The Great Depression that wasn’t: 1920 – 1921

At the end of World War I, the American economy faced the enormous task of retooling for peacetime. No longer needed were the factories used to support the war effort, or the giant agricultural exports to a Europe that couldn’t grow its own food. The process of shuttering excess war capacity, and its associated layoffs, produced a huge contraction in economic output.

Gross National Product declined nearly 7% in 1920-21, compared with a fall of 8.6% in 1929-30. Unemployment rose from 5.2% to 11.7%. Automobile production declined by 60%, and all industrial production was down almost 30%. The stock market fell 47%.

When performing the task of reorganizing resources, the thing to understand about free markets is that they do so in the quickest manner possible. Time is money, as almost everything depreciates. For owners of assets being liquidated, their goal is to sell as quickly as possible to obtain the best price. Purchasers of these assets are motivated to put them to use in the shortest amount of time in order to start earning a return.

For the recession of 1920-21, the free market reorganized the economy in about a year and a half. By Late 1922, industrial production had returned to peak levels and the unemployment rate was down to 6.7%. In 1923. the unemployment rate was only 2.4%.

And, what was the government’s response to the recession of 1920-21? Nothing. Well, that’s not quite true: President Warren G. Harding cut the federal budget by half and reduced taxes. There were calls for government aid and stimulus from Congress but Harding ignored them all.

So what then is the difference between a recession and a depression? The answer is time. A depression is a recession that drags on for an extended amount of time. And there is only one way that can happen – through government intervention.

When governments and politicians become involved in recessions, there arises a great need to do something. But invariably this something always amounts to preventing the economy from making the necessary changes to align itself with the present needs of the market. In an effort to maintain the status quo, bailouts and stimulus spending are called upon to calm a concerned constituency.

This was not Harding’s approach. In fact, he put it fairly bluntly in his inaugural address:

“Our most dangerous tendency is to expect too much of government, and at the same time do for it too little. We contemplate the immediate task of putting our public household in order. We need a rigid and yet sane economy, combined with fiscal justice, and it must be attended by individual prudence and thrift, which are so essential to this trying hour and reassuring for the future.”

Along with:

“There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization. I would like government to do all it can to mitigate; then, in understanding, in mutuality of interest, in concern for the common good, our tasks will be solved. No altered system will work a miracle. Any wild experiment will only add to the confusion. Our best assurance lies in efficient administration of our proven system.”

It is interesting to note that Harding’s secretary of Commerce, Herbert Hoover, favored intervening in the economy in 1921. He would later have his chance in 1932 when he pursued a massive increase in the Federal budget to stimulate the economy. Included in his budget were numerous make work projects. He also bailed out failing banks that made bad loans during the booming 1920s.
We are all aware of how the recession of 1929-30 turned out; the decade-long Great Depression.

The case of America in 1920 presented a situation in which significant changes to the economy were necessary to align its production with the needs of the peacetime market. So what would the government’s response to such a situation be today?

It would probably start with bailouts of the factories producing war materials in order to “save jobs.” Provide them with the time and money to produce a new product that someone else, with the relevant expertise, was already making. Society ends up with an inferior and more expensive version of the product. And if that weren’t bad enough, it is forced to finance its development via taxes – taxes that, if left in the private sector, would have been spent in other areas to create new jobs.

When you look at the entire picture of economic intervention, and follow all of its consequences, it becomes clear that the only thing government can do is delay a recovery, and waste a tremendous amount of money in the process. It is ironic that we now look to copy the economic policies of the Great Depression – because it was the worst economic period in American history – when it was precisely those policies that made it the worst economic period in American history.