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Jim Grant: Look at the Depression of 1920-21


Jim Grant usually has excellent things to say, and he raps the Fed on their knuckles, in their very office, in a brilliant speech. (Note: I don’t agree with all of it) Specifically, he asks us why the Fed should not do the "right" thing, that was done after the depression of 1920-21.

My reading of history accords with Goodhart’s, though not with that of the Fed’s front office. If Chairman Bernanke were in the room, I would respectfully ask him why this persistent harking back to the Great Depression? It is one cyclical episode, but there are many others. I myself draw more instruction from the depression of 1920-21, a slump as ugly and steep in its way as that of 1929-33, but with the simple and interesting difference that it ended. Top to bottom, spring 1920 to summer 1921, nominal GDP fell by 23.9%, wholesale prices by 40.8% and the CPI by 8.3%. Unemployment, as it was inexactly measured, topped out at about 14% from a pre-bust low of as little as 2%. And how did the administration of Warren G. Harding meet this macroeconomic calamity? Why, it balanced the budget, the president declaring in 1921, as the economy seemed to be falling apart, "There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures." And the fledgling Fed, face to face with its first big slump, what did it do? Why, it tightened, pushing up short rates in mid-depression to as high as 8.13% from a business cycle peak of 6%. It was the one and only time in the history of this institution that money rates at the trough of a cycle were higher than rates at the peak, according to Allan Meltzer.

But then something wonderful happened: Markets cleared, and a vibrant recovery began. There were plenty of bankruptcies and no few brickbats launched in the direction of the governor of the New York Fed, Benjamin Strong, for the deflation that cut an especially wide and devastating swath through the American farm economy. But in 1922, the first full year of recovery, the Fed’s index of industrial production leapt by 27.3%. By 1923, the unemployment rate was back to 3.2%. The 1920s began to roar.

You can’t deny that. And see Volcker’s tough action in the late 70s where he took on TWO recessions and brought out America from persistently high inflation by keeping interest rates high. Post that the US saw a near 18 year period of prosperity, where towards the end Mr. Greenspan decided that interest rates needed to see the figure "zero" more often than required.

In comparison, Japan has been easing for 20 years, with no great change in the economy and in fact, like John Mauldin says, it has become a bug in search of a windshield. The US markets haven’t been in great shape since 2000, with the only bubble being real estate prices, which in many places have gone back to the 2000 levels.

Hard action today sees great economic growth tomorrow. Easing simply hasn’t shown the results central banks seem to desire. The "let the banks fail" is an option we must consider or we’ll be forced to consider it when we’ve lost all hope. Europe might just show us how.


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