James Grant, in his new book The Forgotten Depression, makes a strong case for applying a prime directive of the Hippocratic Oath — “First, do no harm” — to economic policy. We today find ourselves beset by economic stagnation, racial strife, political bitterness, infectious diseases, and terrorism. Grant brings back to mind some of the direness of the days of yore, making our current condition seem a pale echo.
By the contemporary reckoning of the English economist T.E. Gregory, the world in 1921 was “nearer collapse than it has been at any time since the downfall of the Roman Empire.” Certainly, in America, there was no mistaking the postwar zeitgeist with the Era of Good Feelings. Preceding the race riots and Red scare of 1919-20 was the worldwide influenza pandemic of 1918-19; it killed 40 million people, including 675,000 Americans. With the advent of Prohibition in January 1920 a major industry was outlawed (yes, said the evangelist Billy Sunday, but “Hell will be forever for rent.”) On September 16, 1920, a terrorist explosion on Wall Street killed 38 and wounded 300. Later, in September, a grand jury started hearing evidence into the Chicago White Sox’s alleged fixing of the 1919 World Series.
A 1920 recession turned into a 1921 depression…. This was no mere American dislocation but a global depression ensnaring nearly all the former Allied Powers (the defeated Central Powers suffered a slump of their own in 1919).
So depression it was: What would the government do about it? It would implement settled doctrine, as governments usually do. In 1920-21, this meant balancing the federal budget, raising interest rates to protect the Federal Reserve’s gold position, and allowing prices and wages to find a new, lower, level. Critically, what it would not do was what the Hoover administration so energetically attempted to do a decade later: there would be no federally led drive to maintain nominal wage rates and no governmentally orchestrated work sharing. For this reason, not least, no one would wind up affixing the label “great” on the depression of 1920-21.
The Forgotten Depression fundamentally is Grant’s deep look into the sharp but short depression of 1921 and his challenge to Neo-Keynesianism, the settled economic doctrine of our era. Grant draws out implications from comparing that painful but relatively brief event with the long misery of the Great Depression and, by implication, with the recent, protracted, Great Recession.
Grant likely is the greatest belle-lettrist (and one of the greatest narrative historians) of our generation’s economic neoclassicists. He is learned, erudite, witty, with an eye for the telling detail. Posterity might consider Grant our era’s Bastiat. The Forgotten Depression is filled with vivid personalities, wisdom and folly, ecstasies and agonies. It brings to fresh life an era that is far more forgotten than it is forgettable.
Grant provides abundant wry observations that make most of the conventional wisdom of Washington’s political elites today appear foolish. We confront a dilemma, however, one which Grant does not resolve. It might be irresolvable. A severe economic downturn causes immense human suffering. The estimable quality of empathy beckons those in authority to alleviate such suffering.
Grant gives the great technocrat Herbert Hoover full credit for such empathy:
No one could doubt Herbert Hoover’s generosity of spirit, even if the secretary of commerce had none of Harding’s personal warmth. The war plunged them (Hoover and his wife) into public service. An estimated 120,000 Americans had been stranded in Europe by the outbreak of the fighting. The Hoovers devoted themselves to the costly and complex logistical task of getting the travelers home. When it came to light that millions were hungry in German-occupied Belgium, Hoover became a pro bonobattler against starvation. Later, after America joined the war, he headed the U.S. Food Administration. With the peace, he led the American Relief Administration. Millions owed their health, if not their lives, to the man who now served as Harding’s secretary of commerce.”
And yet, the road to Hell is paved with good intentions.
Without what would come to be called “macroeconomic” intervention by the government, the Roaring ‘20s swiftly followed the “Forgotten Depression.” Then … Black Tuesday would ensue. As Keynes said to a Saturday Evening Post reporter, in 1932, who asked if there had ever been anything like the Great Depression: “Yes. It was called the Dark Ages and it lasted 400 years.”
The aggressive measures implemented by President Hoover and then by FDR, Grant lucidly argues, protracted what otherwise might have been a short downturn into a decade of perhaps the longest era of economic misery America has experienced.
I (along with Hayek) stipulate to Keynes’s great-heartedness. That said, Grant indicts Keynes, along with Irving Fischer, as the authors of a fundamental conceptual shift of policy that led to the protraction of a major recession into the Great Depression. Grant:
Economists on both sides of the Atlantic were making the case for a new kind of monetary system. Under the pre-war gold standard, exchange rates were fixed and inviolable. If something had to adjust, that something was business or employment or prices, not the gold value of money. Better by far in the postwar world, contended John Maynard Keynes and Irving Fisher, if prices remained stable while currency values were allowed to adjust. To achieve the great desideratum of “price stability,” the theorists advocated a new style of central banking. … The mark of success in central banking was no longer a currency fully convertible into gold at a fixed and statutory rate. It was stable prices and lots of jobs.”
These very objectives remain with us. The statutory mission of the Federal Reserve System has been called the “dual mandate.” It is price stability and full employment. Were it capable of “targeting” these outcomes successfully a great leap forward indeed would have been made in human welfare.
Yet according to the Bank of England’s Financial Stability Paper No. 13, published in December 2011, all economic outcomes under the current monetary regime — notably price stability and employment —have underperformed — dramatically —both the gold and the Bretton Woods gold-exchange standard.
It now may be intolerable, politically, for a government to do nothing to alleviate the deep misery associated with a recession. That said, not all interventions are equal. Although not quite brought to the fore by Grant it might be possible for the government to provide fast — virtually immediate — relief by doing the right thing thereby honoring both the economic and the political imperatives.
It is hard to imagine a state of greater destitution than that of the exhausted, bombed out, Germany financially ruined by the Nazis and its infrastructure and industry demolished by allied forces. As I previously have written Ludwig Erhard’s Wirtschafswunder — the German Economic Miracle — began on a dime, as recorded by Erhard in Prosperity Through Competition quoting Jacques Rueff, whom Grant mentions but briefly, and Piettre:
Shop windows were full of goods; factory chimneys were smoking and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored in their faces while on the next a whole nation looked hopefully into the future.
Rueff, with Pinay, later engineered the French “Economic Miracle” founded on comparable principles. Prosperity, not austerity, is the means as well as the ends.
There is a third way between doing nothing and doing the wrong thing. Grant observes, rightly, that government typically implements “settled doctrine.” Settled doctrine has a poor track record. Time to pivot back to what has proven to work in practice.
As the late presidential economic advisor Walter Heller once observed to Congress, in 1985, sometimes one must “Rise above principle and do what’s right.” The Forgotten Depression would be a suitable place for our policy makers to begin to tousle the settled doctrine and embrace policies that will return us to to robust job creation and economic mobility.