“Liquidate Labor, Liquidate Stocks…”
I have known Jim Grant for about 25 years and he never ceases to amaze me with his lucid style of writing. As the proprietor of “Grant’s Interest Rate Observer” he continually demonstrates his ability to bring to life the most mundane of economic and financial topics. His “Forgotten Depression,” an account of the 1919-1922 boom, bust and recovery, is no exception.
Grant’s thesis is that left to its own devices an unfettered price system without the intervention of government policy gives the economy the ability to shake off the effects of a depression. In this case study Grant admires the stand-offish policies of Presidents Wilson and Harding. If anything fiscal policy was extremely contractionary and the nascent Federal Reserve was tightening credit well into the contraction. It is as if Grant is channeling his inner Andrew Mellon, the attributed author of my title quote. And remember the 1920-21 decline was severe with wholesale prices dropping by an astounding 56% and unemployment rising well into the double-digits. As a side-bar Grant notes that a small haberdasher in Kansas City failed. The co-owner was one Harry S. Truman.
To Grant the key to the pricing mechanism working was the ability of wages to exhibit downward flexibility With wages falling with prices, businesses adjusted to find profitability with a much lower cost structure. Although the downward spiral did feed on itself for a while, a new equilibrium was quickly found, at least relative to the early 1930s and our recent experience this decade. By contrast in 1929 it was government policy to keep wages up, and hence all of the adjustment had to fall on the quantity of labor.
What Grant seems to undervalue is the role of the Fed in easing credit in 1921 that helped the economy find a bottom. To be sure the inflow of gold, responding to the U.S. economy’s improved competitive position, made their life much easier, but the fact remains that Fed policy became highly expansionary as 1921 progressed.
Grant is correct in arguing the recovery in 1922 laid the basis for the great boom that was to follow. It also made policy makers complacent about the recuperative powers of the economy. When the next crunch came in 1929 the outcome wasn't nearly as favorable. To Grant it was Hoover’s wage maintenance policies that were at fault; to the economic mainstream it was the workings of the gold standard. Nevertheless Grant tells a compelling story about a long forgotten episode in American history.
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