The crash of 1921. I certainly didn’t know about it before reading James Grant’s most enjoyable new book, The Forgotten Depression: The Crash That Cured Itself. It sent Harry Truman’s haberdashery store in Kansas City into bankruptcy, among many other businesses. It was bad enough that there was even a song about it, Ain’t We Got Fun?: “Times are bad and getting badder/ Still we have fun.”
It is certainly not received wisdom that the downturn of 1921 classes as a depression – and, as the book notes, people were not yet speaking about ‘the economy’, although the terms inflation and deflation were in use. Yet GNP fell 24% in nominal terms in 1921, 9% in real terms. Industrial production fell twice as much in 1920-21 as it did in 2007-9. As an aside, I love the Oskar Morgenstern description here of the aggregate economic statistics as “an opinion in quantitative form.” (I’ve made a note to read Morgenstern’s On The Accuracy of Economic Observations, which sounds a corker just from the title.)
I learned a lot from The Forgotten Depression. The early 1920s are a lacuna, in my knowledge and I think generally in historical overviews, as the period is understandably overshadowed by the Great War and its immediate aftermath beforehand, and the crash of 1929 and the Great Depression afterwards. This book is an excellent supplement from the US perspective of the monetary and central banking pre-history to the period covered in Liaquat Ahamed’s Lords of Finance about the 1930s. The early history of the Federal Reserve system, the move away from a strict gold standard, and the development of monetary policy – intensely debated – are described here in just the right amount of detail.
As the subtitle makes plain, James Grant (famous of course for his Interest Rate Observer) argues that the absence of any economic stimulus policy in 1921 meant the forgotten depression was acute but brief. It corrected itself in about a year, through the price mechanism – lower prices for goods and labour moved output and employment back up within a relatively short time. The federal budget was balanced. The Federal Reserve raised interest rates rather than lowering them. By contrast in 1929 the government piled in with policies to prevent wages falling and introduced deficit spending – and, as we know, that was anything but a shortlived depression. The reader is clearly meant to carry over the lesson to our own context.
I doubt the argument will change minds, given the entrenched positions people have at present over the contribution of stimulus versus austerity in explaining the paths different economies have taken since 2008. Reading The Forgotten Depression made me reflect on the impossibility of identifying empirically cause and effect at the macro level: it is simply impossible to isolate the contributions of specific policies and timings, given not only Milton Friedman’s “long and variable” lags in the effect of monetary (and fiscal) policy but also the importance of initial conditions, specific contextual events, different economic structures, and the sheer complexity of a modern economy (especially compared to that of the 1920s). For example, I’m sure a macroeconomist of a different disposition could make the opposite case to Mr Grant’s, and argue that the hike in interest rates in January 1920 (a 1.25% point rise in one go, to counter the post-war inflationary surge) turned a mild slowdown into a serious downturn.
There is an awful lot to be said for governments not trying to fine tune (or even approximately tune) the economy, given the general sea of uncertainty; equally the possibility of low-activity traps is evidently non-trivial, and it takes co-ordinated action to get out of them. The debt and financial market context in 2008 was so very different from that of 1920-21 that I’m not persuaded there are clear lessons for today from the forgotten depression. As the book concludes: “There are no controlled experiments in economics.”
But that does not mean we have nothing to learn from history – on the contrary, it is only history that teaches proper humility about the limits of economic knowledge and tools. I strongly recommend reading The Forgotten Depression - with an open mind – and thinking about its central point about that markets are (sometimes) a highly effective self-correcting process.