The Forgotten Depression from 1920 to 1921

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Facts about the Depression of 1920 that was short-lived due to non-intervention of the government.

One of the worst depressions ever seen in the United States began in 1920, not 1929. The government and Federal Reserve did the exact opposite of they are currently doing to correct the natural cycles of boom and bust. Instead of inflating the money supply buy printing currency or lowering interest rates, Harding’s administration slashed its budget tremendously, and the Fed hiked rates to record highs. This goes counter the Keynesian and monetarist remedies implemented by Hoover and Roosevelt and now Bush and Obama.

At the conclusion of World War I, the United States’ federal debt had exploded because of wartime expenditures, and annual consumer price inflation rates had jumped well above 20 percent by the end of the war. Soldiers returning from Europe looking for jobs caused the unemployment to jump.

Many men went back to work on farms, causing overproduction and agricultural prices to fall drastically.

To restore fiscal and price stability, the government slashed spending in Fiscal Year 1919 to 1920 by more than 65%; from $18.5 billion to $6.4 billion. The budget was pushed down the next two years as well, to $3.3 billion in FY 1922. Andrew Mellon began cutting the top marginal tax rate from 74 to 23 percent after studying the cash flow of the income tax revenues. He found that as the rates increase, the revenues are reduced. He discovered the Laffer Curve about 60 years before Art Laffer publicized this correlation.

On the monetary side, the New York Fed raised its discount rate to a record high of 7 percent by June 1920. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression. Whether we look at nominal interest rates or “real” (inflation-adjusted) interest rates, the Fed was very “tight” during the 1920–1921 depression and very “loose” during the onset of the Great Depression.

Deflation in 1921 was horrendous as there was a loss of half the value and price of all goods. For comparison the loss of housing value in the last year is around 18%, lower in many areas and a bit higher in others. Even though it was worse than 1930 we don’t remember the 1920 depression because the President didn’t manage the economy and built the groundwork to allow quick recovery without wide spread damage.

President Warren G Harding embraced the advice of Treasury Secretary Andrew Mellon and called for tax cuts in his first message to Congress on April 12, 1921. The highest taxes, on corporate revenues and "excess" profits, were to be cut. Personal income taxes were to be left as is, with a top rate of 8 percent of incomes above $4,000. Harding recognized the crucial importance of encouraging the investment that is essential for growth and jobs, something that FDR did not.

Under Harding, GNP rebounded to $74.1 billion in 1922. The number of unemployed fell to 2.8 million.

The relationship with congress deteriorated as the Harding asked the Senate to cut spending. Congress wanted government intervention and the Harding insisted that relief measures were a local responsibility. While the President pushed through tax and spending cuts his relationship with Congress became severely strained.

A break with Congress came after a group of powerful Senators passed a bonus bill. When the Harding vetoed that bill in an election year, both Republicans and Democrats were enraged. As the President lost the support of Congress, the Secretary of Commerce spoke out against the President in support of the people on “Main Street.”

The Secretary of Commerce was Herbert Hoover who wanted government intervention in the economy which as president he would adopt a decade later when he transformed the second Great Depression into the beginning of a disaster.

The 1920–1921 depression was very bad with the unemployment rate at 11.7 percent in 1921. But it had dropped to 6.7 percent by the following year, and was down to 2.4 percent by 1921 largely due to letting the free market work. After the depression the United States proceeded to enjoy the “Roaring Twenties,” the most prosperous decade in the country’s history up to that point. Some of this prosperity was false since it was a result of later Fed inflation.

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Rae Morvay
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