Warren Harding: More on the Depression of 1920-1921

Thursday, Nov 26, 2009

Warren Harding was the president of the United States in the early 1920s. He shepherded the economy out of one of the worst depressions [1] 2 in just about 1 year, subsequently leading to the Roaring 20s (which in itself did not lead to the Great Depression... that was caused by a classic credit expansion by the Federal Reserve starting in 1927). He used the classical economic approach of cutting government, paying off debt, asking citizens to save and work hard, and letting capitalism (i.e. the people) liquidate bad assets and correct malinvestments instead of "wild government experiments" which further distort the economy and prolong the agony:

Perhaps we can make no more helpful contribution by example than prove a Republic's capacity to emerge from the wreckage of war. While the world's embittered travail did not leave us devastated lands nor desolated cities, left no gaping wounds, no breast with hate, it did involve us in the delirium of expenditure, in expanded currency and credits, in unbalanced industry, in unspeakable waste, and disturbed relationships...

We must face the grim necessity, with full knowledge that the task is to be solved, and we must proceed with a full realization that no statute enacted by man can repeal the inexorable laws of nature. 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.

The business world reflects the disturbance of war's reaction. Herein flows the lifeblood of material existence. The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. The normal balances have been impaired, the channels of distribution have been clogged, the relations of labor and management have been strained. We must seek the readjustment with care and courage. Our people must give and take. Prices must reflect the receding fever of war activities. Perhaps we never shall know the old levels of wages again, because war invariably readjusts compensations, and the necessaries of life will show their inseparable relationship, but we must strive for normalcy to reach stability. All the penalties will not be light, nor evenly distributed. There is no way of making them so. 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.

The forward course of the business cycle is unmistakable. Peoples are turning from destruction to production. Industry has sensed the changed order and our own people are turning to resume their normal, onward way. The call is for productive America to go on. I know that Congress and the Administration will favor every wise Government policy to aid the resumption and encourage continued progress.

I speak for administrative efficiency, for lightened tax burdens, for sound commercial practices, for adequate credit facilities, for sympathetic concern for all agricultural problems, for the omission of unnecessary interference of Government with business, for an end to Government's experiment in business, and for more efficient business in Government administration. With all of this must attend a mindfulness of the human side of all activities, so that social, industrial, and economic justice will be squared with the purposes of a righteous people...

If revolution insists upon overturning established order, let other peoples make the tragic experiment. There is no place for it in America. When World War threatened civilization we pledged our resources and our lives to its preservation, and when revolution threatens we unfurl the flag of law and order and renew our consecration. Ours is a constitutional freedom where the popular will is the law supreme and minorities are sacredly protected...

It has been proved again and again that we cannot, while throwing our markets open to the world, maintain American standards of living and opportunity, and hold our industrial eminence in such unequal competition. There is a luring fallacy in the theory of banished barriers of trade, but preserved American standards require our higher production costs to be reflected in our tariffs on imports. Today, as never before, when peoples are seeking trade restoration and expansion, we must adjust our tariffs to the new order. We seek participation in the world's exchanges, because therein lies our way to widened influence and the triumphs of peace. We know full well we cannot sell where we do not buy, and we cannot sell successfully where we do not carry. Opportunity is calling not alone for the restoration, but for a new era in production, transportation and trade. We shall answer it best by meeting the demand of a surpassing home market, by promoting self- reliance in production, and by bidding enterprise, genius, and efficiency to carry our cargoes in American bottoms to the marts of the world.

We would not have an America living within and for herself alone, but we would have her self-reliant, independent, and ever nobler, stronger, and richer. Believing in our higher standards, reared through constitutional liberty and maintained opportunity, we invite the world to the same heights. But pride in things wrought is no reflex of a completed task. Common welfare is the goal of our national endeavor. Wealth is not inimical to welfare; it ought to be its friendliest agency. There never can be equality of rewards or possessions so long as the human plan contains varied talents and differing degrees of industry and thrift, but ours ought to be a country free from the great blotches of distressed poverty. We ought to find a way to guard against the perils and penalties of unemployment. We want an America of homes, illumined with hope and happiness, where mothers, freed from the necessity for long hours of toil beyond their own doors, may preside as befits the hearthstone of American citizenship. We want the cradle of American childhood rocked under conditions so wholesome and so hopeful that no blight may touch it in its development, and we want to provide that no selfish interest, no material necessity, no lack of opportunity shall prevent the gaining of that education so essential to best citizenship.

There is no short cut to the making of these ideals into glad realities. The world has witnessed again and again the futility and the mischief of ill-considered remedies for social and economic disorders. But we are mindful today as never before of the friction of modern industrialism, and we must learn its causes and reduce its evil consequences by sober and tested methods. Where genius has made for great possibilities, justice and happiness must be reflected in a greater common welfare.

Service is the supreme commitment of life. I would rejoice to acclaim the era of the Golden Rule and crown it with the autocracy of service. I pledge an administration wherein all the agencies of Government are called to serve, and ever promote an understanding of Government purely as an expression of the popular will.

Inaugural Address of Warren G. Harding, March 4, 1921, http://avalon.law.yale.edu/20th_century/harding.asp.

The Depression of 1920 is the basic economic counter-argument to Big Government Keynesian stimulus, which didn't work in the Great Depression, nor will it work now. I haven't seen a good counter-argument from the Keynesians against this episode.

The conventional wisdom holds that in the absence of government countercyclical policy, whether fiscal or monetary (or both), we cannot expect economic recovery — at least, not without an intolerably long delay. Yet the very opposite policies were followed during the depression of 1920–1921, and recovery was in fact not long in coming.

The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent...

Instead of "fiscal stimulus," Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third.

The Federal Reserve's activity, moreover, was hardly noticeable. As one economic historian puts it, "Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction."[2] By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.

It is instructive to compare the American response in this period to that of Japan. In 1920, the Japanese government introduced the fundamentals of a planned economy, with the aim of keeping prices artificially high.

The great banks, the concentrated industries, and the government got together, destroyed the freedom of the markets, arrested the decline in commodity prices, and held the Japanese price level high above the receding world level for seven years. During these years Japan endured chronic industrial stagnation and at the end, in 1927, she had a banking crisis of such severity that many great branch bank systems went down, as well as many industries. It was a stupid policy. In the effort to avert losses on inventory representing one year's production, Japan lost seven years...

The federal government did not do what Keynesian economists ever since have urged it to do: run unbalanced budgets and prime the pump through increased expenditures. Rather, there prevailed the old-fashioned view that government should keep taxation and spending low and reduce the public debt...

It is hardly necessary to point out that Harding's counsel — delivered in the context of a speech to a political convention, no less — is the opposite of what the alleged experts urge upon us today. Inflation, increased government spending, and assaults on private savings combined with calls for consumer profligacy: such is the program for "recovery" in the 21st century.

Not surprisingly, many modern economists who have studied the depression of 1920–1921 have been unable to explain how the recovery could have been so swift and sweeping even though the federal government and the Federal Reserve refrained from employing any of the macroeconomic tools — public works spending, government deficits, and inflationary monetary policy — that conventional wisdom now recommends as the solution to economic slowdowns. The Keynesian economist Robert A. Gordon admitted that "government policy to moderate the depression and speed recovery was minimal. The Federal Reserve authorities were largely passive.… Despite the absence of a stimulative government policy, however, recovery was not long delayed."[5]

Another economic historian briskly conceded that "the economy rebounded quickly from the 1920–1921 depression and entered a period of quite vigorous growth" but chose not to comment further on this development.[6] "This was 1921," writes the condescending Kenneth Weiher, "long before the concept of countercyclical policy was accepted or even understood."[7] They may not have "understood" countercyclical policy, but recovery came anyway — and quickly...

The years preceding 1920 were characterized by a massive increase in the supply of money via the banking system, with reserve requirements having been halved by the Federal Reserve Act of 1913 and then with considerable credit expansion by the banks themselves.

Total bank deposits more than doubled between January 1914, when the Fed opened its doors, and January 1920. Such artificial credit creation sets the boom–bust cycle in motion. The Fed also kept its discount rate (the rate at which it lends directly to banks) low throughout the First World War (1914–1918) and for a brief period thereafter. The Fed began to tighten its stance in late 1919...

If the Austrian view is correct — and I believe the theoretical and empirical evidence strongly indicates that it is — then the best approach to recovery would be close to the opposite of these Keynesian strategies. The government budget should be cut, not increased, thereby releasing resources that private actors can use to realign the capital structure.

The money supply should not be increased. Bailouts merely freeze entrepreneurial error in place, instead of allowing the redistribution of resources into the hands of parties better able to provide for consumer demands in light of entrepreneurs' new understanding of real conditions. Emergency lending to troubled firms perpetuates the misallocation of resources and extends favoritism to firms engaged in unsustainable activities at the expense of sound firms prepared to put those resources to more appropriate uses...

The experience of 1920–1921 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920–1921 depression. It is because those things were avoided that recovery came. The next time we are solemnly warned to recall the lessons of history lest our economy deteriorate still further, we ought to refer to this episode — and observe how hastily our interrogators try to change the subject.

The Forgotten Depression of 1920, Thomas E. Woods, Jr., November 27, 2009, http://mises.org/daily/3788.

Warren Harding's speech had some other interesting quotes related to war, peace, entangling alliances, international trade, etc.:

I am sure our own people will not misunderstand, nor will the world misconstrue. We have no thought to impede the paths to closer relationship. We wish to promote understanding. We want to do our part in making offensive warfare so hateful that Governments and peoples who resort to it must prove the righteousness of their cause or stand as outlaws before the bar of civilization.

We are ready to associate ourselves with the nations of the world, great and small, for conference, for counsel; to seek the expressed views of world opinion; to recommend a way to approximate disarmament and relieve the crushing burdens of military and naval establishments. We elect to participate in suggesting plans for mediation, conciliation, and arbitration, and would gladly join in that expressed conscience of progress, which seeks to clarify and write the laws of international relationship, and establish a world court for the disposition of such justiciable questions as nations are agreed to submit thereto. In expressing aspirations, in seeking practical plans, in translating humanity's new concept of righteousness and justice and its hatred of war into recommended action we are ready most heartily to unite, but every commitment must be made in the exercise of our national sovereignty. Since freedom impelled, and independence inspired, and nationality exalted, a world supergovernment is contrary to everything we cherish and can have no sanction by our Republic. This is not selfishness, it is sanctity. It is not aloofness, it is security. It is not suspicion of others, it is patriotic adherence to the things which made us what we are...

Amid it all we have riveted the gaze of all civilization to the unselfishness and the righteousness of representative democracy, where our freedom never has made offensive warfare, never has sought territorial aggrandizement through force, never has turned to the arbitrament of arms until reason has been exhausted. When the Governments of the earth shall have established a freedom like our own and shall have sanctioned the pursuit of peace as we have practiced it, I believe the last sorrow and the final sacrifice of international warfare will have been written...

There is something inherently wrong, something out of accord with the ideals of representative democracy, when one portion of our citizenship turns its activities to private gain amid defensive war while another is fighting, sacrificing, or dying for national preservation.