Warren Harding Knew How To End a Depression

[mRx 16]

By Tom Woods Jr.

When Barack Obama urged passage of his so-called stimulus measure in February, he claimed that only bold government action would prevent the economy from slipping into a deep depression. In making that argument, he was only repeating the conventional wisdom, according to which markets are not self-correcting—except in the very long run—and state intervention is necessary to revive economic activity.

Economic theory can tell us why these claims are incorrect and why, in fact, even the appearance of prosperity that those measures can produce causes still greater damage and leads to a more severe correction in the long run. But we can also refer to the testimony of history. In particular, the depression of 1920-21, which most people have never heard of, is an example of the resumption of prosperity in the absence of government stimulus, indeed in the face of its very opposite. If economies cannot turn around without these interventions, then what happened in this instance should not have been possible. But it was.

During and after World War I, the Federal Reserve inflated the money supply substantially. Once the Fed finally began to raise the discount rate—the rate at which it lends to banks—the economy slowed as it started readjusting to reality. By the middle of 1920, the downturn had become severe, with production falling by 21 percent over the next 12 months. The number of unemployed people jumped from 2.1 million in 1920 to 4.9 million in 1921.

From 1929 onward, Herbert Hoover and then Franklin Roosevelt tried to fight an economic depression by making labor costlier to hire. Warren G. Harding, on the other hand, said in the 1920 acceptance speech he delivered upon receiving the Republican nomination, “I would be blind to the responsibilities that mark this fateful hour if I did not caution the wage-earners of America that mounting wages and decreased production can lead only to industrial and economic ruin.” Harding elsewhere explained that wages, like prices, would need to come down to reflect post-bubble economic realities.

Few American presidents are less in fashion among historians than Harding, who is routinely portrayed as a bumbling fool who stumbled into the presidency. Yet whatever his intellectual shortcomings—and they have been grotesquely exaggerated, as recent scholars have admitted—and whatever the moral foibles that afflicted him, he understood the fundamentals of boom, bust, and recovery better than any 20th-century president.

Harding likewise condemned inflation: “Gross expansion of currency and credit have depreciated the dollar just as expansion and inflation have discredited the coins of the world. We inflated in haste, we must deflate in deliberation. We debased the dollar in reckless finance, we must restore in honesty.”

And instead of promising to blow unprecedented sums, he called for cutting back:

We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens but because it will be an example to stimulate thrift and economy in private life.

The economy, Harding explained in his Inaugural Address the following year, had “suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals.” Now the country was enduring the inevitable adjustment. No shortcuts were possible:

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. … 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.

Harding was true to his word, carrying on budget cuts that had begun under a debilitated Woodrow Wilson. Federal spending declined from $6.3 billion in 1920 to $5 billion in 1921 and $3.3 billion in 1922. Tax rates, meanwhile, were slashed—for every income group. And over the course of the 1920s, the national debt was reduced by one third.

In contrast to Japan, which engaged in massive government intervention in 1920 that paralyzed its economy and contributed to a severe banking crisis seven years later, the U.S. allowed its economy to readjust. “In 1920-21,” says economist Benjamin Anderson,

we took our losses, we readjusted our financial structure, we endured our depression, and in August 1921 we started up again. … The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good.

That is not supposed to happen, or at least not nearly so quickly, in the absence of fiscal or monetary stimulus. But who are you going to believe, Paul Krugman or your own eyes?

Naturally, some modern economists who have looked into the matter have been stumped as to how economic recovery could have occurred in the absence of their cherished proposals. Robert Gordon, a Keynesian, admits, “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.” Kenneth Weiher, an economic historian, notes, “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.” He then briskly concedes that “the economy rebounded quickly from the 1920-1921 depression and entered a period of quite vigorous growth,” but (as with most such historians) he chooses not to dwell on this development or learn anything from it.

Weiher, in fact, notes with some condescension that “this was 1921, long before the concept of countercyclical policy was accepted or even understood.” Er, yes, and lacking those indispensable tools, the American economy rebounded all the same.

The reader has probably noticed that Harding’s advice and course of action are basically the exact opposite of the conventional wisdom in political and media circles today. The government has to do something, we’re told. Barack Obama has said that economic downturns degenerate into long-term depressions because governments fail to act with sufficient vigor to head them off.

It is not mere coincidence that the economy returned to health relatively quickly following the downturn of 1920, while on the other hand depression conditions persisted throughout the 1930s, a decade of government activism. It is precisely because monetary and fiscal stimulus measures were avoided that sound economic progress was possible.

The very ideas of fiscal and monetary stimulus stem from a misdiagnosis of the causes of economic depressions and then apply exactly the wrong remedies. The problem is not with an inadequate level of spending, but that in the wake of a central bank-induced boom, the capital structure is out of conformity with consumer demand. The recession is the period in which this mismatch is rectified through the reallocation of capital into more appropriate channels. Fiscal and monetary stimulus only interferes with and delays this purgative process.

Harding, unlike our political class today, actually understood this. The 20th-century president we’re most taught to hate saw the United States through an even worse downturn than the one we’re experiencing now by simply allowing the free market to make the necessary adjustments. And Harding, as his remarks indicate, pursued the policies he did not out of inertia or because he was incapable of conceiving of alternative approaches. This despised figure was in fact a far better economist than most of the geniuses who presume to instruct us now.

Today we have a president urging us to learn the lessons of history, and there are indeed lessons to be learned. But to the state and its purchased intellectuals, history is an instrument to be placed at the service of the propaganda demands of the moment, not an impartial source of wisdom or instruction.

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

[Peikko 1,575]

I think the bigger lesson of history, in terms of the presidents responsibility, is what happened to all the people during this market re adjustment. Markets work so much better without people.

[mRx 16]

What happened to them? The market re-adjusted to reflect actual wealth, citizens were allowed to keep more of their earnings, government played less of a role in their lives, and our currency began to reverse the dilution caused by inflation. A farcry away from monetary and fiscal policies of today.

[Peikko 1,575]

What earnings would those be? Those that suffer in these events are not the people who remain in employment now are they?

[Mr. Big Dog 10,747]

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

Good thing Harding's economic approach didn't end in disaster. Oh wait, there was the Great Depression that started in the late 20's.

[mRx 16]

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

Good thing Harding's economic approach didn't end in disaster. Oh wait, there was the Great Depression that started in the late 20's.

He knew how to end a depression, as he did in the not-so-known depression in '21. That's the point of the article.

[Mr. Big Dog 10,747]

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

Good thing Harding's economic approach didn't end in disaster. Oh wait, there was the Great Depression that started in the late 20's.

He knew how to end a depression, as he did in the not-so-known depression in '21. That's the point of the article.

The article closes claiming that the approach applied by Obama will end in a disaster. That's speculation. Harding's approach, on the other hand, sure did end in disaster. That we know. That's the point of my post.

[mRx 16]

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

Good thing Harding's economic approach didn't end in disaster. Oh wait, there was the Great Depression that started in the late 20's.

He knew how to end a depression, as he did in the not-so-known depression in '21. That's the point of the article.

The article closes claiming that the approach applied by Obama will end in a disaster. That's speculation. Harding's approach, on the other hand, sure did end in disaster. That we know. That's the point of my post.

It's not speculation. The same flawed Keynesian approach was applied by Hoover, and continued by FDR. It's principally flawed and dangerous.

The only hedge in this recession is that the banks are scared to lend. They're depositing their bills lent by the Fed right back into the Federal Reserve branch at a loss. The M3 has skyrocket since mid-08 as seen here:

If the banks are forced to lend, it would be catastrophic.

Oh, and Harding's lassiez-faire approach didn't lead to disaster, as evident of the short-lived recession of '21. Again, the main point of the article. You must be confusing the '21 recession with the '29 depression. I'm afraid Harding didn't live long enough to take the blame for that one.

[Mr. Big Dog 10,747]

That’s why watching events unfold in our own time is like watching a slow-motion train wreck. We know it has to end in disaster, and we’re helpless to stop it. We know politicians won’t learn whatever lessons history has to teach. But if they won’t learn them, we must, if only to prepare ourselves for the disaster that is coming.

Good thing Harding's economic approach didn't end in disaster. Oh wait, there was the Great Depression that started in the late 20's.

He knew how to end a depression, as he did in the not-so-known depression in '21. That's the point of the article.

The article closes claiming that the approach applied by Obama will end in a disaster. That's speculation. Harding's approach, on the other hand, sure did end in disaster. That we know. That's the point of my post.

It's not speculation. The same flawed Keynesian approach was applied by Hoover, and continued by FDR. It's principally flawed and dangerous.

The only hedge in this recession is that the banks are scared to lend. They're depositing their bills lent by the Fed right back into the Federal Reserve branch at a loss. The M3 has skyrocket since mid-08 as seen here:

If the banks are forced to lend, it would be catastrophic.

Oh, and Harding's lassiez-faire approach didn't lead to disaster, as evident of the short-lived recession of '21. Again, the main point of the article. You must be confusing the '21 recession with the '29 depression. I'm afraid Harding didn't live long enough to take the blame for that one.

What good is a short lived recession if it is followed by a short lived recovery and an even deeper recession?

[mRx 16]

What good is a short lived recession if it is followed by a short lived recovery and an even deeper recession?

The recession of '21 caused massive price and wage drops, and was over in '23, with net national production up around 25%, and overall production up something over 50%. In no way did it lie dormant, grow strength, and re-emerge in '29. Preposterous.

Recessions, depressions, downturns, and economic turmoil are all business cycle products. Strictly due to monetary expansion.

For Harding, by allowing prices to fall, wages to fall, and deflation to commence--the downturn was a short-lived, painful market correction.

For FDR, by enacting price and wage controls, subsidizing everything, and continuing inflation-- the downturn was a long-lived, extremely painful market correction.

Note: The market corrected; as it always will, and no thanks to divine government intervention.

[Heracles 417]

What worsened the depression was the protectionist measures known as the Smoot-Hawley Tariff Act.

Market corrections are a consequence of allowing the private sector to do as they please. The lack of regulation in America is what got us into this mess, as it has done so many times before. Australia learned from the last recession and enacted the appropriate measures (rules) to protect the market. Hence why their last recession was in 1988.

Harding's approach was flawed and led to millions of America ending up on a street. As well as to the failure of thousands of banks.

You also mention wages falling, falling to what? Americans are already underpaid, especially blue collar workers. How low can wages go? The $5 minimum wage is laughable by any measure.

Our right wing economics lecturers used to mock and ridicule Libertarians in the US. Now I know why. The ideology is both flawed and ridiculous. It would be the equivalent of removing rules and umpires / referees from sport and say let the players decide the rules. As I have said to you before, show me one, just one, country or example where a system of no government intervention has worked. There must be one place.

On the other hand I can use Australia to prove otherwise. A country which is quite regulated with the appropriate government intervention to promote an equitable free market. few billionaires get to exploit the poor there. I just noticed that our property prices rose there this quarter, with the median house price being $375K. Canada is in a similar boat. Two social democracies whose living standard and prosperity speaks for itself. Sure we don't have a handful of trillionaires but what we do have is a hell of a lot of middle class people who are doing pretty well for themselves. Even in this economic crisis.

Edited May 2, 2009 by Constellation

[Heracles 417]

Note: The market corrected; as it always will, and no thanks to divine government intervention.

You act as if this is a rule of economic law and a necessity, it's not. Rather, it is a consequence of an overinflated market. One that has been allowed to over inflate. aka no regulation.

Machines, for example, use pressure values to prevent similar situations from happening. That is, they release excess steam or pressure rather than blowing up. The same rules can be applied to the economy. Prevent and ease over heating. Too late once you reach the Chernobyl point. The libertarian view is that explosions are just a fact of life, of the cycle. Therfore, they should be allowed to play out. I disagree as do many prominent economists living in 2009.

Edited May 2, 2009 by Constellation

[Heracles 417]

The ultra wealthy can generally weather the storm. Whereas the poor family is fu-ked. Hence the need for appropriate regulation and protection. Currently in the US a CEO can bankrupt a company, yet walk away with millions. Whereas the employee of this company is SOL.

Which is why since Enron so many countries now hold the executives and CEOs personally liable, if a company fails. Their personal assets can be seized and sold, regardless of how they have hidden then or transferred them. They also have a FDIC equivalent ensuring that the employees paychecks are protected.

Regulation and government intervention is absolutely necessary to ensure an equal and equitable playing field. Remember the government is there for we the people. Not we the corporation, shareholder or management.

First rule of thumb I have since moving here, that is, never trust a US corporation. Certainly don't trust any corrupt US politician who can be bought by lobbyist and power corporations.

Edited May 2, 2009 by Constellation

[mRx 16]

Australia learned from the last recession and enacted the appropriate measures (rules) to protect the market.

Really? Australia is in a recession! Glenn Stevens is just too much of a bumbling idiot to admit it to the Australian people.

Your wildly stimulated manufacturing industry's producer prices have risen nearly double the rate of the CPI. (I don't believe the CPI serves any use in itself, other than as a simple comparison)

Your reserve bank is still rapidly inflating trying to keep up:

Australia will suffer, but they just don't want to admit it yet. Some appropriate measures, pffft.

Market corrections are a consequence of allowing the private sector to do as they please.

Negative. Market corrections correct wildly inflating bull economies. The private sector has never caused a recession, depression, or downturn. Your facts are wrong.

Harding's approach was flawed and led to millions of America ending up on a street. As well as to the failure of thousands of banks.

You are very confused. Harding presided over the little-known 1921 recession, with the sharpest deflation, and quickest rebound in our nation's history. You're thinking of Hoover/FDR's Great Depression.

You also mention wages falling, falling to what? Americans are already underpaid, especially blue collar workers. How low can wages go? The $5 minimum wage is laughable by any measure.

Wages fell in 1921 by nearly 60%. Allowing this to happened ensured that the market supply of labor, which had recently been greatly increased due to returning WW1 troops reached an equilibrium. Not forcing wages up, kept unemployment at a warm 11%, despite the influx of returning soldiers.

Wages aren't really important anyway; purchasing power is. When inflation dilutes it, then the blue collar workers suffer. Again, thank the FED.

Our right wing economics lecturers used to mock and ridicule Libertarians in the US. Now I know why. The ideology is both flawed and ridiculous.

What economic ideology would that be? AFAIK Libertarianism is not a economic school of thought. If you can show me specifically how the principles are flawed and/or ridiculous, I would warmly welcome it.

[mRx 16]

You act as if this is a rule of economic law and a necessity

It is an axiom. The business cycle is cyclic. Continuing on with perpetual inflation would lead to hyperinflation. The Federal Reserve knows this, and raises rates to avert such hyperinflation, which kicks off the recession.

Rather, it is a consequence of an overinflated market. One that has been allowed to over inflate. aka no regulation.

Inflation cannot take place without government. De-regulation is not cause for inflation.

Machines, for example, use pressure values to prevent similar situations from happening. That is, they release excess steam or pressure rather than blowing up. The same rules can be applied to the economy. Prevent and ease over heating. Too late once you reach the Chernobyl point.

Your example is not applicable to the economic business cycle. Once inflation commences, the market must correct. The degree of correction correlates with the amount of inflation. There is no magic valve to prevent a recession once a government expands the money supply. The only prevention is to abandon fiat currency, and thereby abandon inflation.

The libertarian view is that explosions are just a fact of life, of the cycle. Therfore, they should be allowed to play out. I disagree as do many prominent economists living in 2009.

Apparantly, you don't know many Libertarians. I do not think recessions are a fact of life.

They are caused solely by inflation. Not the private sector, not de-regulation, and not lazziez-faire thinking. To avoid recessions, you must avoid inflation.