Forum Post: How austerity cured a depression

From James Grant, Interest Rate Observer

Our Great Recession ended 2½ years ago, according to the official cyclical timekeepers, but you wouldn’t know it by a glance at the news. Zero percent interest rates and $1 trillion in “stimulus” notwithstanding, the U.S. economy can hardly seem to heave itself out of bed in the morning. Now compare this with the first full year of recovery from the ugly depression of 1920-21. In 1922, under the unsung stewardship of the president best remembered for his underlings’ scandals and his own early death in office, the unemployment rate fell from 15.6 percent to 9 percent (on its way to 3.2 percent in 1923), while constant-dollar output leapt by 16 percent. After which the 1920s proverbially roared.

And how did the administration of Warren G. Harding, in conjunction with the Federal Reserve, produce these astonishing results? Why, by raising interest rates, reducing the public debt and balancing the federal budget. Let 21st-century economists rub their eyes in disbelief. Eighteen months after the depression started, it ended.

When he wasn’t presiding over a macroeconomic miracle cure, Harding convened a world disarmament conference and overhauled the creaky machinery of federal budget-making. For his trouble, historians customarily place him last, or next to last, in their rankings of U.S. presidents. Incredibly, they consign him near the bottom even in the subcategory of economic management, about 40 places behind Franklin D. Roosevelt, who inherited a depression that he didn’t actually fix. This year’s GOP aspirants are tussling over the mantle of “Reagan Republican.” A forward-thinking politician might lay claim to the Harding legacy instead.

You couldn’t dislike the handsome and amiable alumnus of Ohio Central College. He was one of three members of the Class of 1882 who, with some partners, bought control of the decrepit Marion, Ohio, Star newspaper in 1884 and turned it into a moneymaker. Gentle and accommodating to a fault, editor Harding would gladly withhold a fact or a name from a delicate story lest his newspaper cause unnecessary hurt to a neighbor. He was elected a state senator in 1899, lieutenant governor in 1903 and a U.S. senator in 1914.

Harding’s style of politicking was as easygoing as his personality. What his constituents were for, he liked, too. Peace, harmony and party loyalty were his watchwords. You’d never hear him sniping at a fellow Republican (except once, at Teddy Roosevelt) or even at a Democrat. In Washington, his cigar box, liquor cabinet and poker table were open to good fellows of any political stripe. Present for only slightly more than half of the recorded floor votes during his single Senate term, Harding made time for the little pleasures in life.

Possibly no political figure in Washington bore less resemblance to the austere occupant of the White House than the convivial senator from Ohio. President Woodrow Wilson — moralist, reformer and intellectual — read books and wrote them. Harding made no pretense to living the life of the mind. He liked people better than books, anyway.

And when, at the 1920 National Republican Convention, the hot and exhausted delegates looked for someone who could win the presidency and unite a deadlocked party, they picked Harding. “Everyone’s second choice,” the pundits sneered.

“I guess you have nominated the wrong candidate, if this is the plan,” Harding told the handlers who urged him to attack the, by then, hugely unpopular incumbent, “for I will never go to the White House over the broken body of Woodrow Wilson.” Campaigning from his front porch in Marion, Harding had hardly a cross word for anyone. Rather, he called for lower taxes, economy in government, restricted immigration, an anti-lynching law and responsible enforcement of the Volstead Act, by which America had voted to enforce Prohibition. “Most of all,” wrote Harding’s best biographer, Robert K. Murray, “he advocated allowing the nation to experience a period of tranquility in which it could restore itself and return to ‘normalcy.’ ” Against fellow Ohioan James M. Cox, Harding won in a landslide.

It was an untranquil country he was elected to govern. In the 1918-19 flu pandemic, 675,000 Americans died, more than 10 times the number of U.S. battle deaths in the Great War. In the months before Election Day, consumer prices were rising at year-over-year rates of more than 20 percent, a legacy of wartime spending and borrowing. Partisans picked sides in the Bolshevik Revolution, and capital and labor were at each other’s throats. On Sept. 16, 1920, a bomb exploded on Wall Street, killing or wounding more than 200 people. Normalcy was, indeed, just what the doctor ordered.

Candidate Harding had promised “less government in business and more business in government,” and he was as good as his word. In June 1921, he signed the bill that created the Bureau of the Budget, forerunner to today’s Office of Management and Budget. “There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures,” the new president said. “We want to reverse things.”

Harding uttered these words as prices were collapsing and the nation’s output was shrinking. From top to bottom, 1920-21, consumer prices fell by 8.3 percent, wholesale prices by 40.8 percent and the Dow Jones Industrial Average by 36 percent. The Federal Reserve, founded in 1913 and still new to the job, regarded these dislocations clinically. As prices had skyrocketed in the war, so they should come back down to earth, the central bank reasoned. Besides, the nation was on the gold standard; they couldn’t just print the money.

“[A]fter a year or two of discomfort, embarrassment, some losses, some disorders caused by unemployment,” Ben Strong, the Ben Bernanke of his time, predicted in 1919, “we will emerge with an almost invincible banking position, prices more nearly at competitive levels with other nations, and be able to exercise a wide and important influence in restoring the world to a normal and livable condition.” You can call it monetary malpractice — farmers called it worse — but tight money hastened the liquidation of misconceived wartime investments. And just as Strong predicted, the banking system weathered the storm. In 1920-23, the biggest institution to fail was little First National Bank of Cleburne, Tex.

Well, how did the nation ever climb out of the deflationary abyss? By the age-old magnetic power of high interest rates and low investment values. Foreigners sent their gold to America to seize the bargains before they vanished — and up went the prices that had fallen so frighteningly. As for Harding, he fostered recovery as much by what he didn’t do as by what he did. The Bureau of the Budget brought public spending to heel, but the president encouraged private spending by speaking up for business. The Harding administration’s “avowed purpose,” historian George Soule writes in “Prosperity Decade,” “was to withdraw as far as possible from exerting any influence on the economic life of the country except the encouragement that might be derived from a balanced budget and nonintervention with private enterprise.” The nation was duly encouraged.

Harding, the 882-day president, died on Aug 2. 1923. He lived to see the first fruits of his policies, though not their full flowering under his boom-time successor, Calvin Coolidge (nor, happily, the disgrace of some of his crooked friends and deputies in the Teapot Dome affair). Remarking on the depression that came and went, Murray observes that “the art of economic prognostication and statistical evaluation was still in its infancy.” A good thing, too, if one judges by the results.