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A Critique of the Recession of 1920

A Critique of the Recession of 1920



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Published by: zerohedge on Apr 06, 2010
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The Great Imbalance: A Critique of the Recession of 1920-21
Causes, Responses and Insights
: Many attribute our current recession to the evils of unbridledcapitalism. In response, our leaders have embarked on the typicalKeynesian recession prescriptions in order to stimulate the economy andlead the nation out of the economic doldrums. Unbeknownst to mostAmericans however, prior to the Great Depression, policymakers useddifferent tools to help guide the country out of recessions. Herein weexamine the causes, responses and insights gleaned from the Recession of 1920-21, the last downturn in which leaders relied on the age-old policy of laissez-faire, combined with massive reduction in government andencouragement of deflation.
I. Introduction
Today the United States finds itself in one of the longest and deepest recessions inits history. Many have blamed deregulation, greed and a naive ideological adherence tofree market capitalism for our current woes. As such, the US has embarked on a courseof policies largely Keynesian in nature, including deficit spending, public works projectsand a variety of policies revolving generally around increasing demand and lessening theblows of the deleveraging private sector. In many ways, this era has paralleled that of theDepression, with President Obama playing FDR and George W. Bush playing Hoover.Popular refrains in contemporary America include “We are all Keynesians now,”and “There are no libertarians in financial crises.” With Keynesian nostrums en vogue,the liberal economic schools appear to have grown obsolete. And on some levels this isunderstandable, given that the Keynesian prescriptions for our maladies seem to reflectcommon sense. If people are out of work, let the government gainfully employ them. If the private sector is overlevered, counteract their delevering by levering up the publicsector. If banks are failing to generate credit, print money and force it into their coffers,so that they lend and the economy can once again grow.However, as Frédéric Bastiat, the sage 19
century French theorist, politicaleconomist and assemblyman noted in his work 
That Which Is Seen, and That Which is Not Seen
, the prudent economist looks at the consequences of actions both intended andunintended. This is analogized in the so-called “broken window fallacy,” in which a boythrows a rock through a shopkeeper’s window. One observer argues that this is ablessing because the glazier will now have work in installing a new window, stimulatingthe economy. However, what he misses is the fact that had the window not been broken,2
the shopkeeper would have perhaps used the money now being paid to the glazier to buya new set of shoes, employing the shoesmith, or a book, increasing his knowledge(Bastiat, 1-4). There are other considerations as well. What if the boy is employed bythe glazier to break windows? Then this act would be regarded as theft, not stimulus.Finally, if it is economically beneficial to break one window, why not break all windowseverywhere? Extending the analogy, classical liberals argue that government representsthe boy throwing the rock through the window, causing unintended, damagingconsequences in its economic intervention, and distributing wealth from one class toanother, never creating it. It is under Bastiat’s essential insights that we will proceed.Herein I will first develop the theoretical underpinnings to our study, in giving anelementary summation of what a free market entails, introducing to it a central bank andthen giving a brief overview of the results of central banking under the Austrian theory of the business cycle. Next, I will analyze within this framework the Recession of 1920-21,the conditions it created and the policy prescriptions applied to it for economiccorrection. Upon explaining how we exited from the deep recession, I will enumerate theinsights from a political economy perspective that this historical episode provides us.Finally, I would be remiss in not briefly divulging why I chose to study theRecession of 1920-21. This was a particularly brutal recession not unlike the one we areexperiencing today. Yet policymakers did not undertake Keynesian countermeasures,which made me as a contrarian naturally curious. This was in fact the last recession inwhich US representatives administered what I would come to discover were their age-oldrecovery policies – they decreased the size of government, encouraged economiccontraction and restructuring, and generally unencumbered the economy, allowing it to3

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