Liveblogging the Great Depression: James Grant’s The Forgotten Depression

By Bob Bruner-

This post continues a commentary on readings about the Great Depression.  In the second meeting of our seminar, Richard A. Mayo and I assigned James Grant’s The Forgotten Depression: 1921, the Crash that Cured Itself.  This book focuses on the deep economic contraction in 1920-1921: output declined 8.7% in real terms (23.9% in nominal terms), national unemployment reached 19%, and civil unrest (strikes and violence) surged.  Grant offers this story as an arresting case of “constructive federal inaction”—arresting, because today’s policy response to an economic crisis is to promote rapid recovery and provide social relief until recovery comes.  Grant writes, “federal passivity did not destroy confidence but rather enhanced it.” [1]   The contraction was brief and followed by the Roaring Twenties.  Published in 2014, this study of the crash of 1920-21 draws an inevitable comparison to the Great Depression (1929-1939) and to the Panic of 2008 and Great Recession, both cases in which government intervened extensively in the economy and recoveries were slow and painful.  Grant writes, “The depression of 1920-21 was terrible in its own way.  In comparison to what was to follow, it was also, in in its own way, a triumph.” [2]


This book and our discussion of it extended our understanding of the build-up to the Great Depression.  In our first meeting, Liaquat Ahamed’s Lords of Finance argued that the roots of the Depression lay in the Armistice of World War I, in the terms of the Versailles Treaty, in policies of war reparations and debt repayment, and generally, in international monetary considerations.  Grant’s The Forgotten Depression complements Ahamed by focusing on domestic U.S. economics and politics.  Grant raises a number of important themes and stimulating critical thinking about that period of time. 


American involvement in World War I foretold a wave of inflation and a correction.   The build-up of the American war effort increased output and unleashed a flood of federal funds into the economy.  Observers expected that a recession would follow the end of the War.  Shortly after the Armistice in 1918, the government cancelled contracts equaling 3.3% of GDP.  But the decline in domestic trade was offset by a boom in exports, especially to war-ravaged Europe. Farm production surged, as did the market price of farm land.  Bankers extended more credit to firms, consumers, and farmers.  Seeing new opportunities in banking, City National Bank (the largest at the time and forerunner to today’s Citigroup) opened 22 new branches outside the U.S. including in places such as Cuba and Russia.  And the inflationary legacy of the War proved intractable: consumer prices rose 11% in 1916, 17% in 1917, 18.6% in 1918, and 13.8% in 1919.  As the following graph shows, double-digit inflation has been a relative rarity in modern U.S. history—only nine of the 102 years since 1913.  And the inflation at World War I dwarfs the rest, for both height and duration.




The distortions induced by double-digit inflation found their way into consumer behavior: buying goods quickly because waiting imposed the depreciating purchasing power of the earned dollar; buying on credit because repayment would become easier later as the dollar inflated; and hoarding goods for sale because tomorrow they would fetch a higher price.  Union activism increased.  Strikes, work stoppages, and mass meetings calling for the nationalization of industries occupied headlines.  Anarchists detonated a bomb outside of the offices of J.P. Morgan & Company in New York City.  Grant wrote,

“Pensioners, judges, professors—anyone on a fixed income—suffered a crippling loss in living standards.  Class rose up against class and interest group against interest group.  Especially did the great inflation set labor against management, city dwellers against farmers, creditors against debtors and the Federal Reserve against a growing legion of monetary critics…And hovering in the background of these economic conflicts was the outbreak of revolution in Europe and the triumph of Communism in Russia.” [3]

The historical regularity is that episodes of high inflation (and/or material deflation) produce social stress.  Governments hear calls to respond. 


Should governments intervene in an economic crisis?  The Federal Reserve System, founded in 1913, became the focus of intense interest.  Grant noted that “Price stability, that chestnut of modern central-banking doctrine, was no part of the original remit of the Federal Reserve.”  ((Page 58.))  In 1919 and early 1920, the Fed tightened the supply of money, raising the rate at which it loaned to member banks from 4% to 6%.  Such increases seem small, but they echo loudly through the economy.  On January 21, 1920, the Fed raised the rate 1.25% in one step, which Grant calls “one of the Federal Reserve’s single most violent policy strokes from that day till this.” [4]  In May 1920, W.P.G. Harding, the Governor of the Fed (today, we would call him “Chairman”) said,

“It is evident that the country cannot continue to advance prices and wages, to curtail production, to expand credits, and to attempt to enrich itself by nonproductive operations and transactions without fostering discontent and radicalism, and that such a course, if persisted in, will bring on a real crisis….[Therefore, we must] bring about a normal and healthy liquidation without curtailing essential production and without shock to industry, and, as far as possible, without disturbance of legitimate commerce and business.”  ((Pages 96-97.)) 

Despite some evidence of a moderation in the rate of inflation, the Fed again raise the interest rate on June 1, 1920 from 6% to 7%.  Deflation set in: prices in some commodities started to decline in May, others by September, and some resistant products took until February, 1921 to start to turn down. 


Deflation commenced.  As the graph above shows, episodes of deflation are a rarity notable by their brevity and few number.  In my blog post about the previous class meeting, I outlined the devastating dynamics of deflation (“the more debtors pay, the more they owe”), which suggest why, if governments must choose, they would rather deal with low-ish levels of inflation than with any episodes of deflation.  Warren G. Harding, President of the U.S. took office in march, 1921, as the economy was in the crunch of deflation.  He, and his new Secretary of the Treasury, Andrew Mellon, saw the depression as a time to cut government spending and balance the budget, which withdrew fiscal stimulus as a possible instrument of recovery.  Furthermore, he opposed accelerating the payment of a “bonus” to war veterans.  And he signed a new tariff bill that protected U.S. farmers from imported goods.  Finally, President Harding seemed reluctant to provide social relief to the unemployed.  “Constructive federal inaction,” indeed.


Harding’s reluctance comes as no surprise.  Though it is true that Progressivism was a couple of decades old by 1920, the philosophy of laissez-faire in government was much older and still had some popular support.  In the history of U.S. financial crises of the 18th and 19th Centuries, there is no precedent for a Presidential impulse for social relief.  Henry David Thoreau opened his pamphlet, “Civil Disobedience,” with a quote he attributed to Thomas Jefferson: “That government is best which governs least.”  The Presidents up to Teddy Roosevelt and Woodrow Wilson more or less observed that.  But government really pivoted in March, 1934 with the inauguration of Franklin D. Roosevelt.  To appreciate the significance of that pivot, it helps to grasp what it left behind.


Laissez-Faire is French for “let it do” or “leave it alone.”  It describes a point of view, consistent with 19th Century liberalism, that advocated the minimum of government intervention in economic affairs necessary for a free economic system to operate.  Discouraged are taxes, import tariffs, government subsidies, bailouts, handouts, onerous regulations, etc.  Encouraged are rights of the individual, belief that Nature is self-regulating, and a view that market competition is good.  The “it” in “let it do” is the economy or the market system.  Iconic economists and philosophers, such as Adam Smith, Thomas Malthus, David Ricardo, Jeremy Bentham, and James Mill, fought the mercantilist system in which governments intervened deeply in markets, impaired rights, restricted foreign trade, and managed competition for the sake of nationalist political goals.  By the early 20th Century, the classical economics of the early economists had been challenged by Karl Marx and transformed into “neoclassical economics,” which assumed rational individuals seeking to maximize their own utility or profits in efficient and competitive markets would produce equilibrium, a balance of supply and demand.  This idealization of equilibrium underlay the propensity of President Harding and Treasury Secretary Mellon not to intervene in markets and social distress.  Come 1934, all that would change with the activism of FDR.  In 1936, John Maynard Keynes would publish his General Theory of Employment, Interest, and Money, which would provide an intellectual argument for government intervention through fiscal and monetary policy. 


In short, the great value of Grant’s book is that it can provide half of a before-and-after comparison: The Great Depression was one of the most significant pivots in economic and political history.  We’ll get the rest of the story in the next few sessions of the course.


Our discussion did note some aspects of the book that merited further development:

1.      Social cost of intentional deflation.  By focusing mainly on policy makers and industry leaders, the human impact from the depression remains an abstraction.  What was the impact on health, nutrition, enterprise survival (i.e., bankruptcy), education, capital investment, community development, culture, and the like?  Grant notes that Massachusetts reached an unemployment rate of 30% in 1921—this was the official unemployment rate in Detroit in 2009, when the city began a sharp decline.  So, what happened in Massachusetts in 1921?  The point is not to wallow in the sorrowful conditions, but rather to understand more clearly the consequential tradeoff between crisis policies and outcomes.

2.      The international context.  1920-21 was the first major crisis faced by the new Federal Reserve System.  Therein the Fed discovered that the it could not operate in complete autonomy from the rest of the world.  Liaquat Ahamed in Lords of Finance develops this point in considerable detail.  But as a stand-alone treatment of 1920-21, Grant owes the reader more discussion than is given.  [Our class discussion raised the “impossible trilemma,” developed by Robert Mundell and Marcus Fleming, as a basis for analyzing the dilemma facing the Fed.]  In their magisterial Monetary History of the United States, 1857-1960, Milton Friedman and Anna Schwartz wrote:

“The Price and output movements of the post-World War I years in this country were, of course, part of a worldwide movement.  Throughout most of the world, for victors, vanquished, and neutral alike, prices rose sharply before or into 1920 and fell sharply thereafter.  …central bank policies nevertheless produced linkages sufficiently  strong to result in a common movement of prices in most national currencies.  …The Federal Reserve Board emphasized the international character of the price movements in justifying its own policies during that period.  It argued that changes in U.S. prices were effect rather than cause, that the Reserve Board was powerless to do more than adapt to them, and that the Board’s policies had prevented financial panic at home and moderated the price changes.  Its position was somewhat disingenuous.  The United States had by that time become a substantial factor in the world at large and could no longer be regarded as dancing to the tune of the rest of the world.”  ((Pages 236-237.))

Would the markets self-correct under these conditions?  Would interest rates naturally rise in the U.S. to quell inflation?  Not necessarily so. 

3.      The gold standard.  Grant is a longstanding advocate for a return to the gold standard.  The Forgotten Depression is not a tract advocating the gold standard.  But we get a good dose of Grant’s criticisms of fiat money, which are trenchant and often witty.  One wishes he would give similar illumination to the gold standard, to which the U.S. adhered at the time.  Under a gold standard, the money supply in a country is “inelastic,” meaning that it cannot expand to provide liquidity during seasonal shifts such as the holiday shopping season or the movement of harvests to market.  Nor does the money supply necessarily expand as the entire economy grows: a slow-growth gold supply would result in rising costs of capital which would tend to choke off an expansion.  And last (but not necessarily all) a gold standard inflames geopolitics: given that the world supply of gold is rather fixed (or growing slowly), it creates a zero-sum competition to amass gold supplies sufficient to sustain each country’s national growth aspirations.  The amassing of gold is the foundation of mercantilism, which almost all economists condemn, and which leads to serious market distortions. 


The crisis of 1920-21 sets the stage for us to consider the onset of the Great Depression, especially the Crash of 1929 and the policy responses of President Herbert Hoover, 1929-1934.  More to come…




  1. Grant, page 3. []
  2. Page 218. []
  3. Page 15. []
  4. Page 95. []