Why we need a “good” depression

Chris Leithner

Leithner & Company Ltd

Have you ever heard of the Depression of 1920-1921? In the U.S., where historical data are extensive, reliable and widely available, it was painfully sharp but mercifully short. According to the National Bureau of Economic Research, that country’s unofficial arbiter of the business cycle’s ups and downs, it commenced in January 1920 and ended in July 1921; it thereby partly overlapped and immediately followed the Spanish Flu pandemic of 1918-1920. It’s clearly as topical as the pandemic. Yet unlike the pandemic of a century ago (with whose broad outlines many laypeople have become familiar since February) virtually nobody – including economic “experts” – recalls the Depression of 1920-1921.

And hardly anybody, it seems, wants to know anything about it. Figure 1 compares the global popularity of Google searches of “Depression 1920” relative to “Spanish Flu” during the past year. Numbers for “Spanish Flu” represent search interest relative to the highest point on the chart. Until January of this year, hardly any people searched this term. Unsurprisingly, searches then skyrocketed in February, peaked on 15 March and collapsed in April-June. Since then, searches have stabilised at ca. 12% of their peak. In sharp contrast, searches for “Depression 1920” have continuously been less than 1% as popular as searches for “Spanish Flu.” 

Figure 1: Popularity of Google Searches for “Depression 1920” Relative to “Spanish Flu”


Why does the Depression of 1920-1921 elicit so little interest? One reason is that it ended much more quickly and decisively than the Great Depression of the 1930s. Why did it disappear so fast? The U.S. Government drastically slashed expenditures, cut taxes, removed myriad shackles from the economy and doggedly repaid debt; and its central bank relaxed its interventionist grip, allowed market forces to prevail – and thus rates of interest to rise to an unprecedented high. These actions rapidly dislodged the considerable economic and financial debris that had accumulated during the Great War; figuratively speaking, they returned the clogged economic stream to healthy flow.

Hence another reason why so few people remember the Depression of 1920-1921: these policies’ success severely embarrasses contemporary mainstream economists! Their forebears’ interventions caused and greatly extended the length and severity of (and hence exacerbated the suffering that occurred during) the Great Depression – and, it seems, they’re doing the same today. Perhaps that’s why the Depression of 1920-1921 has been dubbed the “forgotten Depression.” Insiders probably want it to stay that way; I certainly don’t.

What Is a Recession?

Contemporary mainstream economics is a vast edifice of arcane models that rest upon a flimsy foundation of precise but often arbitrary assumptions. Its definition of recession (a six-month period during which Gross Domestic Product decreases) provides a good example. Why not three months? Nine? Some other interval? There’s no particular reason – it’s merely the “consensus.” In December of 2019, Australia’s GDP reached $480.6 billion. By June, it crashed 7.2% to $445.8 billion. That’s not just the first recession by this conception since the early-1990s (in January-June 1991, GDP fell 1.3%): it’s probably the severest drop of national income since the 1930s. Will it continue to fall? If in December it’s lower than it was in June, then that’s a 12-month period of decline – which will, by the mainstream’s seldom-uttered conception, constitutes a depression.

What’s wrong with this line of thinking? It induces academics, journalists, and above all bureaucrats and politicians to indulge their fetish for fiscal and monetary “stimulus.” The problem is two-fold. First, and as I demonstrated in my previous article, stimulus is poison: bloating central banks’ balance sheets and governments’ budgets, suppressing rates of interest, subsidising all and sundry, etc., do much more long-term damage (including moral harm) than short-term good. Stimulus, in short, creates “zombies.” These are addled individuals, households, businesses, industries – even nations – that (like all addicts) devote their energies not to productive activities but the receipt of ever-more “stimulus.”

Second, obsession about today’s stimulus distracts attention from yesterday’s mistaken policies – namely the stimulus which caused today’s slump. A large body of logic supports – and evidence fails to refute – the contention that if central banks suppress rates of interest, then “investment” that had hitherto been shunned as uneconomic proceeds. Artificial rates blow “bubbles” into various sectors of the economy. This “malinvestment” must eventually be restructured or liquidated. The bogus boom, in short, causes the genuine bust. A less much precise but more fruitful conception of recession/depression therefore is: a period during which the invidious consequences of “stimulus” come home to roost. Further, a downturn is: 

  1. “good” if policymakers learn their lessons, correct the mistakes which caused it, and thus take sensible steps to end it (i.e., disavow “stimulus”);
  2. “bad” if they fail to trace trace their policies’ consequences back to its origin, and therefore refuse to acknowledge the suffering that “stimulus” causes.

 How Severe was the Depression of 1920-1921?

 Figure 2 plots U.S. Gross National Product (GNP) during two eight-year periods: 1916-1923 and 1928-1935. To compare them on a like-for-like basis, it standardises GNP in each series’ first year at 100 (data from Historical Statistics of the United States underpin Figure 2-Figure 6). From the peak in 1929 to the trough in 1933, GNP fell almost twice as much (46%) as it did between 1920 and 1921 (24%); but in no equivalent length of time during Great Depression did GNP collapse as severely as in 1920-1921. In that sense, the Depression of 1920-1921 was the toughest of the 20th century. It’s therefore no accident that American stocks were cheaper in 1920-1921 than at any other time since the 1880s. Robert Shiller’s Cyclically-Adjusted PE ratio fell below 5 in December 1920; between January 1920 and July 1921, it averaged 5.3. At its nadir of the Great Depression (June 1932), CAPE was 5.6; throughout that Depression (October 1929-October 1946) it averaged 13.8.

 Figure 2: U.S. GNP (Year 1=100), 1916-1923 and 1928-1935


According to James Grant, 

Over the course of 12 months, wholesale prices plunged by 36.8 percent, consumer prices by 10.8 percent and farm prices by 41.3 percent (for speed of decline, not even the Great Depression would match the break of 1920–21). The Dow Jones Industrial Average, then comprising 20 stocks rather than today’s 30, crested in November 1919 at 119.62 and bottomed in August 1921 at 63.9, for a peak-to-trough decline of 46.6 percent.

The Sharpest Slump – and also the Strongest Recovery

After 1921, GNP rose sharply: from 1921 to 1922 it rose 6.5%; from 1922 to 1923 it soared an astounding 15%; and thereafter (not shown) it continued to lift strongly. Most tellingly, by the mid-1920s GNP recovered all of the ground that it had lost during the Depression of 1920-1921. In 1935, in contrast, the U.S. remained significantly poorer than it had been in the late-1920s – indeed, well into the 1940s it remained poorer than it had been more than a decade previously). The Depression of 1920-1921 was America’s severest of the last century; it was also among the shortest; and the recovery was, by a country mile, the strongest. These three crucial facts are not unrelated. Unfortunately, today’s mainstream can’t or won’t connect the dots.

The Government’s Response to the Forgotten Depression

 Why did the economy rebound so strongly? The U.S. Government – initially under President Woodrow Wilson (Democrat) and subsequently Warren Harding (Republican) drastically slashed both its expenditures and (not least by cutting taxes) its revenues – both in absolute terms and as a percentage of GNP. In other words, it did the diametric opposite of what John Maynard Keynes recommended in the 1930s and his disciples demand today. It’s vital to distinguish correlation and cause: cutting spending, which the war had bloated massively, possibly triggered the post-war slump. What actually caused it? The preceding “stimulus”—the massive growth of government during the First World War – aided and abetted by the aggressive interventionism of the Federal Reserve.

 Figure 3: Expenditure and Revenue, U.S. Government ($m), 1916-1923


The U.S. Government’s expenditure skyrocketed from $713 million in 1916 to $18.5 billion in 1919; it then plummeted to $6.4 billion in 1920, $5.1 billion in 1921, $3.7 billion in 1922 and $3.5 billion in 1923 (Figure 3). That’s not a mis-print: from the crest of the wave of spending in 1919 to its trough in 1923, the U.S. Government’s expenditure plunged an astounding 81%. Revenue followed a similar path: it zoomed from $761 million in 1916 to $6.6 billion in 1920, and then fell steadily to $3.9 billion in 1923. Also note that from 1920 to 1921 – which, it bears repeating, was the single worst year in the 20th century – revenue fell 20% (from $6.4 billion in 1920 to $5.6 billion in 1921); from 1920 to 1923, it plummeted a whopping 42%.

What about the Fed? Figure 4 plots its New York branch’s minimum and maximum discount rates each year from 1916 to 1923. During the single worst year of the 20th century, it sharply raised this rate to an unprecedented high level. Not since its formation in 1913 had it reached 7%; and not until the 1970s would it do so again.

  Figure 4: Discount Rates, New York Branch, U.S. Federal Reserve, 1916-1923


Figure 5 expresses the U.S. Government’s budget surplus (or deficit) in each of these years as a percentage of GNP during the relevant year. In 1916, it roughly balanced its budget; in 1917, as America entered the Great War, it ran a huge deficit (ca. 12% of GNP); the deficit deepened in 1918, and in 1919 (the war ended in November 1918 but the spending spigot took time to seal), its deficit was even bigger (16% of GNP). Within a year, however, the budget returned to surplus (ca. 0.5% of GNP in 1920), and for the next three years it remained in surplus.

This, fundamentally, is why Keynesians dissimulate and rationalise when reprobates bring the Depression of 1920-1921 to their attention. In the 1970s, their models couldn’t explain the “stagflation” that erupted during that decade – and a century later, they still can’t explain how the radical shrinkage of the government’s taxing and spending and the sharp rise of interest rates to unprecedented highs immediately preceded the strongest recovery of the 20th century. These episodes utterly refute Keynesianism. Who would have known? If only Scott Morrison and Josh Frydenberg knew!

Figure 5: U.S. Government’s Budget Surplus/Deficit, Percentage of GNP, 1916-1923


For today’s mainstream, it gets even worse. What did the U.S. Government do with these surpluses? It repaid some of the massive debt which it had incurred during the First World War. Figure 6 expresses the U.S. Government’s debt during a given year as a percentage of GNP during that year. The First World War caused America’s debt to balloon from ca. 3% of GNP in 1916 to 35% in 1921. By 1923, however, debt fell to ca. 25% of GNP. Like its expenditure and revenue, so too its debt: in the mid-1920s, it remained well above it pre-war levels; equally, however, it was significantly lower than it had been at the Armistice.

 Figure 6: Ratio of Debt to GNP, U.S., 1916-1923


Benjamin M. Anderson, a prominent and well-respected professor, banker and economist during the 1920s and 1930s, summarised matters:

In 1920-1921 we took our losses, we readjusted our financial structure, we endured our depression, and in the month of August, 1921, we started up again. By the spring of 1923 we had reached new highs in industrial production and we had labour shortages in many lines.

As Grant wryly notes, “by the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined.”By the standards of common sense, real-world experience and morality, on the other hand, no more effective measures could be pursued. Alas, today’s mainstream sneeringly dismisses these policies: “maybe they worked in practice in the 1920s – but today they’ll never work in theory!”

As a Matter of Morality and Prosperity, We Need a “Good” Depression … 

Let’s recapitulate. Contemporary mainstream economics is a vast edifice of arcane models that obscure a weak foundation of arbitrary assumptions. Of its nostrums, few have been more central – and damaging – than its fetish for fiscal and monetary “stimulus.” Engrossed by their models, adherents ignore or deny the fundamental reality that government intervention emits false signals – and, in effect, throws sand into the economy’s gears, adds lead to its saddlebags, causes the ship’s anchor to drag along the seabed, etc. That’s what happened during the 1930s and 1970s – and, I fear, has been happening much more recently (particularly during and since the GFC) and is now intensifying.

The Depression of 1920-1921 was the severest – but also the shortest – in modern American history. Yet the recovery in 1921-1923 was the strongest. These facts are not unrelated. The genuine austerity of the U.S. Government, which quickly and thoroughly removed many of the distortions, “malinvestments,” etc., that had accumulated during the Great War, set the stage for the robust recovery. (By 1927, the Fed had once again become highly interventionist – and thereby helped to foment the Great Depression). After the war, most Americans of all walks of life agreed: they wanted to return to what Warren Harding, who was president from 1921 to 1923 and perhaps its greatest of the century, called the “normalcy” of the years before the war. To do that, they needed to shrink the grossly bloated wartime state into something that resembled its trim condition in peacetime.

The implication is vital: real stimulus is the exact opposite of Keynesian “stimulus.” Genuine austerity doesn’t cause misery; it removes its cause – which today’s mainstream worships as “stimulus.”

Genuine stimulus – that is, authentic austerity – rapidly and thoroughly razes the shoddy construction that accumulates during the false boom, and in its place erects the firm foundation that supports genuine recovery. Keynesian “stimulus,” on the other hand, encourages and accumulates the impenetrable flotsam that indefinitely impedes recovery. Genuine stimulus allows markets to work; Keynesian “stimulus” corrupts them with what insiders want – and damn the consequences for outsiders. As the GFC and its aftermath have demonstrated and the Global Viral Crisis has reiterated, “stimulus” isn’t an “emergency” expedient: it’s become a permanent lie.

Morally, what’s preferable: a severe-but-short depression, like the Depression of 1920-1921, or a severe-and-long-one like the Great Depression? Today, Australians (and Americans, Britons, Canadians, etc.) desperately need a “good” depression. If our rulers truly wanted what they relentlessly insist that they seek – a return to “sustainable” prosperity – they’d disavow Keynesianism, bite the bullet and confess the truth that 

  1. the fiscal and monetary “stimulus” of recent decades has led us to our current impasse; and
  2. only a diametric reversal of course – which entails drastically slashing government spending, taxes and regulations, swiftly returning the budget to surplus, repaying debt and letting rates of interest tell the truth about time preferences – will right the ship.

… But We’ll Probably Get a Bad One

Of course, there’s absolutely no way that’s going to happen. First, immensely powerful vested interests will ensure that genuine reform never sees the light of day: one man’s harmful regulation, onerous tax, etc., provides bureaucratic sinecures for several – who vote! Second, our rulers and their acolytes would have to admit not just that for years they’ve been completely wrong, but also that they’ve long done far more harm than good; and that’s an admission they’ll never make. They’re determined to “serve” and even “save” us – even if, economically and financially, they enfeeble, impoverish and even kill us! C.S. Lewis put it best. “Of all tyrannies,” he wrote in God in the Dock: Essays on Theology and Ethics (1970),

a tyranny exercised for the [alleged] good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron’s cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end, for they do so with the approval of their own conscience.

Thirdly, it’s not merely governments: households, too, can’t handle the truth. As a whole they’re up to their eyeballs in debt, and a free-market rate of interest would expose their folly, i.e., bankrupt many of them. In short, today’s Zeitgeist (“vibe of the times”) forbids a “good” Depression. Almost exactly a century ago, in his acceptance speech for the Republican nomination at the election in 1920, Warren Harding declared:

Let us call to all the people for thrift and economy, for denial and sacrifice if need be, for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic. There hasn’t been a recovery from the waste and abnormalities of war since the story of mankind was first written, except through work and saving, through industry and denial, while needless spending and heedless extravagance have marked every decay in the history of nations.

A century later, no politician of any partisan stripe utters anything remotely similar – and if he did, voters would shun him. Most people recoil in anger, bewilderment, fear and horror at the very thought that they should depend not at all upon the state but rather themselves, their families and friends. As a result, elections have (to rephrase H.L. Mencken, America’s finest journalist of the 1920s) become sordid auctions-in-advance on the sale of stolen goods – and politicians enthusiastically seek to out-loot one another. Why bother to riot or burgle when, via the ballot box, you can easily and “legally” confiscate others’ property? Our rulers have long been comprehensively and diametrically wrong about the sources of prosperity, and their determination to dig bigger and deeper holes – and ever more people’s eagerness to jump into them! – won’t change. As a result, in Australia as well as the U.S. and elsewhere, the next several years will more closely resemble the (bad) Great Depression than the (good) Depression of 1920-1921. 

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This blog contains general information and does not take into account your personal objectives, financial situation, needs, etc. Past performance is not an indication of future performance. In other words, Chris Leithner (Managing Director of Leithner & Company Pty Ltd, AFSL 259094, who presents his analyses sincerely and on an “as is” basis) probably doesn’t know you from Adam. Moreover, and whether you know it and like it or not, you’re an adult. So if you rely upon Chris’ analyses, then that’s your choice. And if you then lose or fail to make money, then that’s your choice’s consequence. So don’t complain (least of all to him). If you want somebody to blame, look in the mirror.

Chris Leithner
Managing Director
Leithner & Company Ltd

After concluding an academic career, Chris founded Leithner & Co. in 1999. He is also the author of The Bourgeois Manifesto: The Robinson Crusoe Ethic versus the Distemper of Our Times (2017); The Evil Princes of Martin Place: The Reserve Bank of...

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