The Case of the Self-Correcting Depression

Uncle Sam’s various economic and political ailments, shown in a 1919 cartoon

By James Grant

This article appears in the Winter 2025 issue of the Coolidge Review. Request a free copy of a future print issue.

A little more than a century ago, America toiled through its last governmentally unmedicated business-cycle downturn. Short, sharp, and self-correcting, the 1920–21 depres­sion was the economic capstone of the brief, constructive administration of War­ren G. Harding. Today, it commands our attention, even our admiration, if only we open our minds a little.

What preceded the deflationary slump was an inflationary boom. World War I ignited it, and wartime finance per­petuated it. Consumer prices were rising by double digits even before 1917, the year America entered the war as a bellig­erent, and they were still climbing in 1919, the year after the armistice. They stopped rising and began falling early in 1920. By the time Tin Pan Alley got around to enshrining the inflation in a song—“I’ve Got the Profiteering Blues”—a full-fledged deflation had begun.

The National Bureau of Economic Research, America’s cyclical scorekeeper, identifies January 1920 as the peak of the boom and July 1921 as the trough of the slump. The successive administrations of Woodrow Wilson and Warren G. Harding met the crisis of plunging prices, incomes, and employment by balancing the budget and, through the newly instituted Federal Reserve System, raising interest rates.

By late 1921, a powerful, job-filled recovery was under way.

Today’s readers, accustomed to all-season federal deficit spending and to a Federal Reserve sworn to forestall inflation, deflation, and unemployment, may wonder how the nation escaped its troubles—why, indeed, the 1920–21 depression ever ended.

“NOT FOR VERY LONG”

From top to bottom, producer prices fell by 40.8 percent, industrial production by 31.6 percent, stock prices by 46.6 per­cent, and corporate profits by 92 per­cent. The government had not yet begun to keep track of unemployed workers, but estimates of their numbers ranged from 2 million to 6 million out of a nonagricultural labor force of 31.5 million. Average disposable farm income between the crop years 1919–20 and 1920–21 fell by 56.7 percent—no small thing when the agricultural economy contributed some 17.5 percent of national income. Bank­ruptcies claimed thousands of businesses, including Truman & Jacobson, a Kansas City haberdashery co-owned by the future thirty-third president of the United States.

By the contemporary reckoning of the English economist T. E. Gregory, the world in 1921 was “nearer collapse than it has been at any time since the downfall of the Roman Empire.” Certainly, in America, there was no mistaking the postwar zeit­geist for the Era of Good Feelings. The influenza pandemic of 1918–19 preceded race riots and the Red Scare of 1919–20; the pandemic killed 40 million people world­wide, including 675,000 Americans out of a U.S. population of 103 million. On Septem­ber 16, 1920, a terrorist explosion on Wall Street killed thirty-eight and wounded three hundred. Later that month, a grand jury began hearing evidence about several Chicago White Sox players’ alleged fixing of the 1919 World Series.

The past, it’s said, is a foreign country. Who, today, can easily imagine the Fed­eral Reserve raising its policy interest rate to treat the scourge of deflation? Or who can imagine a Federal Reserve chairman writing the words that Benjamin Strong, governor of the New York Fed, presciently committed to paper in 1919, even before prices had begun to tumble? Of the defla­tion he anticipated, Strong opined:

I believe that this period will be accompanied by a considerable degree of unemployment, but not for very long, and that after a year or two of discomfort, embarrass­ment, some losses, some disorders caused by unemployment, we will emerge with an almost invincible banking position, with prices more nearly at competitive levels with other nations, and be able to exercise a wide and important influence in restoring the world to normal and livable conditions.  

Strong was neither ignorant nor cruel. Implicit in his words was a deep faith in the self-correcting nature of markets and in the strength and resilience of American finance. Inflation had distorted wages and prices. Both were destined to fall. If the central bank could give them a push, so much the better for the timely return to a sustainable prosperity.

But prices and wages fell only so far. They stopped falling when they became low enough to entice consumers into shopping, investors into committing cap­ital, and employers into hiring.

Over and done within eighteen months, the depression of 1920–21 was the beau ideal of a deflationary slump. 

“CHARGE OFF OUR LOSSES AND START AFRESH”

It’s a modernist dogma that the econ­omy is the government’s to manage. A second such article of faith is that hard times are no occasion for balanced federal budgets or high real interest rates. The Harding-Coolidge administration cred­ited none of the second doctrine and little of the first. President Harding delivered his inaugural address of March 4, 1921, without once speaking the word recession or depression. Even if he had used either word, he probably would not have felt obliged to pull a macroeconomic rescue plan out of his sleeve.

“The economic mechanism is intri­cate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals,” Harding said. Here he acknowledged both the war-induced derangements to the established channels of trade and the complexity of all human action.

Vague as to what the administration could do, the president was definite as to the innovations it would never attempt. Striking to the twenty-first-century reader of the president’s text is the absence of today’s deflation-phobia.

“Perhaps,” said Harding, “we never shall know the old level of wages again, because war invariably readjusts com­pensations…. We must face a condition of grim reality, charge off our losses, and start afresh. It is the oldest lesson of civilization.”

Harding’s secretary of the treasury, the banker and industrialist Andrew Mellon, set about making that fresh start. Growth through reduction was the essence of the Mellon program. Shrink tax rates, interest rates, and public spending, the Harding-Coolidge administration urged—and it proceeded to do just that.

Market interest rates had in fact been falling since the bond market put in its lows in price (which is to say, its highs in yield) in May 1920. Mellon sought, and promptly achieved, a corresponding reduction in the Federal Reserve’s tower­ing 7 percent discount rate. He refinanced the immense federal war debt, announced a $500 million budget surplus for the 1921 fiscal year, and began the work (especially congenial to him) of slashing the previous maximum income-tax rate of 70 percent to 40 percent.

Over and done within eighteen months, the depression of 1920–21 was the beau ideal of a deflationary slump. Constructive federal inaction gave scope to the free play of the price mechanism, Adam Smith’s invisible hand. Not only did prices tumble; wages, too, were allowed to fall, thereby affording some small pro­tection, at least, to eviscerated corporate profit margins.

But no sooner did the stock mar­ket crash in 1929 than Herbert Hoover, Harding’s and Calvin Coolidge’s hyperenergetic secretary of commerce, declared that wages should not, and must not, fall. So saying, Hoover contributed the might of his office to the collapse of corporate profitability in the Great Depression.

In the spring of 1930, Irving Fisher, the brilliant (though not unerring) Yale economist, remarked that “the difference between the present comparatively mild business recession and the severe depres­sion of 1920–21 is like that between a thunder-shower and a tornado.”

Anticipating myriad historians and economists yet unborn, Fisher had it exactly backwards.

James Grant is the founder and editor of Grant’s Interest Rate Observer. He is the author of nine books, including The Forgotten Depression: 1921—The Crash That Cured Itself, from which this essay is adapted.

This article appears in the Winter 2025 issue of the Coolidge Review. Request a free copy of a future print issue.