The Forgotten Depression: 1921: The Crash That Cured Itself

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CONTENTS

Epigraph

Preface

1. The Great Inflation

2. Coin of the Realm

3. Money at War

4. Laissez-Faire by Accident

5. A Depression in Fact

6. City Bank on the Carpet

7. Egging On Deflation

8. A Debacle Without Parallel

9. The Comptroller on the Offensive

10. A Kind Word for Misfortune

11. Not the Government’s Affair

12. Cut from Cleveland’s Cloth

13. A Kind of Recovery Program

14. Wages Chase Prices

15. Shrewd Judge Gary

16. A Higher Sense of Service

17. Gold Pours into America

18. Back to Barbarism?

19. America on the Bargain Counter

20. All for Stability

Epilogue: A Triumph, in Its Way

Photographs

Acknowledgments

About the Author

Notes

A Select Bibliography

Index

In memory of A. Alex Porter, investor, scholar, bon vivant.

In the economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause—it is seen. The others unfold in succession—they are not seen: it is well for us if they are foreseen.

—Frederic Bastiat, That Which Is Seen, That Which Is Unseen, 1850

PREFACE

This slim volume describes a weighty and wonderful event. In 1920, the American economy entered what would presently be diagnosed as a depression. The successive administrations of Woodrow Wilson and Warren G. Harding met the downturn by seeming to ignore it—or by implementing policies that an average 21st century economist would judge disastrous. Confronted with plunging prices, incomes and employment, the government balanced the budget and, through the newly instituted Federal Reserve, raised interest rates. By the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined. Yet by late 1921, a powerful, job-filled recovery was under way. This is the story of America’s last governmentally unmedicated depression.

The United States was not without a government in the early 1920s, of course. It taxed and regulated. It furnished courts, the rule of law, a dollar defined in law as a weight of gold and an army and navy. Federal officers examined the nationally chartered banks. Other public officials infused illiquid though solvent banks with cash. Contemporaries credited the latter functionaries—new hires of the Federal Reserve—with forestalling an otherwise certain money panic. What the government did not do was socialize the risk of financial failure or attempt to steer and guide the national economy by manipulating either the rate of federal spending or the value of the dollar. Compared to the federal establishment that would take form in the 1930s (or to that which had recently waged the war against Germany), it was a small and unintrusive government.

The hero of my narrative is the price mechanism, Adam Smith’s invisible hand. In a market economy, prices coordinate human effort. They channel investment, saving and work. High prices encourage production but discourage consumption; low prices do the opposite. The depression of 1920–21 was marked by plunging prices, the malignity we call deflation. But prices and wages fell only so far. They stopped falling when they became low enough to entice consumers into shopping, investors into committing capital and employers into hiring. Through the agency of falling prices and wages, the American economy righted itself.

I write in the fifth year of a historically lackluster recovery from the so-called Great Recession of 2007–09. To address the crisis of failing banks and collapsing credit, the administrations of George W. Bush and Barack Obama borrowed and spent hundreds of billions of dollars. They threw a governmental lifeline to dozens of financial institutions, some of which would have otherwise drowned. The Federal Reserve pushed its money-market interest rate to zero and materialized trillions of new dollars (thereby further subsidizing the banks and government-sponsored enterprises whose errors of omission and commission had helped to precipitate the crisis in the first place). Yet for all these exertions, some 9.8 million Americans remain out of a job while millions more have given up hope of finding one.

Just about no one with a public voice nowadays would dare to propose the policies that the government implemented (or, more to the point, refused or neglected to implement) almost a century ago. But the fact is that, in the wake of those decisions, growth resumed and the 1920s proverbially roared. We can’t know what might have been if Wilson and Harding had intervened as presidents of the late 20th and early 21st centuries are wont to do. Herbert Hoover, Harding’s secretary of commerce, was seemingly champing at the bit to act; the slump was ending by the time he swung into action. When, as the 31st president, Hoover did intervene—notably, in an attempt to prevent a drop in wages—the results were unsatisfactory.

Recessions and depressions don’t announce their own arrival. Economists rather piece together the chronology after the fact. The recognized arbiter of the cyclical calendar, the National Bureau of Economic Research, dates the start of the downturn of 1920–21 in January 1920 and its conclusion in July 1921; which is to say that things stopped getting better in January 1920, and they stopped getting worse in July 1921. The elapsed time was 18 months.

On the one hand, a year and a half is a very long time to any who suffered unemployment, bankruptcy or destitution. On the other, it is a great deal shorter than the 43 months of the Great Depression of 1929–33. I propose that constructive federal inaction contributed to the relatively satisfactory outcome. To the financiers and capitalists weaned on the idea of laissez-faire, federal passivity did not destroy confidence but rather enhanced it.

Confidence is a concept as vital as it is amorphous. What imparts a feeling of trust to one generation may frighten another. What seemed to brace up the generation of Americans who confronted the 1920–21 slump was a collective belief in the underlying soundness of American finance. In a world that in many ways had seemed to have lost its moorings, the dollar was still as good as gold. A bipartisan determination to pay down the federal debt and to protect the purchasing power of the U.S. dollar thus likely contributed to a belief that the bad times couldn’t and wouldn’t last.

If a government wishes to alleviate, rather than aggravate, a depression, its only valid course is laissez-faire—to leave the economy alone, wrote Murray Rothbard in his history of the 1930s, America’s Great Depression. Only if there is no interference, direct or threatened, with prices, wage rates and business liquidation, will the necessary adjustment proceed with smooth dispatch.¹ Whatever might be said about that proposition in general, the American experience in 1920–21 and 1929–33 does not disprove it.

•  •  •

The Great Depression was the historical touchstone of the advocates of a muscular federal response to our own Great Recession. It was to close the door on any possible repetition of the experience of the early 1930s that the Federal Reserve, under the leadership of Chairman Ben S. Bernanke, embarked on a radical program of money printing, interest-rate suppression and financial market manipulation, policies still in place more than five years after economic healing officially began. In a speech at Jackson Hole, Wyoming, in August 2012, Mr. Bernanke candidly described these experiments as learning by doing.

There was no such improvisation in the monetary and fiscal councils of 1920–21, unless the refusal of the still unseasoned Federal Reserve to budge from its policy of high interest rates even in the teeth of plunging prices can be viewed as experimental. In any case, to the best of my knowledge, no American policy-maker invoked the extraordinary events of 1920–21 as a potentially relevant precedent during the crisis of 2008; the collapse of 1929–33 rather monopolized the market in historical analogy. One can anticipate the arguments in defense of this choice. Thus, in 1920–21, the economy was much smaller than it is today. The political environment was wholly different than ours and the statistics produced to measure the expansion and contraction of economic activity were, at best, crude. Besides, there was no federal safety net and no easily accessible credit, either of the personal or mortgage variety. All this is true, yet each objection might be applied with nearly equal force to the Great Depression itself.

There is something else to consider: Following the 1929 Crash, President Hoover set in motion an unprecedented program of federal activism to head off the threatened business downturn. While these interventions—the First New Deal, some called them—were an undisputed failure, the non-intervention of Wilson and Harding constitutes an uncelebrated success.

•  •  •

If the events of 1920–21 are anything but irrelevant, they are—to the advocates of government intervention in business-cycle downturns—inconvenient. If sick economies need governmentally administered medicine, how did an economy force-fed with what most practitioners today would regard as a kind of policy arsenic ever right itself?

In his review of Austerity: The History of a Dangerous Idea, Mark Blyth’s 2013 attack on the notion of a government not pulling out the stops to combat a downturn, Lawrence Summers, the former secretary of the Treasury, quoted his own dictum: As I have often said, the central irony of financial crisis is that while it is caused by too much confidence, too much lending and too much spending, it can only be resolved with more confidence, more lending and more spending. The 1920–21 experience refutes Summers’s Paradox, as it was certainly not resolved with lending and spending.I

Just how severe it was is a question yet unsettled, and perhaps destined never finally to be settled. Official data as well as contemporary comment paint a grim picture. Thus, the nation’s output in 1920–21 suffered a decline of 23.9 percent in nominal terms, 8.7 percent in inflation- (or deflation-) adjusted terms. From cyclical peak to trough, producer prices fell by 40.8 percent, industrial production by 31.6 percent, stock prices by 46.6 percent and corporate profits by 92 percent.² Maximum unemployment ranged between two million and six million persons—those were the range of estimates at the national conference on unemployment called by President Harding in September 1921—out of a nonagricultural labor force of 31.5 million. At the high end of six million, this would imply a rate of joblessness of 19 percent. Bankruptcies claimed myriad nonfarm businesses, including Truman & Jacobson, a Kansas City haberdashery coowned by the future 33rd president of the United States.II

The adage that the past is a foreign country is nowhere more apt than in economic history. In the case at hand, anachronism is inherent in the very language of economics. Readers of this book speak and think about aggregate demand and aggregate supply. Having imbibed at least the rudiments of macroeconomics, they casually talk about the national income. In the early 1920s, such ideas were yet unformed. You can comb through the professional economics journals of the day, as I have done, without finding a single article espousing the notion of macroeconomic management.

Whatever the defects of 21st century American economic statistics, the data available to Wilson and Harding were worse. Modern national income accounting did not come into existence until the 1930s and 1940s. The services portion of the American economy was not systematically measured until the 1990s.

The 1920–21 affair was the 14th business-cycle contraction since the panic year of 1812. Commercial and financial disturbances of one kind or another occurred in 1818, 1825, 1837, 1847, 1857, 1873, 1884, 1890, 1893, 1903, 1907, 1910 and 1913. Not since the early 19th century had prices fallen so far or so fast as they did in 1920–21. In this period of 120 years, according to a contemporary inquest, the debacle of 1920–21 was without parallel.³

Christina Romer, a distinguished economic historian who served as chair of President Obama’s Council of Economic Advisers, has contended that the ordeal of 1920–21 was not so severe as it was subsequently portrayed statistically. In so many lay words, she characterized the slump as a not especially troublesome recession. In further support of my contention that the depression of 1920–21 was just as intense as contemporary reports made it out to be, I submit an item of noneconometric evidence. Herewith a sample of the bitterly sardonic lyrics to the 1921 hit song Ain’t We Got Fun?

Every morning, every evening

Ain’t we got fun?

Not much money, oh, but honey

Ain’t we got fun?

The rent’s unpaid, dear

And we haven’t a bus

But smiles were made, dear

For people like us

In the winter, in the summer

Don’t we have fun?

Times are bum and getting bummer

Still we have fun

There’s nothing surer,

The rich get rich and the poor get children

In the meantime, in between time,

Ain’t we got fun?

Landlord’s mad and getting madder

Ain’t we got fun?

Times are so bad and getting badder

Still we have fun

There’s nothing surer

The rich get rich and the poor get laid off

In the meantime, in between time

Ain’t we got fun?

Depression is a term of no hard and fast statistical definition. It is a term that many contemporaries—the Harvard Economics Society and the Federal Reserve Bank of New York, among others—used to describe the depth of the downturn, and it’s the term I have chosen to use in this history. I will posit, too, that they don’t write songs about recessions.

Especially foreign to the time-traveling contemporary reader may seem the banking and monetary arrangements of the Wilson and Harding era. In 1920 there was no federal deposit insurance and no doctrine that some banks were too big to fail. If a bank became impaired or insolvent, chances were that its stockholders (never the taxpayers) would receive a call to stump up funds with which to reimburse the depositors. It was, after all, the stockholders’ bank, in sickness as in health. This standing reminder of the potential cost of mismanagement by no means forestalled failure. But as much as any law or convention it delineated the boundaries between public and private interest. Such was the record of safety and soundness in banking during the first two decades of the 20th century, the Panic of 1907 notwithstanding, that the senior federal bank regulator could express the hope that bank failures in America were a thing of the past. This was in the summer of 1920, six months after the economy had begun its slide into depression.

The dollar in those days was still defined as a weight of gold, as it had been since Alexander Hamilton’s time at the Treasury: An ounce was the equivalent of $20.67 and could be exchanged for that sum at the option of the holder. And because anyone could make the exchange, the Federal Reserve was inherently constrained. It could do only so much to salve a wounded economy, even if it believed that monetary medication was within its congressional remit, which it certainly did not. Any proposal to anticipate the 21st century policy of printing money with which to stimulate business activity (quantitative easing) would have been laughed out of court.

Politicians were no more inclined than economists to throw the weight of the government behind policies to keep the national economy on an even keel. This was not necessarily because the political class was philosophically averse to regulation or taxation. Woodrow Wilson ran for president in 1912 promising to bring Wall Street and big business to heel. In 1917, following America’s declaration of war on Germany, the administration blazed new trails in government economic intervention and control. But even if the president had wished to graft his experiments in wartime socialism on to the postwar American economy, he would probably not have gotten far. At first, he was preoccupied with his battle to win Senate approval of the peace treaty and the League of Nations. Later, after his September 1919 stroke, he became incapacitated, as did his administration. By no means did Wilson espouse the Jeffersonian doctrine that that government is best which governs least. It was by accident that the Progressive Democrat presided over America’s final laissez-faire depression.

The story of a depression that healed itself is necessarily short on political craftsmanship. Histories of the response of the administration of Franklin D. Roosevelt—and, before him, of Herbert Hoover—to the Great Depression brim with chronicles of action. Here is a history of instructive inaction.

I. Certitude about the need for federal activism in the face of economic dislocation finds its ultimate expression in the pronouncement of another Harvard professor, Kenneth Rogoff. The Obama administration had no choice but to enact the American Recovery and Reinvestment Act of 2009, said Professor Rogoff, an accomplished chess player as well as the author of the 2009 best-seller This Time Is Different. The so-called stimulus act was, indeed, an only move, he was quoted as saying by the New York Times in 2012. In chess, an only move is one without which a player would certainly and immediately lose.

II. There were between five and six millions of our workers without employment. Industries were closed or closing. Economic authorities predicted industrial panic. We were on the highway to the economic chaos which at present prevails in Europe. So wrote President Harding’s secretary of labor, James J. Davis, in his 1923 annual report. Even making allowances for the fact that some of the goings-on to which the passage referred took place in a Democratic administration, the secretary’s choice of words is striking. [p. 90]

1

THE GREAT INFLATION

The coda to the murderous Great War of 1914–18 was an influenza pandemic even more lethal than the war itself. But the wounded world of 1919 could count one saving grace, at least. The oft-predicted postwar depression had failed to materialize. Quite the contrary: Business was booming.

Here was a most pleasant anomaly. History taught that peace would bring depression. Such had been the experience of America after both the War of 1812 and the Civil War. The Great War was a world war. No doubt, many reasoned, a worldwide economic adjustment would prove even more disruptive than the slumps that had followed more isolated conflicts of the past.

No template for government action to resist depressions was yet in place. Long-established economic doctrine rather favored laissez-faire. As the natural seasons turned, so did the economic ones: summer and winter, boom and bust. Individuals might prepare for the inevitable lurches to the down side—a workman might save, a farmer might market his crops in anticipation of lower prices, a banker might call in loans to brace for a depositors’ run. But from the government, not much was expected but to balance its budget, maintain a sound currency and allow business to take its natural, improving course. [T]hough the people support the government, the government should not support the people, declared President Grover Cleveland in vetoing a $10,000 appropriation to pay for the distribution of seed grain to drought-stricken Texas farmers in 1887.¹

It was the letter of the Cleveland doctrine rather than the spirit that still prevailed in some policy-making circles. Many voices now pressed the government to intervene. Progressive, the speakers styled themselves, though the progress to which they aspired concerned not the management of the business cycle but redressing the supposed injustice in the distribution of income. By 1892, the Populist Party was demanding inflation of the currency, a graduated income tax, strict limitations on corporate ownership of land and the nationalization of the railroads and telephone and telegraph companies.² By 1908, Eugene Debs was demanding a republic in which the working class governed the plutocracy, rather than the other way around. By 1910, Theodore Roosevelt, no avowed socialist, was demanding that human welfare be raised above property.³

From the same prolific womb of governmental injustice we breed the two great classes—tramps and millionaires, the Populists had alleged. Certainly, electrical illumination, the internal combustion engine and related marvels lightened the burden of labor and thereby liberated many from drudgery and want. But, equally, according to the composite Progressive indictment, the rich had never been richer, nor the gap between rich and poor provokingly wider.⁴

In the 1912 presidential election, Debs drew 6 percent of the popular vote on the Socialist ticket, the best showing by any left-wing candidate in any presidential contest before or since.⁵ He finished fourth.

William Howard Taft, the 300-odd-pound Republican incumbent, campaigning on the doctrine that [a] National Government cannot create good times (but could, through ill-advised policy, institute bad times), won a mere two states, Utah and Vermont.⁶ He came in third.

Theodore Roosevelt, who had bolted from the GOP to preach that government could, in fact, effect the very improvements that Taft resisted, pledged to use the whole power of government to resist an unregulated and purely individualistic industrialism.⁷ He placed second.

Candidate Wilson vowed to tame the trusts, rein in the big Wall Street banks, lower tariffs and—to compensate for lost revenue from reduced import duties—tax the rich. President Wilson, having beaten the divided GOP, proved as good as his word. By the close of his first year in office, the former president of Princeton University had presented the nation with an income tax and a central bank (in name, a kind of decentralized central bank). The federal government would never again lack the means of financing itself.

In 1916, at the end of his first term, Wilson sought a second. He was deserving on financial grounds alone, the Democratic Party platform asserted: Our archaic banking and currency system, prolific of panic and disaster under Republican administrations—long the refuge of the money trust—has been supplanted by the Federal Reserve Act, a true democracy of credit under government control, already proved a bulwark in a world crisis, mobilizing our resources, placing abundant credit at the disposal of legitimate industry and making a currency panic impossible. Then, too, the Democrats commended themselves for the splendid diplomatic victories of our great president, who has preserved the vital interests of our government and its citizens and kept us out of war.

New vistas of federal activism opened on April 6, 1917, when the president led the nation into war. As Washington drafted men, so it conscripted incomes. In House debate in 1913 over the proposed income tax, a seemingly wild-eyed Progressive had called for a schedule of rates culminating in 68 percent on incomes above $1 million. The amendment was, of course, beaten, reported the New York Times, the paper seeming to roll its eyes at the very notion of so confiscatory a marginal rate of taxation.⁸ By 1918, the Treasury was taking 77 percent of incomes above $1 million.⁹ The Wilson administration took control of merchant shipping, the railroads and the telegraph and telephone companies. It rationed raw materials and set ceilings on prices and wages. It intervened in labor disputes. It allocated, requisitioned and commandeered private property. It liberalized the banking rules and thereby encouraged the expansion of credit: After June 1917, a New York bank could lend 38.8 percent more against every dollar of reserve it was required to hold than before the change was enacted.¹⁰ Woodrow Wilson delivered the activist government that America’s populists and socialists had long demanded.¹¹

So when Frank Morrison, secretary of the American Federation of Labor, warned in January 1919 that the government was the only instrument of postwar economic salvation—and that, barring federal intervention, there could be bread lines in every industrial center before May 1—his message had none of the shock value it would have had before the war.¹² More conventionally familiar was the fatalistic voice of the Babson economic forecasting service, which predicted a period of trouble and depression. There was no getting around it, said the founder, Roger W. Babson: We can prepare for reaction and prevent it from being disastrous, but to stop it is impossible.

Right as rain did the bears initially appear to be. Within four weeks of the November 11, 1918, Armistice, the War Department had cancelled $2.5 billion of its then outstanding $6 billion in manufacturing contracts;¹³ for perspective, $2.5 billion represented 3.3 percent of the 1918 gross national product.¹⁴ In January 1919 commodity prices tumbled. Steel mills, which had hardly been able to keep up with war-induced demand, now operated at 60 percent to 65 percent of capacity. Order books dwindled, that of the United States Steel Corporation by 42 percent between the Armistice and May 1919. Not since the Panic of 1907 had the giant steel maker seen the likes of it.¹⁵

But the Morrisons and Babsons had failed to reckon with the long-thwarted American consumer. Purchases patriotically deferred during the year and a half of U.S. belligerency were now exuberantly rung up. War or not, Americans had continued to drive their Fords and Chevrolets and Buicks (gasoline sales never wavered during the ostensibly luxury-free duration of the conflict). Now, with the peace, the people demanded silk shirts, new cars and a little fun.

European consumers, too, were buying American, their spending power enhanced by loans funneled through their governments from the U.S. Treasury. In the five years prior to the outbreak of war in Europe in 1914, American exports had averaged $2.1 billion a year. They accelerated during the war and soared again with the peace. In 1919, they reached nearly $8 billion.¹⁶

Doomsayers could hardly believe their eyes. Surely, they reasoned, a postwar boom was a contradiction in terms. What was needed—and what was, on form, inevitable—was a bust. As with physical objects, so with prices: What goes up would have to come down. Consumer prices had risen by 11 percent in 1916, by 17 percent in 1917 and by 18.6 percent in 1918. They were on their way to rising by 13.8 percent