dislocations of commodity prices and production no attempt was made to bring about artificially easy conditions. The results of this were simple. Firms whose position was fundamentally sound obtained what was necessary. Having confidence in the future, they were prepared to foot the bill. But the firms whose position was fundamentally unsound realised that the game was up and went into liquidation. After a short period of distress the stage was once more set for business recovery.

In the present depression we have changed all that. We eschew the sharp purge. We prefer the lingering disease. Everywhere, in the money market, in the commodity markets and in the broad field of company finance and public indebtedness, the efforts of Central Banks and Governments have been directed to propping up bad business positions.

We can see this most vividly in the sphere of Central Banking policy. The moment the boom broke in 1929, the Central Banks of the world, acting obviously in concert, set to work to create a condition of easy money, quite out of relation to the general conditions of the money market. This policy was backed up by vigorous purchases of securities in the open market in the United States of America. From October 1929 to December 1930 no less than $410 millions was pumped into the market in this way. The result was as might have been expected. The process of liquidation was arrested. New loans were floated.” (Robbins 1935: 72–73).

Robbins asserts that the pre-WWI central bank policy had been to keep discount rates high and only “discount freely on good security.”

He then asserts that in the 1929–1933 contraction “we have changed all that.” Yet Robbins is wrong, certainly with respect to the United States.

For the Federal Reserve banks had regularly lowered rates and engaged in substantial bond buying programs to fight the 1920s recessions before 1929. The Fed cut rates in 1921, 1924 and 1926–1927 to fight recessions, and cut rates and bought bonds in 1924 and 1926–1927.

Here is a list of 1920s recessions:

1920s Recessions
Recession | Duration Months
January 1920–July 1921 | 18
May 1923–July 1924 | 14
October 1926–November 1927 | 13.

http://www.nber.org/cycles.html

Let us look at the policy responses of the Fed to the 1920s recessions:

(1) 1920–1921 Recession

Here are the Fed cuts to the discount rate during the recession of 1920-1921:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1920
May | 6%
June | 7%
Dec. | 7%
1921
Jan. | 7%
Apr. | 7%
May. | 6.5%
Jun. | 6%
Jul. | 5.5%
Sep. | 5%
Nov. | 4.5%

1922
Jan. | 4.5%
Jun. | 4%.
http://fraser.stlouisfed.org/download-page/page.pdf?pid=38&id=1477

Although the rate was raised to 7% in June 1920, the rate was cut from 7% in 1921 to 5.5% by July, and a further cut to 5% in September as the recovery had begun, and then to 4.5% in November.

(2) 1923–1924 Recession

Let us start with bond purchases:

Bond Purchases
Date | Fed government security holdings
1923
Apr. | $229
July | $97
Oct. | $91

1924
Jan. | $118
Apr. | $274
Jul. | $467
Oct. | $585

1925
Jan. | $464.
(Wheelock 1992: 22).

By early 1924, the Federal reserve banks began a bond buying program. Federal Reserve holdings increased from $91 million in October 1923 to $585 million by October 1924. That was increase of $494 million over about a year. In other words, a six-fold increase in the course of a year.

By April 1924, the Fed bought $156 million in bonds in the period from January, and by July 1924 had bought about another $193 in bonds to fight the recession.

Next, the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1923
Apr. | 4.5%
Jul. | 4.5%
Oct. | 4.5%
1924
Jan. | 4.5%
Apr. | 4.5%
Jul. | 3.5%
Oct. | 3.0%
1925
Jan. | 3.0%.
(Wheelock 1992: 22).

In 1924, the rate was brought down from 4.5% to 3% – a reasonable cut.

So here we have quite clear evidence that the Fed fought the 1923–1924 recession with both discount rate cuts and a bond buying program. The bond buying program, in particular, was large and comparable to that done by the Fed between late 1929 and 1930.

(3) 1926–1927 Recession

First, the bond purchases:

Bond Purchases
Date | Fed government security holdings
1926
Oct. | $306
1927
Jan. | $310
Apr. | $341
Jul. | $381
Oct. | $506
1928
Jan. | $512.
(Wheelock 1992: 22).

From October 1926 to October 1927, the Fed increased its government security holdings by $200 million.

Next, the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1926
Oct. | 4.0%
1927
Jan. | 4.0%
Apr. | 4.0%
Jul. | 4.0%
Oct. | 3.5%
1928
Jan. | 3.5%.
(Wheelock 1992: 22).

Here the discount rate cut was not very large, but bond buying program was hardly insignificant.

Again, both rate cuts and asset purchasing were the norm.

When we come to 1929–1933, we can see that monetary policy actions were not “qualitatively different” (the expression Murphy uses here in this comment) from previous policy – they differed merely in quantity, not quality: lower rate cuts and some more bond purchases than previously.

Let us look at the bond buying program:

Bond Purchases
Date | Fed government security holdings
1929
Jul. | $147
Oct. | $154
1930
Jan. | $485
Apr. | $530
Jul. | $583
Oct. | $602
1931
Jan. | $647
Apr. | $600
Jul. | $674
Oct. | $733.
(Wheelock 1992: 22).

Far from being unprecedented, the similar program from 1923–1924 provides a good precedent.

From July 1929 to late 1931, Fed holdings of treasuries increased about fivefold, and this was in a period of over two years.

Yet in the year from 1923-1924, Federal Reserve holdings increased from $91 million in October 1923 to $585 million by October 1924. That was a six-fold increase over about a year, much more radical than the 1929-1931 program and in a shorter time too!

Next the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1929
Jul. | 5.0%
Oct. | 6.0%
1930
Jan. | 4.5%
Apr. | 3.5%
Jul. | 2.5%
Oct. | 2.5%
1931
Jan. | 2.0%
Apr. | 2.0%
Jul. | 1.5%
Oct. | 3.5%. (Wheelock 1992: 22).

Here the discount rate was quite high in late 1929, but the cuts were certainly sharper than in previous recessions.

The rate came down to 1.5% by July 1931. This was a low rate, but we are dealing with quantity, not a qualitative difference, for the use of discount rate cuts had perfectly good precedents in 1924 and 1927.

We might also note that in 1931 the New York Fed raised the discount rate to 3.5% by October from 1.5%: right in the midst of the worst depression ever seen. Now, if anything, that was a “qualitatively different” policy measure from previous 1920s policy!

Conclusion
Murphy is dead wrong in thinking that the Fed policy in 1929–1933 “was a complete reversal of traditional central bank doctrine” – it was nothing but a development of already existing policy actions.

It is also utterly absurd to say that “central banks in the early 1930s were actively trying to ease credit (by lowering interest rates, setting up special asset purchases or loan programs, etc.) when they had never done things like this in earlier crises” – in the case of the Federal Reserve banks, they had done precisely these policy interventions from 1923–1924 and 1926–1927.

If it is any consolation to Murphy, I have now bought a copy of his book The Politically Incorrect Guide to the Great Depression and the New Deal...

BIBLIOGRAPHY

Murphy, Robert. 2009. The Politically Incorrect Guide to the Great Depression and the New Deal. Regnery Publishing, Inc. Washington, DC.

Robbins, Lionel Charles Robbins. 1935. The Great Depression. Macmillan, London.

Wheelock, David C. 1992. “Monetary Policy in the Great Depression: What the Fed Did, and Why,” Federal Reserve Bank of St. Louis Review 2: 3–27.
http://research.stlouisfed.org/publications/review/92/03/Depression_Mar_Apr1992.pdf

James Galbraith on the Federal Reserve

A very short but quite interesting statement by James Galbraith on the Federal Reserve.

There was no US Recovery in 1921 under Austrian Trade Cycle Theory!

Austrian economists and their sympathizers are fond of pointing to the US recession of 1920–1921 as proof that recessions can end “quickly” with a recovery and no government intervention.

In fact, their claims are false and misleading, as I have shown here:

“The US Recession of 1920–1921: Some Austrian Myths,” October 23, 2010.

The following points should be made in response to them:

(1) The recession lasted from January 1920 to July 1921, or for a period of 18 months. This was a long recession by the standards of the post-1945 US business cycle, where the average duration of US recessions was just 11 months. The average duration of recessions in peacetime from 1854 to 1919 was 22 months, and the average duration of recessions from 1919 to 1945 was 18 months (Knoop 2010: 13). Therefore the recession of 1920–1921 was not even short by contemporary standards: it was of average length.

(2) The period of 1920–1921 was not a depression (a downturn where real GDP contracted by 10% or more): it was mild to moderate recession, with positive supply shocks. Christina Romer argues that actual decline in real GNP was only about 1% between 1919 and 1920 and 2% between 1920 and 1921 (Romer 1988: 109). So in fact real output moved very little, and the “growth path of output was hardly impeded by the recession” (Romer 1988: 108–112). The positive supply shocks that resulted from the resumption in international trade after WWI actually benefited certain sectors of the economy (Romer 1988: 111).

(3) there was no large collapsing asset bubble in 1920/1921, of the type that burst in 1929, which was funded by excessive private-sector debt;

(4) Because of (3) the economy was not gripped by the death agony of severe debt deflation in 1920-1921;

(5) There was no financial and banking crisis, as in 1929–1933;

(6) The US economy in fact had significant government intervention in 1921: it had a central bank changing interest rates. The Fed lowered rates and had a role in ending this recession: in April and May 1921, Federal Reserve member banks dropped their rates to 6.5% or 6%. In November 1921, there were further falls in discount rates: rates fell to 4.5% in the Boston, Philadelphia, New York, and to 5% or 5.5% in other reserve banks (D’Arista 1994: 62). By June 1922, the discount rate was lowered again to 4%, and the recovery gained momentum.

It is the height of stupidity to claim that a recession that was ended partly by Federal Reserve intervention through interest rate lowering can be ascribed to the “free market,” or is a vindication of Austrian economics. Nor did the recession end “quickly,” either by contemporary or modern (post-1945) standards.

And there is yet another absurd contradiction here.

An Austrian cannot claim that the recession of 1920–1921 ended with a real and proper recovery. Why? The Fed lowered interest rates. Why did this not cause an Austrian trade cycle and unsustainable boom, distorting capital structure? If it did not, they must explain why the Fed’s lowering of interest rates did not make the market rate fall below the natural rate. How did the economy avoid distortions to its capital structure when it had a fractional reserve banking system and Fed inflating the money supply in 1921/22? How could there have been any real “recovery” in 1921?

In other words, by the Austrians’ own economic theory, the “recovery” of 1921 was no recovery at all: just the beginning of another Austrian business cycle!

BIBLIOGRAPHY

D’Arista, J. W. 1994. The Evolution of U.S. Finance, Volume 1: Federal Reserve Monetary Policy: 1915–1935, M. E. Sharpe, Armonk, New York.

Knoop, T. A. 2010. Recessions and Depressions: Understanding Business Cycles (2nd edn), Praeger, Santa Barbara, Calif.

Romer, C. 1988. “World War I and the Postwar Depression: A Reinterpretation based on alternative estimates of GNP,” Journal of Monetary Economics 22.1: 91–115.