James Grant - The Forgotten Depression

[classhandicapper]

By JAMES GRANT
Jan. 2, 2015 10:25 a.m. ET

To combat the Great Recession and its long-lingering aftermath, leading central banks have pulled some $10 trillion out of thin air. Governments of the world’s principal economies have rung up almost $20 trillion in deficit spending. We often hear that the authorities have done too little. Perhaps they have done too much.

Not so long ago, the authorities did hardly anything. In response to the severe, little-known economic slump of the early 1920s, they virtually sat on their hands. It is an often forgotten episode that suggests the potential for constructive federal inaction—and underscores the healing power of Adam Smith ’s invisible hand.

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), as well as a 31.6% drop in industrial production and a 46.6% fall in the Dow Jones Industrial Average. Unemployment spiked, and corporate profits plunged.

What to do? “Nothing” was the substantive response of the successive administrations of Woodrow Wilson and Warren G. Harding. Well, not quite nothing. Rather, they did what few 21st-century policy makers would have dared: They balanced the federal budget and—via the still wet-behind-the-ears Federal Reserve—raised interest rates rather than lowering them. Curiously, the depression ran its course. Eighteen months elapsed from business-cycle peak to business-cycle trough—following which the 1920s roared.

The adage that “the past is a foreign country” is especially apt in economics. In 1920, “macroeconomics” had yet to be invented. People spoke of prosperity and depression but not of a national economy. Still less did they identify an organic whole for the government to manage. Intervention came later; by 1929, central bankers had begun to dabble in the technique of price-level “stabilization.” After the crash, President Herbert Hoover famously pressed employers not to cut wages.

Laissez faire had its last hurrah in 1921. In the 1920 Republican Party platform, the only comment on “national economy” had to do with the stewardship of the federal finances.

Borrowing and interest-rate suppression during World War I had fostered a postwar boom. Imbibing the inflationary ether, Harry Truman, then in his mid-30s, opened a new haberdashery in Kansas City. General Motors built the world’s largest headquarters building in Detroit. National City Bank , forerunner to today’s Citibank , overexpanded in Cuba.

The sky took its time in falling. A belated monetary tightening compounded the hardship of plunging prices—a combination that battered bankers, laborers, farmers, corporate titans and small businesspeople alike. By the close of 1920, Billy Durant, the flamboyant chief of GM, was broke and jobless. A year and a half later, the future 33rd president of the U.S. and his haberdashery partner were out of business, and the mighty City Bank was nursing its self-inflicted wounds in Cuba.

All this made 1921 a grim time. There had been a flu pandemic and a Red Scare. Labor and management were at each other’s throats. Prohibition had closed the bars and taverns (or driven them underground). Someone had fixed the 1919 World Series. And the Federal Reserve, determined to protect the purchasing power of the gold dollar, actually raised interest rates in the face of collapsing business activity—to as much as 8% in 1920. Without a federal safety net, people got by on savings, wits or charity—or they didn’t get by.
In the absence of anything resembling government stimulus, a modern economist may wonder how the depression of 1920-21 ever ended. Oddly enough, deflation turned out to be a tonic. Prices—and, critically, wages too—were allowed to fall, and they fell far enough to entice consumers, employers and investors to part with their money. Europeans, noticing that America was on the bargain counter, shipped their gold across the Atlantic, where it swelled the depression-shrunken U.S. money supply. Shares of profitable and well-financed American companies changed hands at giveaway valuations.

Of course, the year-and-a-half depression must have seemed interminable for all who were jobless or destitute. It was, however, a great deal shorter than the 43 months of the Great Depression of 1929-33. Then too, the 1922 recovery would bring tears of envy to today’s central bankers and policy makers: Passenger-car production shot up by 63%, for instance, and the Dow jumped by 21.5%. “From practically all angles,” this newspaper judged in a New Year’s Day 1923 retrospective, “1922 can be recorded as the renaissance of prosperity.”

In 2008, as Lehman Brothers toppled, the Great Depression monopolized the market on historical analogies. To avoid a recurrence of the 1930s, officials declared, the U.S. had to knock down interest rates, manipulate stock prices to go higher, repave the highways and trade in the clunkers.
The forgotten depression teaches a very different lesson. Sometimes the best stimulus is none at all.

—Mr. Grant is the author of “The Forgotten Depression: 1921: The Crash That Cured Itself.”

[Clocker]

That must be wrong. That flies in the face of all that is holy in the sacred writ of Keynes and Krugman.

[reckless]

James Grant is the most articulate business/financial writer in the world today and every day.

Thanks, classhandicapper, for providing the article.

[classhandicapper]

James Grant is the most articulate business/financial writer in the world today and every day.

Thanks, classhandicapper, for providing the article.

You're welcome. I've been a fan of his for a very long time. I have a couple of his books, used to be an avid reader of his newsletter, and was lucky enough to speak to him on the phone for awhile one time. Seemed like a very nice guy.

[Ocala Mike]

That must be wrong. That flies in the face of all that is holy in the sacred writ of Keynes and Krugman.

Well, actually, it is at least partially wrong. There were key reversals to monetary policy made at the time which guided the "invisible hand"; the depression didn't completely cure itself.

[classhandicapper]

Well, actually, it is at least partially wrong. There were key reversals to monetary policy made at the time which guided the "invisible hand"; the depression didn't completely cure itself.

"They balanced the federal budget and—via the still wet-behind-the-ears Federal Reserve—raised interest rates rather than lowering them. "

IMO, they'd have been better off doing nothing at the Fed. Heck, IMO we'd be better off with sound money and no Fed at all. But they did the opposite of what we do now. By raising rates, they probably accelerated and deepened the cleansing process that would have occurred on it own if left alone.

[badcompany]

Interview with Grant on this Podcast:

http://mcalvanyweeklycommentary.com/category/podcasts/

[classhandicapper]

Interview with Grant on this Podcast:

http://mcalvanyweeklycommentary.com/category/podcasts/

Great stuff! Thanks so much! This is a "must listen" if you are interested monetary policy, the Fed, economic history etc..

[whodoyoulike]

"They balanced the federal budget and—via the still wet-behind-the-ears Federal Reserve—raised interest rates rather than lowering them. "

IMO, they'd have been better off doing nothing at the Fed. Heck, IMO we'd be better off with sound money and no Fed at all. But they did the opposite of what we do now. By raising rates, they probably accelerated and deepened the cleansing process that would have occurred on it own if left alone.

I believe that's the reason for the change to the latest attempt of lowering rates. They realized the raising of rates in the 1920's and 1930's prolonged or made the depression worse but, they couldn't do nothing.

[badcompany]

Great stuff! Thanks so much! This is a "must listen" if you are interested monetary policy, the Fed, economic history etc..

Grant is great if you're not familiar with Mises and Rothbard, but he's never told me anything I haven't already read from the real masters.

Like this classic which could've been written yesterday.

http://mises.org/library/world-currency-crisis

[classhandicapper]

Grant is great if you're not familiar with Mises and Rothbard, but he's never told me anything I haven't already read from the real masters.

Like this classic which could've been written yesterday.

http://mises.org/library/world-currency-crisis


You're right. He's preaching to a specific choir, but I always felt an obligation to expand that choir and I enjoy him personally.

[classhandicapper]

I believe that's the reason for the change to the latest attempt of lowering rates. They realized the raising of rates in the 1920's and 1930's prolonged or made the depression worse but, they couldn't do nothing.

The whole point of Grant's analysis is that if you leave markets alone, they clean up the mess fairly quickly. Perhaps painfully, but it's over quickly.

The modern view is that you should try to avoid that short sharp downside cleansing process with deficits and easy money...which in turn extends the period of cleansing for many years and creates new malinvestment that messes you up even worse. Welcome to our world.

[DJofSD]

From the memory archives: http://www.nytimes.com/2006/05/03/business/media/03rukeyser.html?pagewanted=all&_r=0

[RunForTheRoses]

The mises.org site is a treasure trove of free books, audio, commentary. Along with Mises and Rothbard they have stuff by old line Conservatives like Garett Garrett and Bettina Graves Bien.

Regarding Grant's thesis one modern Austrian I respect is not convinced although he states he hasn't read the book yet. I'd like to get a copy of Grant's work.

http://www.economicpolicyjournal.com/2014/12/paul-krugman-is-right-on-this-point-and.html

[DJofSD]

https://www.youtube.com/watch?v=OeHZoG0h_QQ&list=UUsgWR55UyAiFarZYl1u1l9Q

[reckless]

From the memory archives: http://www.nytimes.com/2006/05/03/business/media/03rukeyser.html?pagewanted=all&_r=0

Thanks for link, DJ.

I really enjoyed re-reading Jim Grant's obit on Rukeyser. God, I think I watched every show from the very beginning.

[DJofSD]

I think I was a fan ~1973 or '74.

P.S. I can recall trying to get the hell out of dodge on Fridays at DMR to be able to catch the broadcast -- way before VCRs.

[whodoyoulike]

The whole point of Grant's analysis is that if you leave markets alone, they clean up the mess fairly quickly. Perhaps painfully, but it's over quickly.

The modern view is that you should try to avoid that short sharp downside cleansing process with deficits and easy money...which in turn extends the period of cleansing for many years and creates new malinvestment that messes you up even worse. Welcome to our world.

But back then, the FED was newly created and they had to do something. Without any history, they took a shot (this is how one learns). Way before the recent crisis occurred, I've read that Bernanke was a student of the Great Depression which is why I think he pushed for a different solution.

[classhandicapper]

But back then, the FED was newly created and they had to do something. Without any history, they took a shot (this is how one learns). Way before the recent crisis occurred, I've read that Bernanke was a student of the Great Depression which is why I think he pushed for a different solution.


The solution Greenspan, Bernanke and now Yellen have been using has given us rotating bubbles and crashes in various markets, a world so heavily in debt it has to print trillions of dollars annually just to keep the economy afloat, and an interest rate environment where prudent responsible savers are having their wealth slowly confiscated because real interest rates are negative.

If that's the lesson central bankers have learned, IMO it's time to go back to school.

That of course takes me right back to the beginning. The entire purpose of the history lesson by Mr Grant was to say free markets clean excesses if left alone. It may be painful, but it's quick. What we did during the 30s and what we are doing now to an even greater extent it propping up excesses by fighting markets with deficits and easy money. That's extending the period of pain significantly, creating new excesses, and potentially creating a much much bigger bust later.

[DJofSD]

That of course takes me right back to the beginning. The entire purpose of the history lesson by Mr Grant was to say free markets clean excesses if left alone. It may be painful, but it's quick. What we did during the 30s and what we are doing now to an even greater extent it propping up excesses by fighting markets with deficits and easy money. That's extending the period of pain significantly, creating new excesses, and potentially creating a much much bigger bust later.
Yes, and that is why during that 2007-2008 period the so called evil side of capitalism should have been allowed to work.

[Ocala Mike]

Yes, and that is why during that 2007-2008 period the so called evil side of capitalism should have been allowed to work.



Reminds me of the Vietnam Era quote, "We had to destroy the village in order to save it." All well and good, unless it's your hootch burning down.

[DJofSD]

Not the same.

[classhandicapper]

Yes, and that is why during that 2007-2008 period the so called evil side of capitalism should have been allowed to work.

Citibank, JP Morgan, Goldman Sachs etc... should have been allowed to fail, but in a controlled fashion.

You wipe out the shareholders, replace the executives, send a lot of the executives to jail, but backstop the obligations so the entire financial system doesn't go down.

Then a permanent lesson is learned.

If you lie, cheat, promote excesses, sell crap to the public and other institutions, use easy money from the fed to promote excesses etc... you will be punished severely by markets and not have your criminal and irresponsible behavior socialized by the Fed and taxpayer.

Lesson learned.

Then you dismantle the Fed and create a sound monetary system.

Why didn't it happen?

Because Wall St runs Washington and uses the Fed, federal government, IMF and other institutions to rape and pillage the world. The fox is in charge of the henhouse! The hens (politicians) go along because they can't maintain power without that support and because they ALSO use the fed to monetize the welfare and warfare state. They tax people via inflation instead publicly putting their names on a bill that either cuts spending or raises actual taxes.

It's an unholy (borderline evil) alliance that give markets a bad name when it has nothing to do with markets at all.

[whodoyoulike]

The solution Greenspan, Bernanke and now Yellen have been using has given us rotating bubbles and crashes in various markets, a world so heavily in debt it has to print trillions of dollars annually just to keep the economy afloat, and an interest rate environment where prudent responsible savers are having their wealth slowly confiscated because real interest rates are negative.

If that's the lesson central bankers have learned, IMO it's time to go back to school.

That of course takes me right back to the beginning. The entire purpose of the history lesson by Mr Grant was to say free markets clean excesses if left alone. It may be painful, but it's quick. What we did during the 30s and what we are doing now to an even greater extent it propping up excesses by fighting markets with deficits and easy money. That's extending the period of pain significantly, creating new excesses, and potentially creating a much much bigger bust later.

I hope I didn't imply I agreed with the approach by the Fed in dealing with the recent crisis. I agree with the part "free markets clean excesses if left alone. It may be painful, but it's quick." Anything artificially propped up will eventually unwind and I really don't want to be in the market when it does. My focus now is when will it unwind and how do I get out of it's way.

And, I agree with most of your #23 post.

[classhandicapper]

I hope I didn't imply I agreed with the approach by the Fed in dealing with the recent crisis.


Sometimes it's hard to pick up on intent from a forum conversation. No biggie either way. I just hate the Fed. :lol:

[whodoyoulike]

See, this is one part we disagree. I think the Fed is necessary because it was chaos prior to their creation. I think there were recessions every few years (boom then bust cycles). The part which I don't like about the Fed is their change in attempting to manipulate the market. IMO, a lot of their initial responses to the recent crisis was to help other countries e.g., China and some in Europe. These countries had bought U.S. stocks and bonds and they couldn't let these U.S. companies fail (i.e., banks, AIG etc.) without damaging the economies of these countries and our country's reputation. So, basically their actions postponed damaging these other economies but, hurt the majority of U.S. citizens (unless you have money).

I'm still pissed, the banks awarded bonuses just after they received their bailout.

Btw, again JMO, the Fed didn't create QE. I believe Japan started using QE back around the year 2000 to combat deflation and an attempt to stimulate their economy. They're still using QE.

[Robert Goren]

Citibank, JP Morgan, Goldman Sachs etc... should have been allowed to fail, but in a controlled fashion.

You wipe out the shareholders, replace the executives, send a lot of the executives to jail, but backstop the obligations so the entire financial system doesn't go down.

Then a permanent lesson is learned.

If you lie, cheat, promote excesses, sell crap to the public and other institutions, use easy money from the fed to promote excesses etc... you will be punished severely by markets and not have your criminal and irresponsible behavior socialized by the Fed and taxpayer.

Lesson learned.

Then you dismantle the Fed and create a sound monetary system.

Why didn't it happen?

Because Wall St runs Washington and uses the Fed, federal government, IMF and other institutions to rape and pillage the world. The fox is in charge of the henhouse! The hens (politicians) go along because they can't maintain power without that support and because they ALSO use the fed to monetize the welfare and warfare state. They tax people via inflation instead publicly putting their names on a bill that either cuts spending or raises actual taxes.

It's an unholy (borderline evil) alliance that give markets a bad name when it has nothing to do with markets at all.Actually if the truth be known, very little if anything the bankers did was illegal. Thank you, deregulation. But we don't ever learn. There is a push to undo what little regulation was passed to try stop it from happening again.

[classhandicapper]

See, this is one part we disagree. I think the Fed is necessary because it was chaos prior to their creation.

You are right. This is where we disagree.

I think the monetary and banking system was fundamentally flawed way back then, but rather than fix it, they created the Fed to act as a band-aid. You need a system of hard money with no fractional reserves. That keeps credit creation under control and dramatically reduces the possibility of bank runs.

The banks didn't want that because it cuts into profits (and neither did government expansionists for other reasons) . So they created a Fed to PRINT reserves when they didn't have them and sold it as a way to greater stability. We went from a flawed gold system with fraction reserves to a partial gold and partial paper system (which was worse). Now we have a totally paper system which is ridiculous.

[classhandicapper]

Actually if the truth be known, very little if anything the bankers did was illegal. Thank you, deregulation. But we don't ever learn. There is a push to undo what little regulation was passed to try stop it from happening again.

I've often wondered how much of it was illegal, but we aren't going to find out because no one is going to tell us. Even though I'm libertarian, I'm not opposed to all regulation. I think you have to lay out sensible rules for business. But I'm not sure it was all deregulation that caused the problem. It was deregulation combined with an unsound monetary and banking system. That's like not giving rules to a child and then giving him matches and lighter fluid to play with.

[Robert Goren]

I've often wondered how much of it was illegal, but we aren't going to find out because no one is going to tell us. Even though I'm libertarian, I'm not opposed to all regulation. I think you have to lay out sensible rules for business. But I'm not sure it was all deregulation that caused the problem. It was deregulation combined with an unsound monetary and banking system. That's like not giving rules to a child and then giving him matches and lighter fluid to play with.It is always greed that causes every economic turn down. Most people can't handle a little success. They think if they keep doing the same thing only with borrowed money riches will come sooner. Give them somebody else money to play with and reward them on ROI without looking at how they get it is bound to end up badly.