Have you ever heard of the other Depression of the 1920s? Sure, you've heard of the Great Depression that started under Hoover in 1929. But have you heard about the one that started under Wilson in 1921?
The Depression of 1920/21
The 1929 depression was characterized by double digit unemployment. The 1920/21 depression was also characterized by double digit unemployment. According to historian Burt Folsom, the 1920/21 meltdown "had economists excited over what was shaping up to be one of the worst crises in American history."
Come again?
Folsom says the end of the Wilson administration was characterized by massive unemployment as troops returned from the Great War (World War I). In 1918, the armed forces employed 2.9 million. By 1920, 320 thousand were in the armed forces. Unemployment reached 12% and was a huge issue in the presidential election.
Mismanagement at the Federal Reserve compounded problems. The Fed raised interest rates from 4% at the end of 1919 to 7% six months later. This choked off credit needed by businesses and consumers at a time when the labor force was swelling with returning veterans.
The economy contracted 6.9%, technically making the contraction a sharp recession and not a depression (a 10% contraction is necessary for a depression). Prices fell by 18% in a single year. Wholesale prices feel by 37%. Automobile production dropped 60%. Overall industrial production fell by 30%.
Technically, 1920/21 may not have been a depression, but it felt like one. Between the end of 1919 and the middle of 1921, the Dow fell 47%. The rate of business failures tripled and solvent businesses experienced a 75% decline in profitability.
Promising a "return to normalcy," Warren G. Harding was swept into office by a 60% to 34% landslide with Calvin Coolidge as his vice president. Half way through his term, Harding died from a heart attack and Coolidge was sworn in as president. Coolidge, one of the country's greatest and most overlooked presidents, continued Harding's economic policies seamlessly.
Harding's Secretary of Commerce was Herbert Hoover. Hoover pushed Harding to "do something." So Harding held a President's Conference on Unemployment. All of the brightest minds of industry, academia, and government were involved. Collectively, they urged Harding to engage in a massive stimulus program, putting unemployed vets to work on infrastructure projects, such as roads and bridges.
Warren Harding Cut Taxes and SpendingHarding's response? He said the spending would require massive tax increases that would cripple the economy. Instead, Harding did the opposite. He cut taxes and spending, which Coolidge continued after Harding's death.
Harding cut the top income tax rate from 73% to 25%. With better after tax returns, entrepreneurs were willing to risk their capital. If an entrepreneur risked and lost, he lost it all. If he risked and won with a 73% marginal rate, he could only keep 27% of his profit. When the rate lowered to 25%, he could keep 75%. Suddenly, more people were willing to take a chance.
Someone who wasn't taking much of a chance was Harding. As Treasury Secretary, Andrew Mellon said, "Seventy-three percent of nothing is nothing. Twenty-five percent of something is something."
Was Andrew Mellon The Original Supply Sider?Harding coupled the tax rate reductions with cuts in federal spending. Folsom reports that Harding wanted to keep the U.S. competitive globally and attract investment.
If you think that cutting government spending and tax rates is a recipe for massive deficits, guess again. The economy boomed as entrepreneurial activity was released. Overall tax receipts went from $700 million in 20/21 to over $1 billion by 28/29. The government ran surpluses, cutting 1/3rd of the national debt.
The Best Economic Performance of Any President Was Calvin Coolidge'sDuring Coolidge's term as president, unemployment averaged 3.3%. According to Folsom, at the end of his presidency, unemployment was 1%. Since inflation was 1%, Coolidge averaged a misery index (inflation + unemployment) of 4.3%, which half any other 20th century president.
The Great DepressionThe 1920s depression you've probably heard about is the one that commenced under Hoover and was continued under Roosevelt. Hoover, if you recall, was one of the people who wanted to enact a stimulus program during the earlier depression. In private, Coolidge called Hoover, "wonder boy" and once remarked that, "He's been giving me advice for six years, all of it bad."
In school I learned that the Great Depression was started by the 1929 market crash, which was a failure of capitalism and free markets. The mythology is that Hoover did nothing. He sat back in callous disregard for the plight of the public. If only.
Herbert Hoover Was NOT an Advocate of the Free MarketIn reality, the Depression didn't start with the stock market crash. In fact, the markets had started to recover. From mid November, 1929 to April, the Dow recouped half the decline from the peak and was nearly level with the prior year.
The Markets Were Rebounding From The CrashMilton Friedman, the greatest economist of the 20th century, advanced the belief that the Fed's contraction of the money supply (and increase in rates) kick started the Great Depression. Others blame the Smoot-Hawley tariff. Still others, credit a combination.
Smoot & Hawley May Have Drafted The Most Economically Damaging Piece of Legislation In History(Though Congress Keeps Trying To Get One Worse)Smoot-Hawley was the largest tariff increase in U.S. history. The merits of free trade is one area with almost no disagreement among economists. Over 1,000 economists sent Hoover a petition urging a veto. Industrialist pleaded with him personally to veto the bill.
Hoover didn't listen. He signed Smoot-Hawley into law, raising tariffs on over 20,000 products, launching retaliatory tariffs around the world. The bill artificially raised prices on products made more competitively overseas. This led other countries to artificially raise the price of products we produced more competitively, killing our exports. Exports fell 27% in 1930, 36% in 1931, and 34% in 1932 (
Source).
Next, Hoover launched his infrastructure stimulus program. To pay for it, he raised top marginal income tax rates from 25% to 63%. Unemployment soared to 25% in 1932.
Roosevelt Campaigned On Tax & Spending Cuts... Then, RenegedRoosevelt entered the picture promising tax cuts and federal spending cuts. The party platform called for spending cuts of 25%. If Roosevelt would have kept his promises, the depression might have soon ended. He didn't and it didn't.
Roosevelt didn't like or trust entrepreneurs (the feeling was mutual). Rather than turn to business people for solutions to the economic problems Roosevelt assembled a "brain trust" of college professors. Yikes!
Folsom described the academic solutions. Farm exports were down, resulting in surplus production, and falling prices. The brain trust's solution? Pay farmers not to produce.
The farmers thought getting paid not to produce was a fine idea, but actually idling good farmland seemed kind of silly. So they cheated.
To stop the cheating, the government hired inspectors to physically check on the farms. So the farmers bribed the inspectors and kept on cheating.
In response, the government hired inspectors to check on the inspectors. When this didn't work because the inspectors split the bribes, aerial photography was deployed with auditors studying aerial photographs.
The Feds were determined and eventually, the U.S. did develop farm shortages. By 1935 we were importing cotton, corn, and wheat because farmers weren't producing enough. Some of the shortfall was due to the 1930's era global warming and the Dust Bowl. Still, it was absolutely ludicrous that we were paying farmers not to farm, importing farm products at a premium, and paying a legion of bureaucrats to oversee the entire mess. As Folsom says, this was only one government program and not even the worst.
The Dust Bowl: 1930s Era Global WarmingWe had government sponsored price fixing. Business owners were told what they should charge and literally tossed in jail if they didn't charge enough.
Roosevelt started massive government programs left and right. New regulations and taxes arose in a kind of government schizophrenia that froze business investment out of uncertainty. We saw the creation of gas taxes, tire taxes, telephone taxes, telegram taxes, movie ticket taxes, and on and on.
Roosevelt boosted income tax rates to 79%. Later he even tried to hike the top marginal rate to 99.5%. When Congress resisted, he issued an executive order instituting a 100% income tax on all income over $25,000. Congress repealed this to 90%, which stayed in place until the Kennedy tax cuts in the early 1960s.
Henry Morenthau Admits The New Deal FailedThe tax and spend stimulus worked so well that U.S. unemployment was still at 19% in 1938, compared to 11% for the rest of the world. The Secretary of the Treasury, Henry Morgenthau, declared privately, "We have tried spending. We are spending more than we ever spent before and it does not work. We have never made good on our promises. I say that after eight years of this administration we have just as much unemployment as when we started and an enormous debt to boot."
The 1920s had two depressions. Harding and Coolidge fought one with low taxes and reduced spending to create an environment ripe for entrpreneurial stimulus. The result was a rapid end to the depression and one of the most prosperous decades in history. Harding and Coolidge were so successful that we don't even remember the depression they confronted.
The second depression was addressed by higher taxes across the board, massive government stimulus, tremendous government debt, and increased regulation that created an environment of uncertainty and froze entrepreneurial activity. Hoover and Roosevelt deepened and expanded the 1929 depression, turning it into the Great Depression.
Listen to the following address to a group of college students by Burt Folsom, where he compares and contrasts the economic policies and outcomes of Harding/Coolidge with Hoover/Roosevelt.
