Tuesday, December 2, 2014

Paul Krugman is Right on This Point and Some Austrians are Wrong

For some reason, and I haven't quite figured out why, some Austrian economists have identified the 1921 recession and its aftermath as an example of the Fed staying out of the way and allowing a non-manipulated recovery to occur.

James Grant, a quasi-Austrian, even has a new book out on this point, The Forgotten Depression: 1921: The Crash That Cured Itself . (Note: I haven't read Grant's book, yet, but I will, no doubt have further comment after I do.)

Paul Krugman argues otherwise about Grant's assertion in a blog post today:
Two things to say about the bizarre citation of the 1921 economic recovery as somehow refuting everything we’ve learned about macroeconomics since then....The 1921 thing is of no use precisely because it looks like the kinds of recession where the Fed creates a slump with tight money, then relents...Second, there is a familiar phenomenon here, in which a certain kind of would-be economic expert loves to cite the supposed lessons of economic experiences that are in the distant past, and where we actually have only a faint grasp of what really happened. Harding 1921 “works” only because people don’t know much about it; you have to navigate through some fairly obscure sources to figure out that it’s a tight-money recession that ended when the Fed reversed course.
His comments surrounding this observation are typical nonsense, but his observation about 1921 is absolutely spot on in my view. I wrote about this last year:
There is no reason to single out the 1920-21 recession as different from other Federal Reserve money manipulations.

According to A Monetary History of the US by Friedman and Schwartz (Table 10) money growth was at 15% between May 1919 and May 1920. This according to Austrian theory would have fueled the boom. Eyeballing Chart 1 in Friedman-Schwartz one can see that money supply growth peaked in 1921 but then bottomed in 1922. Thus, money supply would have started to slow in 1920, but would have started to climb in 1922. Indeed, money growth according to Murray Rothbard (America's Great Depression Table 1) for the period June 1921 to June 1922 was at  4.1%. but for the period June 1922 to June 1923 money growth was at 9.8%. This growth would  have thus started in 1922, when the economy was coming out of the recession. Thus, as far as I am concerned, the boom, bust and new boom were all the result of Federal Reserve money manipulations.

I have no idea how the urban myth started that the 1921 recession was different from other Federal Reserve manipulations, that said, after this period for the remainder of the 1920s, money supply growth until 1928 was pretty much between 5% and 10% (See Rothbard, Table 1), which justifies...Austrian claims that it was money printing in the 1920s that caused the 1929 stock market crash and start to the Great Depression.

Ron Paul's claim that government stayed out of the way in the early 1920s, applies more to the propping up of wages and businesses, that didn't occur, so there was no suffocation of the overall economy as occurred in the 1930s and at present, but the Fed was, indeed, up to its dirty tricks in the early 1920s.

(ht Travis Holte)


  1. Robert,

    I'm not following you. Rothbard identifies the 1920-21 as the curtain call for laissez-faire in "America's Great Depression." The Fed boom from the last part of WWI liquidated itself and the healing process was allowed to work.

    1. I don't believe Wenzel is referring to Rothbard but others that have misinterpreted Rothbard. There are many out there that claim that the 1920-21 recession was "cured by itself" and judging from the title of Grant's book, he thinks the same.

    2. but we need to distinguish between fed intervention and gov. intervention in general. I haven't read Grants book, but Wenzel is implying that Grant focuses blame on the fed.

      I would very much like to hear more on this. Would love to hear Grant, Wenzel and perhaps Murphy talk this thru. It seems like it would be good for this group to be on the sam page.

    3. Well, if Grant is calling it the crash that "cured itself," and the Fed was printing money as Wenzel indicates, then Grant is wrong.

    4. Somehow I think there's a lot more to this than sweeping statements based on the book title.

    5. The "Roaring 20's" was a false boom created by the FED, to be sure. But the point about 1921 is that recovery began to take place way earlier than after other recessions because centrally planned interventions weren't anywhere near as aggressive.

      These may help:

      Why You've Never Heard of the Great Depression of 1920 | Thomas E. Woods, Jr.

      Hazlitt, My Hero | Jim Grant

    6. Also this:

      Tom Woods vs. the Fed

      "The 1920s

      "First, ... most people haven’t heard of this recession because Harding followed the opposite of the Keynesian prescription: ... In short order, prosperity was restored.

      "Second, that prosperity, which included genuine increases in production in the private sector, was also fueled by the Fed increasing the money supply by 55% — largely through loans to businesses, rather than through currency expansion — from 1921—1929. With drastically increased production, consumer prices should have been falling; the fact that they were constant throughout the decade was evidence at the time of the Fed’s manipulation.

      "Austrian theory holds that such a false, inflationary boom will artificially stimulate capital-goods industries like real-estate; and, since a company’s stock price represents the perceived value of its capital, it will also create a stock market bubble."

  2. It is a fool's errand to analyze empirical evidence of economic activity in order to prove precise causal relationships. Only the most general of statements can be made and even than it is full of caveats because the activity is full of variables based on personal subjective valuations. And there is no need to do this. Logic tells us that the manipulation of money (coercion) will cause distortions in economic valuations leading to booms and busts and only voluntary trade to mutual benefit (non-coercion) offers the most accurate economic valuation for any given moment.

  3. Daniel Kuehn wrote a paper claiming that the Fed financed WWI and caused the accompanying inflation and that the slash in spending post war caused the recession. I've been asking him to provide evidence that the recession was caused by market failure. That hasn't happened.


    Also, I think it is important that both wages and prices were allowed to fall and they did, in fact fall during the "cure" stage. I think it puts a lie to the constant Keynesian claim about "sticky" prices and wages.

  4. A typical attack on the Austrian account of the 20' to 21' depression is that it "wasn't really a depression". No matter how one cuts it, the administration did practically nil and the economy did recover. There was no endless spiral. It didn't turn into a massive depression for this reason.

    1. Allegedly, GDP didn't fall enough to qualify the crisis as a crisis. However…..

      "Out of Work" by Vedder and Gallaway, page 62:

      Factory employment from the beginning of 1920 to the trough in the third quarter of 1921 fell slightly more than 30 percent on a seasonally adjusted basis, a sharp drop by any standard. Similarly, industrial production fell by a like proportion. An even steeper decline occurred with respect to wholesale prices. Between the second quarter of 1920, when they peaked, to the third quarter of 1921, a period of slightly over one year, wholesale prices fell nearly 44 percent, one of the steepest decreases recorded in American history.

      The substantial fall in prices greatly exceeded the drop in money wages, so real wages rose markedly until the third quarter of 1921. It would be an overstatement, however, to characterize money wages as rigid. After all, they did fall over 19 percent from the summer of 1920 to the end of 1921. It is more accurate to say that wages proved less flexible than prices.

      All that happened without a government program.

  5. Note that Krugman long ago cited the Kuehn paper as proving the failure of Austrians:


    Note also that Kuehn has conceded that his paper was consistent with the Rothbardian narrative:


    This is all also consistent with David Stockman's point that the problems of 1920 and 1929 were caused by unresolved central bank sheanigans going back to WWI. The Keynesians can point to no market failure whatsoever and have no basis to suggest that the world works the way they say it does. Again, they still have good reason to avoid mentioning 1920 because the price and wage adjustments of the market did cure an admittedly government-induced crisis.

  6. Here is Jim Grant so anyone can judge for themselves

  7. Roddis is right, Stockman is good on this.

    Hard to believe Krugman would even bring this up, since he and other Keynesians don't have a leg to stand on.

    There was no fiscal stimulus from the Federal Gov, as Keynesian policy would prescribe. And, as Roddis mentions, there was no sign of "sticky prices" (specifically wages). No programs intended to animate idle recources.

    Maybe a Fisher-ite could claim that once prices "stabalized", the economy boomed. But he could only claim that for 7 more years, or so.

    It fits the Austrian "model" better than the other two. No government involvement prolonging adjustment, keeping prices up, then a FED manipuated boom. What's the problem?