Monthly archives "August 2011"

1920 depression

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When one discusses the 1920’s people think of the roaring twenties, a time of prosperity, speak easies, dancing, and singing the night away. But contrary to popular belief, that wasn’t always the case. In the beginning of the decade a depression was on the horizon, one where the first year was worse than that of the Great Depression. This depression is often referred to as the forgotten depression.

In the first year of the 1920 depression, production fell 21%, GDP (Gross Domestic Product) fell from 91.5 billion dollars to 69.6 billion dollars, and unemployment went from 4% to 11.7%.

When Warren Harding took office in 1921, he knew he had to act. But, Harding didn’t take action in the same manner as FDR, Bush, or Obama did. He used a different approach.

Here are some quotes from President Harding that sum up his actions. “We must deflate in deliberation”, and “we will attempt intelligent and courageous deflation and strike at government borrowing.”

When President Harding initially took office, the first action he took was to slash, not cut, but slash spending, from 18.5 billion dollars to 6.4 billion in the first year of his presidency. No, they weren’t spending cuts that were going to be made three years from now as in the debt ceiling compromise, they were immediate cuts. During the next three years, the amount of government spending went down from 6.4 billion dollars to 3.3 billion.
Warren Harding, also, cut taxes drastically, freeing up the economy from interference by government bureaucracy.

As a result, unemployment lowered from 11.7% to 6.7% in the first year, and the next year the unemployment rate dropped even further to 2.4%.
GDP also rebounded to 79.1 billion dollars the following year, up from 69.6 billion dollars, and the CPI (consumer price index) fell 15.8 percent.

What also made this recovery possible was the fact that the Federal Reserve didn’t interfere with the markets until 1922.
On the contrary, Japan in the 1920s didn’t let prices fall, and failed to take their losses like the US did. As a result, their economy went stagnate.

In 1913, Japan’s economy began its boom, which was fueled by cheap credit policies and WW1. The wholesale price index finally reached 322 points by the end of Japan’s boom period in 1920. This was a sure sign that Japan’s credit expansion was out of control. But in April of 1920, the wholesale price index finally dropped to 190 points. This brought Japan’s prices back in line with its trading partners.

During Japan’s boom period, the central banks of Japan created cheap credit, which was then loaned out at rates which were below the market rate. This caused firms to engage in projects and investments that were unprofitable due to their dependence on unsustainable low interest rates. These projects couldn’t be completed because there was an insufficient amount of capital goods available, and businesses were unable to cover the rising costs that low interest rates always create.

As a result, Japan’s government froze its banks and large industries, and didn’t permit the adjustment process to take place. As a result the Japanese economy did not recover, it went into economic stagnation, and resulting in Japan’s first lost decade.

This series of events shows that the government and the Federal Reserve cannot spend, or print their way out of a recession. The market must be allowed to run its course and permit bad businesses to fail. Low taxes, little or no intervention, and letting the market run its course is how to have a growing and thriving economy.