The 1870s Economic Crisis in America: Reality versus Rothbard

It doesn’t matter how many times Rothbard’s view of the 1870s is refuted, Austrians and libertarians simply continue to shun reality and repeat Rothbard’s errors (such as here and here).

It can’t hurt to review the data.

First, industrial production. The best and most recent index of US industrial production in this era is Davis (2004) (see Hanes 2013: 121), which draws on many more industrial products and services than other, older indices.

The data from Davis shows that US industrial production contacted from 1873 to 1875, then had a modest recovery in 1876, but then stagnated in 1877:

US Industrial Index, 1870–1880
Index base is 1849–1850 = 100
Year | Index
1870 | 242.97
1871 | 255.29
1872 | 275.74
1873 | 302.17
1874 | 300.7
1875 | 284.2
1876 | 294.0
1877 | 297.8
1878 | 314.0
1879 | 356.4
1880 | 400.9
(Davis 2004: 1189).

Even in 1877 US industrial production remained below its 1873 peak. On the basis of this data, Davis argued that there was a recession in the US probably from 1873 to 1875. Strangely, the real GDP estimates in Balke and Gordon (1989) only show a recession in 1874 in this decade, but Davis’s data clearly are a much better guide to what was happening in the US industrial sector then Balke and Gordon’s work, and we should go with Davis.

The data on US industrial production are best seen in the graphs below.

As we can see in the graph above, the recession and stagnation in industrial production from 1873 to 1877 are clearly visible as compared with the ten years of growth both before and after this period.

We can also see that the serious take-off in the recovery of industrial production only happened from 1878.

It is evident, then, that something went badly wrong with US industrial production from 1873 to 1877, and this is confirmed by the unemployment estimates from this period from Vernon (1994).

As we see here, unemployment was rising from 1873 and kept on rising until 1878. That would strongly confirm that the US economy was in recession in these years or at the very least was stagnating (another point is that, on the basis of analysis of the 1890s and the likelihood that 19th century labour force participation rates were countercyclical in the sense of rising during recessions, there is at least a reasonable case that Vernon’s data seriously underestimates US unemployment in the 19th century, so that the real unemployment rate for the 1870s may have been considerably higher).

All in all, then, it is not possible to claim that the US economy was booming in these years.

Now compare the facts above with the ignorance of Murray Rothbard:

“Orthodox economic historians have long complained about the ‘great depression’ that is supposed to have struck the United States in the panic of 1873 and lasted for an unprecedented six years, until 1879. Much of the stagnation is supposed to have been caused by a monetary contraction leading to the resumption of specie payments in 1879. Yet what sort of ‘depression’ is it which saw an extraordinarily large expansion of industry, of railroads, of physical output, of net national product, or real per capita income? As Friedman and Schwartz admit, the decade from 1869 to 1879 saw a 3-percent per-annum increase in money national product, an outstanding real national product growth of 6.8 percent per year in this period, and a phenomenal rise of 4.5 percent per year in real product per capita. Even the alleged ‘monetary contraction’ never took place, the money supply increasing by 2.7 percent per year in this period. From 1873 through 1878, before another spurt of monetary expansion, the total supply of bank money rose from $1.964 billion to $2.221 billion—a rise of 13.1 percent or 2.6 percent per year. In short, a modest but definite rise, and scarcely a contraction.

It should be clear, then, that the ‘great depression’ of the 1870s is merely a myth—a myth brought about by misinterpretation of the fact that prices in general fell sharply during the entire period. Indeed they fell from the end of the Civil War until 1879. Friedman and Schwartz estimated that prices in general fell from 1869 to 1879 by 3.8 percent per annum. Unfortunately, most historians and economists are conditioned to believe that steadily and sharply falling prices must result in depression: hence their amazement at the obvious prosperity and economic growth during this era. For they have overlooked the fact that in the natural course of events, when government and the banking system do not increase the money supply very rapidly, free-market capitalism will result in an increase of production and economic growth so great as to swamp the increase of money supply. Prices will fall, and the consequences will be not depression or stagnation, but prosperity (since costs are falling, too) economic growth, and the spread of the increased living standard to all the consumers.” (Rothbard 2002: 154–155).

Rothbard makes the following claim about our relevant period:

“Yet what sort of ‘depression’ is it which saw an extraordinarily large expansion of industry, of railroads, of physical output, of net national product, or real per capita income.” (Rothbard 2002: 154–155).

Of course, if one wants to define “depression” as a fall in real GDP of 10% or more (a definition which I accept), then it is likely that the 1873 to 1879 period was not an era of depression. Rather, it was most likely a period of serious recession (where “recession” means a fall in real GDP of less than 10%) and then stagnation of industrial production and rising unemployment, and probably pessimistic business expectations leading to deficient investment.

Moreover, Rothbard is wrong on the following points:

(1) there was no large expansion of industry in this period: our best data shows industrial production was in recession from 1873 and then stagnated until 1877. Indeed for the 1870s as a whole there were 4 years in 1873, 1874, 1875 and 1877 when industrial production was in recession or essentially stagnating.

(2) if industrial production was in crisis, then it is very difficult to see how there could have been a “large expansion” of “physical output” or “net national product” in these years, despite the real GDP estimates of Balke and Gordon (1989: 84): they estimate that average real GDP growth from 1873 to 1877 was 2.8% (which in any case is far lower than Rothbard’s estimate). If real GDP was experiencing such growth rates, one must ask: which sectors were growing? Clearly the industrial sector was not.

(3) there was no “extraordinarily large expansion of … real per capita income” in the relevant period. Even if one accepts the estimates of Balke and Gordon (in Maddison 2006: 87–89) the average real per capita GDP growth rate from 1873–1879 and even from 1871–1880 was just 1.64%: one of the lowest growth rates of all time in relevant periods of economic and historical significance in US history.

(4) finally Rothbard never considered unemployment, which by one influential modern estimate by Vernon (1994) began rising from 1873 and kept on rising until 1878.

Our inescapable conclusion is that the Austrian claim – derived from Rothbard – that the 1870s were an uninterrupted era of “prosperity …[,] economic growth, and the spread of the increased living standards” is an outright historical travesty.

And while Rothbard might claim that he did the best with the data he had at the time (e.g., older and now discredited data from Friedman and Schwartz 1963), that is no excuse for modern Austrians repeating his false and flawed analysis today.

Further Links
“Rothbard on the US Economy in the 1870s: A Critique,” September 24, 2012.

“US Unemployment Graph, 1869–1899,” February 27, 2013.

“Huerta de Soto gets it Wrong on the Gold Standard,” December 20, 2014.

“Libertarian Gold Standard Myths Never Die,” January 13, 2015.

“Real US GDP 1870–2001,” January 13, 2015.

“US Real Per Capita GDP from 1870–2001,” September 24, 2012.

BIBLIOGRAPHY
Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Davis, Joseph H. 2004. “An Annual Index of U. S. Industrial Production, 1790-1915,” The Quarterly Journal of Economics 119.4: 1177–1215.

Davis, Joseph H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Friedman, M. and A. J. Schwartz, 1963. A Monetary History of the United States, 1867–1960. Princeton University Press, Princeton.

Hanes, Christopher. 2013. “Business Cycles,” in Robert Whaples and Randall E. Parker (eds.), Routledge Handbook of Modern Economic History. Routledge, Abingdon, Oxon and New York. 116–135.

Maddison, Angus. 2003. The World Economy: Historical Statistics. OECD Publishing, Paris.

Newman, Patrick. 2014. “The Depression of 1873–1879: An Austrian Perspective,” Quarterly Journal of Austrian Economics17.4: 474–509.
https://mises.org/library/depression-1873%E2%80%931879-austrian-perspective

Rothbard, Murray N. 2002. A History of Money and Banking in the United States. Ludwig von Mises Institute, Auburn, Ala.

Vernon, J. R. 1994. “Unemployment Rates in Post-Bellum America: 1869–1899,” Journal of Macroeconomics 16: 701–714.

The Causes of the Recession of 1920–1921

O’Brien (1997) and Samuelson (1943: 47–50) present some useful analysis of the causes of the recession of 1920–1921, the US downturn that lasted from January 1920 to July 1921 (or for some 18 months).

First, I summarise the arguments of O’Brien.

According to O’Brien, the short recession beginning in August 1918 appears to have been the result of conversion from wartime to peacetime production, and only lasted 7 months (O’Brien 1997: 151).

The mildness of this recession and the mild deflation appear to have boosted business and consumer confidence (O’Brien 1997: 152).

The increased confidence, together with the pent up demand for consumption goods and capital goods, led in 1919 to a boom in residential construction, fixed investment and automobiles (O’Brien 1997: 152).

What set off the recession in 1920 was the following factors:

(1) early in 1920 there were declines in sales, particularly textile products and iron and steel;

(2) continued cuts to government spending and government purchases in 1919;

(3) exports declined by 20% between the 1st and 2nd quarters of 1920;

(4) the Federal Reserve raised discounts rates to 4.75% in late 1919, and then 6% in early 1920. The New York Federal Reserve even raised its discount rate to 7% on 1 June, 1920. This caused a contraction in business and consumer credit, and

(5) since many businesses had accumulated raw materials and intermediate goods in the expectation of further inflation, when the recession struck they suffered heavy losses and in order to reduce inventory they cut production sharply (O’Brien 1997: 152).

Thus a major part of the recession was a contraction in business investment and production to liquidate excess inventory.

To this extent, 1920–1921 was somewhat like post-1945 “inventory” recessions, in which contractions were partly the result of previous and excessive inventory accumulation and then the subsequent liquidation of this stock (Sorkin 1997: 569).

Next, we turn to Samuelson. According to Samuelson (1943: 47–50), demobilisation was largely finished by the first half of 1919, and one year after the armistice of November 1918 4 million men had been discharged (Samuelson 1943: 47).

As an aside, we can note that unemployment was already rising in 1919, as can be seen in the graph below (from Weir’s [1992] unemployment estimates).

So the rise in unemployment in 1920 and 1921 came on top of the previous unemployment caused by demobilisation.

Samuelson (1943: 48–49) further argues that the boom of 1919 was very much dependent on continued government spending, even if that spending was falling.

Just as O’Brien, Samuelson emphasises the role of business confidence and inventory accumulation in 1919:

“Not knowing the troublesome times ahead, the private business community greeted peace with optimism. As the spring of 1919 wore on, sales increased in retail lines such as clothing for returning soldiers, household goods, etc. With the removal of price controls, the wholesale price index began to rise, in the end soaring from the final war level of around 200, on a prewar base, to almost 250. This set off a wave of inventory accumulation, or attempted accumulation, which formed a substantial fraction of total offsets to savings; and the paper increase in inventory values was considerably greater.

From its nature this was an unhealthy base upon which to erect a boom. Price increases led to attempted inventory accumulation, further accentuating the price increases. But it was not enough for prices to stay at these abnormal levels; once they ceased to rise, or leveled off, the whole structure had to collapse.” (Samuelson 1943: 49).

So both O’Brien and Samuelson have a broadly similar story on the cause of the recession of 1920–1921.

Further research has explained the nature of the recession itself. It was an anomalous recession. Real output contraction only became severe after July 1920 (Vernon 1991: 573), and Vernon (1991: 575) points out that even the large rise in unemployment in 1920 is to be explained to some extent by the continued effects of the previous demobilisation and increased immigration in 1920 and 1921.

Romer (1988: 97–99) argues that total consumption from 1920 to 1921 actually increased, not fell, because, even though consumer expenditures on durable goods contracted, expenditures on nondurables and services increased to make up for the shortfall.

Finally, there is still disagreement about the depth of the recession.

Romer (1989) provided a new estimate for GNP declines from 1920 to 1921, as follows:

Year | GNP* | Growth Rate
1914 | $414.599
1915 | $443.048 | 6.86%
1916 | $476.498 | 7.54%
1917 | $473.896 | -0.54%
1918 | $498.458 | 5.18%
1919 | $503.873 | 1.08%
1920 | $498.132 | -1.13%
1921 | $486.377 | -2.35%
1922 | $514.949 | 5.87%
1923 | $583.105 | 13.23%
* Billions of 1982 dollars
(Romer 1989: 23).

These estimates show a GNP contraction of only 3.47% from 1919 to 1921, a mild to moderate recession.

By contrast, Balke and Gordon (1989: 84–85) estimate a GNP decline of 5.58% from 1920–1921, a moderately bad recession.

On either of these estimates, however, the downturn of 1920 to 1921 was nothing like the Great Depression, and it still appears to be an anomaly.

Further Reading
“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.

BIBLIOGRAPHY
Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

O’Brien, Anthony Patrick. 1997. “Depression of 1920–1921,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia. Garland Pub., New York. 151–154.

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

Romer, C. D. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869–1908,” Journal of Political Economy 97.1: 1–37.

Samuelson, Paul A. 1943. “Full Employment after the War,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 27–53.

Sorkin, A. L. 1997. “Recessions after World War II,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia. Garland Pub., New York. 566–569.

Vernon, J. R. 1991. “The 1920–21 Deflation: The Role of Aggregate Supply,” Economic Inquiry 29: 572–580.

Weir, D. R. 1992. “A Century of U.S. Unemployment, 1890–1990: Revised Estimates and Evidence for Stabilization,” Research in Economic History 14: 301–346.

Ireland Returns to Recession: The Failure of Austerity

It is now official: Ireland has slipped back into recession with a 0.2% fall in GDP in the last quarter of 2011. In Q3 2011, GDP contracted 1.1%, so we now have two consecutive periods of contraction: the official definition of a recession.

But it gets worse. In Q4 2011, Irish GNP (probably a better measure of real national output in Ireland’s case) slumped by a shocking 2.2%.

The reason is that exports have fallen, along with the Eurozone problems. Most of the growth Ireland has had since 2010 has been based on exports.

You can see the record of Ireland’s quarterly GDP here:

http://www.tradingeconomics.com/ireland/gdp-growth

From 2008 to 2009, Ireland suffered a depression, both in terms of its GDP decline (10.1%) and its GNP contraction (14.1%) (a depression is technically a fall in the value of real output exceeding 10%). Of the 16 quarters from Q1 2008 (when the global recession hit), Ireland has had but 4 quarters of positive GDP growth. A miserable performance.

Meanwhile unemployment is at 14.2%, and has been stagnating between 14.2% and 14.4% ever since the middle of 2011.

Another development (seen in other nations like Estonia and Latvia that have gone down the path of severe austerity) is that people are leaving Ireland in droves, often the young and unemployed. From 2009 to 2011, some 86,000 emigrated. In 2012, some 75,000 are predicted to leave, figures higher than the last emigration surge owing to economic problems in the late 1980s. That trend can be seen in the video below, describing Irish emigration to Australia in 2011.




Lessons here are obvious: export-led growth is highly unreliable, and it is unlikely a nation will achieve robust, long-term growth by fiscal contraction and domestic wage and price deflation (especially when other nations pursue austerity), which, in any case, guts its domestic sectors.

So much for austerity, the policy prescription of fools and madmen.

Robert Skidelsky on Keynes and the Crisis

This is an interesting interwiew with Robert Skidelsky on the Real News network, with quite a few issues discussed: the historical role of the IMF, Bretton Woods, and the current crisis.

Randall Wray Interview

Here is an interesting interview with Randall Wray on the Real News network. Lots of good stuff here.

In essence, many countries are mired in an underemployment disequilibrium and serious problems with private sector balance sheets, just as Japan was in the 1990s. Fiscal policy is the only thing stopping deep debt deflation and recession/depression. The financial sector needs cleaning up and proper regulation, and much of the private debt needs to be written off or restructured. Randall Wray gives his ideas on a modern monetary theory (MMT) jobs program for the US.

The US Recession of 1920–1921: Some Austrian Myths

The US recession of 1920–1921 is endlessly cited by Austrians as proof that Keynesian economic policies are not needed to stimulate an economy out of recession or depression. Unfortunately, Austrians are deeply ignorant about the recession of 1920–1921. This recession was atypical, occurred shortly after the WWI, and recent research shows that the GDP contraction was not especially severe.

We can list some basic facts about the 1921 recession below and how these facts do not support the Austrian/libertarian myths one endlessly hears on their blogs:

(1) Duration of the Recession
The recession lasted from January 1920 to July 1921 (a period of 18 months). From January 1920 until July 1920 the recession was mild, and only became severe after July 1920 (Vernon 1991: 573), and the downturn persisted until July 1921.

Libertarians claim that the recession of 1920–1921 was short. Of course, what they don’t say is that a recession lasting 18 months is in fact a very long one by the standards of the post-1945 US business cycle. The average duration of US recessions in the post-1945 era of classic Keynesian demand management (1945–1980) and the neoliberal era (1980–2010) has been about 11 months (see Carbaugh 2010: 248 and the data in Knoop 2010: 13; curiously, there has only been one post-1945 US recession that lasted 18 months: the Great Recession of December 2007–June 2009, which was much worse than the 1920–1921 downturn). The average duration of recessions in peacetime from 1854 to 1919 was 22 months (Knoop 2010: 13), and the average duration of recessions from 1919 to 1945 was 18 months (Knoop 2010: 13).

In the post 1945 period this was cut to about 11 months. Thus the average duration of recessions was essentially cut in half after 1945, because of countercyclical fiscal and monetary policy. Even expansions in the post-1945 business cycle became longer: the average duration of post-1945 expansions was 50 months. By contrast, the average duration of expansions from 1854 to 1919 was 27 months, and the average from 1919 to 1945 was 35 months (Knoop 2010: 13). In other words, the average length of post-1945 expansions became 43% higher compared with that of 1919 to 1945, and 85% higher than between 1854 to 1919.

Macroeconomic performance after 1945 has been superior, without any doubt, to that of the previous gold standard eras. The recession of 1920–1921 with a duration of 18 months was in fact of long duration relative to the average of post-1945 recessions. Keynesian and even neoliberal economic management of the business cycle has been superior to the system that existed before 1933.

The empirical data tells us that, if Keynesian stimulus had been applied early in 1920, there are convincing reasons for thinking that the contraction would have been far shorter than 18 months.

(2) Severity of the Recession
Libertarians seem unaware that recent economic research has shown that the downturn of 1920–1921 was not as severe as previously thought. The widely accepted definition of a depression is a fall of 10% in output or GDP. In past estimates of the fall in national output, official Commerce Department data suggested that GNP fell 8% between 1919 and 1920 and 7% percent between 1920 and 1921 (Romer 1988: 108).

But Christina Romer has argued that actual decline in real GNP was only about 1% between 1919 and 1920 and 2% between 1920 and 1921 (Romer 1988: 109; Parker 2002: 2). So in fact real output moved very little, and this was not a depression on the scale of 1929–1933 or previous 19th century depressions. Libertarians cannot claim that 1920–1921 was an example of the free market quickly ending a downturn where output collapsed by 10% or more (a real depression). In reality, GNP contraction was relatively small, and the growth path of output was hardly impeded by the recession (Romer 1988: 108–112; Parker 2002: 2).

(3) Deflation and Positive Supply Shocks
Although deflation was very severe, one significant cause of the deflation was a positive supply shock in commodities due to the resumption of shipping after the war (Romer 1988: 110). After WWI, there was a recovery in agricultural production in Europe, even though American farmers had continued their production at wartime levels. When primary commodity supplies from other countries were resumed after international shipping recovered, there was a great increase in the supply of commodities and their prices plummeted. As Romer argues,

“Tiffs suggests that a flood of primary commodities may have entered the market following the war and thus driven down the price of these goods. That these supply shocks may have been important in stimulating the economy can be seen in the fact that the response of the manufacturing sector to the decline in aggregate demand in 1921 was very uneven …. The industries that were most devastated by the downturn were those in heavy manufacturing …. On the other hand, nearly all industries… that used agricultural goods or imports as raw materials experienced little or no decline in labour input in 1921 .... That industries related to agricultural goods and imports flourished during 1921 suggests that beneficial supply shocks did stimulate production in a substantial sector of the economy” (Romer 1988: 111).

Vernon (1991) comes to the same conclusion as Romer: the deflation in 1920-1921 was caused not just by a decline in aggregate demand but also by a positive aggregate supply shock. Another factor is that deflationary expectations were high after the war, as prices over the 1914–1920 period had increased by 115% (Vernon 1991: 577). This means that business was expecting deflation. We can contrast this with the 1929–1933 period when severe deflation was largely unexpected, and had much more harmful consequences.

(4) No Major Financial Crisis
The recession of 1920–1921 also had no serious financial crisis: although some bank failures occurred, there were no mass bank runs and collapses in 1920–1921 (Brunner 1981: 44). Stock market prices had been high before 1920 and overvalued and hit a peak 2 months before the onset of the recession. But this stock market bubble does not appear to have been caused by excessive private debt and leveraged speculation as in 1929. We can also note that the explosive rise in consumer credit to households and small businesses only occurred in the course of the 1920s (Parker 2002: 2), and thus large levels of private debt were clearly not a significant factor in 1920/1921. Thus debt deflationary effects were not as serious as in other recessions, and certainly not like the downturn of 1929–1933.

(5) The Federal Reserve’s Role
It is perfectly clear that the Federal Reserve had a role both in contributing to the cause of the recession and in ending it. As Vernon (1991: 573) notes,

“Monetary policy began to shift in December 1919, then changed markedly in January 1920. The Federal Reserve Bank of New York’s discount rate, which had been pegged at 4 percent since April 1919, was raised to 4.75 percent in December 1919, to 6 percent in January 1920, and to 7 percent in June 1920. Similar discount rate increases were made at the other Federal Reserve Banks. Friedman and Schwartz argue that these sharp increases came too late to be responsible for the January 1920 turning point but that they produced the severe contraction and deflation which came after mid-year.”

But, by 1921, there was monetary loosening. 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).

The role of the Federal Reserve underscores how the recession of 1920–1921 was not like US downturns in the 19th century, since the US had no central bank before 1914 (and after 1836 when the charter of the Second Bank of the United States expired). If we admit that Fed policy contributed to the recession, then it is highly probable that Fed easing of interest rates in 1921 also had a role in ending the recession, because the relatively lower interest rates after May 1921 preceded the expansion that ended the recession (which began in July 1921).

The recovery, then, has to be partly related to central bank policy, not to the pure free market eulogised by Austrian economists. (And in fact one of the reasons why there was no sharp recession after WWII was that the Federal Reserve kept interest rates very low after 1945 [Vernon 1991: 580]).

In light of all this, the recession of 1920–1921 was very different from the contraction of 1929–1933 and various other pre-1914 recessions that were preceded by excessive private debt, and caused by bursting asset bubbles, severe financial crises, demand contractions and debt deflation.

An obvious example of such a 19th century depression was that of 1893-1895. This was set off by a financial crisis in 1893 and caused the US to suffer high involuntary unemployment throughout the 1890s, even after a technical recovery had begun in 1895 (on this depression, see Steeples and Whitten 1998; Akerlof and Shiller 2009: 59-64; Romer 1986: 31).

The belief that the recovery in 1921 proves that a laissez faire or “do nothing” policy will work in other cases of serious recession or depression is utter nonsense. Above all, the empirical data show that modern macroeconomic policies have reduced the durations of recessions after 1945. There is no reason why in principle the 1920–1921 recession could have been alleviated and brought to an end sooner if countercyclical fiscal policy had been used.


UPDATE
I have recently seen an article by Daniel Kuehn called “A critique of Powell, Woods, and Murphy on the 1920–1921 depression.”
This also presents a critique of the Austrian view of the 1920-21 recession:

http://factsandotherstubbornthings.blogspot.com/2010/10/1920-21-depression-article-is-on-online.html

Kuehn also draws attention to the role of the Federal Reserve, and argues that its high discount rate (the primary policy tool in those days) in 1920 to combat inflation was a major factor in inducing the recession.

UPDATE 2, 18 January, 2011
I have just seen this page on the Mises forum where someone has copied my post above:

http://mises.org/Community/forums/p/22126/391853.aspx#391853

A commentator there has in fact unintentionally provided an important counterargument against the Austrians.

If Austrians think that the 1890s recession and high unemployment in that decade do not provide evidence against their theories (since the US had a national banking system and fractional reserve banking in the 1890s, instead of the pure laissez faire they advocate), then why on earth do they endlessly invoke 1920–1921 as if it proves the Austrian position?

If they really believe that 1890s America (where there was no central bank) cannot be invoked as a criticism of Austrian theory, then it is absurd in the extreme for Austrians to invoke 1920–1921 as vindication of their theories, when, in that period, America had a central bank! By your own definition, it was even less of a laissez faire system than 1890s America.

And, of course, given there was no period in recent history when the fantasy Austrian world of no fractional reserve banking, no fiduciary media, no regulation, and no government has ever even existed, there is no empirical evidence whatsoever that such a system would work or be stable.

All one can do is look to real world capitalism in the 19th century: given there was no central bank, a gold standard and minimal regulation in 1890s America, this must give at least an approximation of what their system would look like.
If Austrians think it is not an approximation, then the 1920–1921 period is utterly invalid too, in any attempt to vindicate their theory.

In short, this is another severe logical contradiction running through Austrian analysis.

APPENDIX 1: GNP ESTIMATES
All GNP figures are merely estimates, since proper data collection was not done before about 1945. There are four important studies on GNP before 1945:

Balke, N. S., and R. J. Gordon, 1986. “The American Business Cycle: Continuity and Change,” in R. J. Gordon (ed.), The American Business Cycle, University of Chicago Press, Chicago.

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Romer, C. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869-1908,” Journal of Political Economy 97.1: 1–37.

Ritschl, A., Sarferaz, S. and M. Uebele, “The U.S. Business Cycle, 1867–2006: Dynamic Factor Analysis vs. Reconstructed National Accounts,” January, 2010
https://www.ciret.org/conferences/newyork_2010/papers/upload/p_200-500401.pdf

The various estimates for 1920–1921 GNP:

The U.S. Department of Commerce = 6.9% GNP decline

Balke and Gordon = 3.5% GNP decline

Romer = 2.4% GNP decline

Balke and Gordon’s figures support a much lower decline for GDP.

The estimate of Ritschl, Sarferaz, Uebele (2010) is higher than that of Balke and Gordon and Romer.

APPENDIX 2: THE DEPRESSION OF THE 1890s
For data on the persistence of double digit unemployment in the 1890s, see the revised figures in Romer 1986: 31.

Year Unemployment rate
1892 3.72%
1893 8.09%
1894 12.33%
1895 11.11%
1896 11.965
1897 12.43%
1898 11.62%
1899 8.66%
1900 5.00%

The US economy did not return to full employment for nearly a decade after 1893. Contrary to Austrian economic analysis, there is no evidence that the 1890s slump was rapidly ended by a laissez faire economy. In fact, since the US had no central bank in the 1890s, Austrians and other free market libertarians should be doubly embarrassed by the downturn in the 1890s and the persistence of high unemployment and sub-optimum growth.

The other widely used estimate of unemployment in the 1890s is the work of Stanley Lebergott. His estimates of unemployment are much higher than Romer’s, so, even if his estimates are invoked as more accurate than Romer’s, they would only make matters worse for the libertarian position.

And one might argue that Romer’s estimates are questionable (Lebergott 1992), and at least for the period from 1900-1929 (Weir 1986), as the idea that movements in the labour force were procyclical before 1945 can be challenged: if aggregate participation rates were anticyclical, then Lebergott’s estimates for 1900-1929 may be better (Weir 1986: 364; Weir 1992, however, does agree that Lebergott’s figures for 1890-1899 are too volatile). Here are Lebergott’s estimates of the unemployment rate:

Year Unemployment rate
1890 4.0
1891 5.4
1892 3.0
1893 11.7
1894 18.4
1895 13.7
1896 14.5
1897 14.5
1898 12.4
1899 6.5
1900 5.0

BIBLIOGRAPHY
Akerlof, G. A. and R. J. Shiller. 2009. Animal Spirits: How Human Psychology drives the Economy, and Why it Matters for Global Capitalism, Princeton University Press, Princeton.

Brunner, K. 1981. The Great Depression Revisited, Nijhoff, Boston and London.

Carbaugh, R. J. 2010. Contemporary Economics: An Application Approach, M.E. Sharpe, Armonk, New York.

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.

Lebergott, S. 1964. Manpower in Economic Growth: The American Record since 1800, McGraw-Hill, New York.

Lebergott, S. 1992. “Historical Unemployment Series: A Comment,” Research in Economic History 14: 377–386.

Parker, R. E. 2002. Reflections on the Great Depression, Edward Elgar, Cheltenham, Northampton, MA.

Romer, C. 1986. “Spurious Volatility in Historical Unemployment Data,” Journal of Political Economy 94.1: 1–37.

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.

Romer, C. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869-1908,” Journal of Political Economy 97.1: 1–37.

Steeples, D. W. and D. O. Whitten, 1998. Democracy in Desperation: The Depression of 1893, Greenwood Press, Westport, Conn.

Vernon, J. R. 1991. “The 1920–21 Deflation: The Role of Aggregate Supply,” Economic Inquiry 29: 572–580.

Weir, D. R. 1986. “The Reliability of Historical Macroeconomic Data for Comparing Cyclical Stability,” The Journal of Economic History 46.2: 353–365.

Weir, D. R. 1992. “A Century of U.S. Unemployment, 1890–1990: Revised Estimates and Evidence for Stabilization,” Research in Economic History 14: 301–346.