The Lesson of a Crash that Cured Itself — by Wendy McElroy

  • The crash of 1920-21 is called “the forgotten depression” because it has almost vanished from history books. The main reason: its lesson is anathema to the political and economic elites who derive power from controlling the marketplace. Its lesson: when the economy is melting down, do nothing because the free market will self-correct and naturally return to a healthier equilibrium. Recessions—even deep ones called depressions—cause short term pain and damage; in the long term, however, such corrections allow for the healthy adjustment of overvalued assets and provide buying opportunities for the prudent.
  •  In America’s Great Depression, Murray Rothbard observed, “The 1920 recession had adjusted itself within a year. There was no reason why the 1929 recession should have taken longer, for the American economy was fundamentally sound.”
  • What happened in 1920 that did not happen in 1929? When World War I ended on November 11, 1918,  A brief recession and a fast recovery followed. Then, a sharp deflation hit and lasted from January 1920 to July 1921. In a Wall Street Journal article entitled “The Depression That Was Fixed by Doing Nothing,” Grant explained, “Beginning in January 1920, something much worse than a recession blighted the world. The U.S. suffered the steepest plunge in wholesale prices in its history (not even eclipsed by the Great Depression).” Indeed, the first year of the 18-month crash was worse than the first year of the Great Depression. Unemployment went from 4 to 12%; production fell by 21%. According to Grant, “the nation’s output in 1920-21 suffered a decline of 23.9 per cent in nominal terms, 8.7 per cent in real terms. From cyclical peak to trough, producer prices fell by 40.8 per cent, industrial production by 31.6 per cent, stock prices by 46.6 per cent and corporate profits by 92 per cent.”
  • And, yet, Grant wrote: “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….” The government did not lower interest rates nor did it ramp up the public debt. Under Harding, the government raised interest rates and paid down the debt. Average money wages were allowed to fall by 19% in one year. “ Grant continued, “Yet by late 1921, a powerful, job-filled recovery was underway. This is the story of America’s last governmentally unmedicated depression.”
  • How specifically did a recovery occur without government “assistance”? A significant part of the answer lies in the incredible power of the price mechanism to motivate human behavior. Which is to say, people want to prosper, and they will respond quickly in the presence of opportunities to advance themselves. “America was on the bargain counter,” Grant observed in his book, and Americans love a bargain.
  • Trump has chosen the path of FDR and the Great Depression rather than Harding and 1920.
  • What the 1920-21 depression demonstrates, however, is the salutary effect of allowing economic consequences to play out; what the Great Depression demonstrates is the incredible damage of doing the opposite.
  • Instead of “doing nothing,” the Trump administration will “do everything.” The money supply will balloon and cause run-away inflation; resources will be misdirected, preventing free-market allocation; the market will be centrally coordinated according to a bureaucratic vision; interest rates will be driven artificially low; spending and debt will explode; unsustainable investments will be bolstered by tax funding…. In short, the depression will grind on to the misery of many and to the profit of a well-connected few.