At the time of the first world war in 1914, the European investors became vary of spending within their own nations or even of keeping their wealth there. Thus, an influx of wealth in the form of gold started flowing into the America, as the Europeans started hoarding their money in America. This sudden inflow of gold suddenly tremendously increased the money supply in the American markets and hence, the spending, goods value and credits also increased immensely. Not only the Americans, but Europeans were also buying American goods. Hence, the American industry was producing goods like never before. Be it clothes, wheat or firearms – there was an enormous demand for it all, both within America and outside. To fuel the production and influx of money into the economy further on, as America too joined the war, the Federal Reserve too decided to keep the interest rates low. As is evident from these events, this sudden boom inflated the prices to the extent of almost doubling them in a span of 6 years (1914-1920).
While people expected the inflation to deflate on its own accord once the war was over, it did not happen and the prices, instead, kept on rising. Now at that point of time, America was still following the gold standard and hence, followed the orthodox ideals that purported that a span of inflation should be followed by deflation. In keeping with these ideals, the then head of the Federal Reserve, Benjamin Strong, started to initiate and implement policies that would bring about such a deflation in the American economy. Although he could foresee the repercussions, as he also confided with one of the journalists, saying that following in these steps would cause considerable unemployment, he also knew that unless these steps were taken, a balance in American economy would be hard to restore. Thus, the interest rates started rising (in a single stroke, the Fed raised the interest rate by 1.25 percentage points), thus defueling the industrial production resulting in deflation of the American product prices.
As the prices fell, people begun to feel the squeeze, even as the interest rates too exceeded 15%. But there was no bringing a change to the fiscal policy. In 1920, Warren Harding was elected as the President of America. In keeping with a low budget policy, he decided to veto the veteran’s bonus as it would have added to the national debt further, reducing the credit value of America. The depression brought about a cascade of unemployment, bankruptcies etc. Among the most notable businesses to go down was that of Harry S. Truman’s haberdashery located in the Kansas City. Everywhere people were committing suicides and extreme hardships were faced by the people of America.
Some within the government thought that the Fed had gone too far in controlling the inflammation and instead had led to sever deflation. The Comptroller of Currency, John Skelton Williams even went ahead and sent severe letters to the Fed members, beseeching them to do something to help the poor farmers and businesses, who were reeling under the effect of the depression. Nevertheless, the Feds turned a deaf ear to all these beseeching. It was only in late 1921, that Herbert Hoover, the then commerce secretary, decided to speed up public works spending and thus created newer jobs in the economy. However, the depression had already started breaking its hold by this time and people were beginning to feel a little relaxed.
As the author says, the key was with the automatic price controlling by market conditions. Since the deflation happened at breakneck speed, when the prices were low enough to invite the customers into buying again, the market conditions began to recover. With consumers shopping again, the producers started producing again, improving the real output and investments figures and eventually unemployment too eased out as more hiring began happening to meet the demand and supply equation.
This is where James Grant presents his thesis point. As he explains, it was because the government decided to turn a blind eye to the prevailing depression, that the market conditions equalized themselves eventually. In later cases of depression, where government decided to follow monetary and fiscal activism, the depression, instead of improving rather worsened. The author tries to convince the reader that had the government followed the same policy of non-interference in the later depressions, namely the Great Depression in the 1930s and the recession in 2007, the outcome would have been much better. While with government stimulus and incentives, the Recession of 2007 is still under recovery in its 5th year (lackluster at that), in 1921, the recovery happened fast and was filled with job opportunities.
While the author, to some extent does manage to grab the reader’s attention, the fact is that the author, in his vehemence to prove that the depression of 1920-21 sorted itself out without any help from outside, forgets to consider some other factors. For example, as is already mentioned in his book, the Fed had decided to keep the interest rates high during the depression of 1920-21. The high interest rates attracted more gold into the economy. This, therefore, with a little help of political pressure and deflation, resulted in the Feds relenting and finally lowering the interest rates eventually. It may hence be concluded that the recovery of the depression of 1920-21 was not because of the market automatic recovery mechanisms, rather because of the policies made by the policy-makers.
The fact is that even while James Grant is so ambitiously explaining how the depression of 1920-21 emerged unaided, the truth is that all this was not without the economy and country paying a huge cost. The book clearly illustrates the hardships and the unemployment that was widespread during the time, even as the economic costs too rode high (the real output fell by 9% and unemployment by 19%). These figures, as mentioned in the book themselves explain how these figures made the depression of 1920-21 twice as bad as the recession of 2007. This clearly illustrates the extent of damage done by the depression at that time.
Grant, James. The Forgotten Depression: 1921: The Crash That Cured Itself. New York: Simon & Schuster, 2014. Print.