Daniel Kuehn Explains the Dearly Beloved Depression of 1920-21

In the folklore of modern Austrian Business Cycle Theory, the Depression of 1920-21 occupies a special place. It is this depression that supposedly proves that all depressions are caused by government excesses and that, if left unattended, with no government fiscal or monetary stimulus, would work themselves out, without great difficulty, just as happened in 1920-21. In other words, government is the problem, not the solution, and the free market is the solution, not the problem. If only (the crypto-socialist) Herbert Hoover and (the not-so-crypto) FDR had followed the wholesome example of the great Warren G. Harding, cut spending to the bone and cut taxes, the Great Depression would have been over in 18 months or less, just as the 1920-21 Depression was. And if Bush and Obama had followed the Harding example, our own Little Depression would have surely long since have been a distant memory.

In two recent papers (“A Critique of the Austrian School Interpretation of the 1920-21 Depression“, “A note on America’s 1920-21 depression as an argument for austerity“), fellow blogger Daniel Kuehn provides some historical background and context for the 1920-21 Depression, showing that the 1920-21 Depression was the product of a deliberately deflationary fiscal and monetary policy aimed at undoing (at least in part) the very rapid inflation that occurred in the final stages and the aftermath of World War I. In that sense, the 1920-21 Depression really is very much unlike the kind of overinvestment/malinvestment episodes envisioned by the Austrian theory.

The other really big difference between the 1920-21 Depression and the Great Depression is that there was effectively no gold standard operating in 1920-21. True the US had restored convertibility between the dollar and gold by 1920, but almost no other currencies in the world were then tied to gold. The US held 40 percent of the world’s reserves of gold, so the US was determining the value of gold rather than gold determining the value of the dollar. The Federal Reserve had as much control over the US price level as any issuer of fiat currency could ever desire. By 1929, there was a world market for gold in which many other central banks were exerting — and none more than the insane Bank of France — a powerful influence, almost exclusively on the side of deflation. Thus, immediately following a wartime inflation — historically almost always a time for deflation — it was relatively easy to unwind the inflationary increases in wages and prices of the preceding few years. When the Fed signaled in 1921, by reducing its discount rate, that it was no longer aiming for deflation, the deflation quickly came to an end. But in the Great Depression, notwithstanding the characteristically exaggerated, if not delusional, Austrian rhetoric about the inflationary excesses 1920s, there was in fact no previous inflation to unwind.  As long as a country remained on the gold standard, there was no escape from deflation caused by an increasing real value of gold.

On at least one occasion, no less an authority on Austrian Business Cycle theory than Murray Rothbard, himself, actually admitted that the 1920-21 Depression was indeed a purely monetary episode, in contrast to the Great Depression in which real factors played a major role. In the late 1960s, when I was an undergrad in economics at UCLA, Rothbard gave a talk at UCLA about the Great Depression. All I really remember is that he spent most of the talk berating Herbert Hoover for being just as bad as FDR. Most people were surprised to find out that Hoover was such an interventionist, though anyone who had read Ronald Coase’s classic article on the FCC would have already known that Hoover was very far from being a free market ideologue. I had just started getting interested in Austrian economics – while my contemporaries were experimenting with drugs, I was experimenting with Austrian economics; go figure! I sure hope no permanent damage was done – and was curious to hear what Rothbard had to say. But it was all about Herbert Hoover. Later, I asked Axel Leijonhufvud, who had also attended the talk, what he thought. Axel said that Rothbard was a scholar, but didn’t elaborate except to say that he had chatted with Rothbard after the talk asking Rothbard if there had ever been a purely monetary depression and that Rothbard had said that the 1920-21 Depression had been purely monetary. So there you have it, Rothbard, on at least one occasion, admitted that the 1920-21 Depression was a purely monetary phenomenon.


27 Responses to “Daniel Kuehn Explains the Dearly Beloved Depression of 1920-21”

  1. 1 Daniel Kuehn February 2, 2012 at 4:52 am

    Thanks for the links, and the additional detail!

    The second article is open access, so please click through, readers.

    I also can’t stress enough how good Christina Romer’s article on 1920-1921 is – that’s worth reading too, and I think the pdf is available for those of you without access to the journal.


  2. 2 Daniel Kuehn February 2, 2012 at 4:55 am

    Also – both links point to the first article. This is the second one (which is open access): http://cje.oxfordjournals.org/content/36/1/155.full.pdf+html


  3. 3 Invisible Backhand February 2, 2012 at 6:55 am

    I think forgot to put ‘sort’ in ‘would themselves out’.

    You and Daniel are much more gracious and charitable to the Austrians than I am. I think it’s economics bought and paid for by the rich to give justification to what the wants of the rich. As such I believe the conclusions come first and the evidence comes after with them.


  4. 4 Daniel Kuehn February 2, 2012 at 7:35 am

    re: “As such I believe the conclusions come first and the evidence comes after with them.”

    In the case of the really strict a priorists, of course, the evidence never comes!


  5. 5 David Pearson February 2, 2012 at 8:40 am

    Did we have a strong recovery because the Fed loosened policy, or because inflation eliminated the debt overhang?

    Today, both the Fed and MM’s argue the debt overhang is irrelevant to the recovery. In fact, all of the major global central banks are actively pursuing a policy of maintaining the value of outstanding debt by 1) promising low and stable l.t. inflation; 2) reducing the carrying cost of impaired collateral (ZIRP); and 3) propping up asset prices. Unfortunately, the latter two reduce expected real returns to new investment in an effort to protect the value of legacy investment. Is it any wonder, then, that the recovery is weak?


  6. 6 David Pearson February 2, 2012 at 8:40 am

    In the first paragraph above, the question refers to the ’21 Depression.


  7. 7 Daniel Kuehn February 2, 2012 at 9:29 am

    David –
    Yes, I think that’s definitely right. I discuss the role of the inflation in eroding debts in my CJE article. There was no consumer debt to speak of at that time either. That prevented the problem of a debt-deflation spiral that Fisher would go on to elaborate a decade later (and would prove such a problem in 1931 and 2008)

    Still, the depression was caused in part by tight money (see Romer for other important causes), and loosening that definitely played a prominent role in the recovery.


  8. 8 David Pearson February 2, 2012 at 11:27 am

    My point is that protecting the value of outstanding debt reduces the effectiveness of monetary policy. “V” is partly a function of expected real returns to investment and new borrowing, as well as of consumer expectations of future real discretionary income growth. Both of these expectations are negatively affected by the Fed’s policy of protecting the value of outstanding debt. Market Monetarists might argue their intent is to reduce the value of debt through higher inflation. The problem with this argument is that a couple years of modestly higher inflation has little impact on debt values. Inflation that is persistently higher than anticipated does.


  9. 9 Lars Christensen February 2, 2012 at 1:56 pm

    David, very, very impressive stuff. Good work from Daniel. I hope I will have time to blog about this as well. I have never spend much time on 1920-21, but it is clearly worth studying. Thanks!


  10. 10 Mike Sax February 2, 2012 at 5:15 pm

    Interesting history. Seems to me to be right on target. In a way I’m even kind of surprised to hear you as a Monetarist-of any kind-admit that the Great Depression was not a wholly monetary phenomenon. To be sure I am not yet as aware of your views as some of the other MMers.


  11. 11 JP Koning February 2, 2012 at 6:54 pm

    “True the US had restored convertibility between the dollar and gold by 1920…”

    I’ve never heard of the Fed removing gold convertibility at all in the period between 1914 and 1920.


  12. 12 Bob Murphy February 2, 2012 at 8:33 pm

    David (Glasner), I confess I don’t understand the dichotomy you are setting up here. Which depression are you saying fits in with canonical Austrian business cycle theory–the 1920 one or the 1930 one? What does it mean to call a depression “purely monetary” in this context? You obviously don’t mean that there were no real effects; unemployment shot up and production fell. So what do you mean, and how was the Great Depression both monetary and real (presumably) in a way that the 1920 depression wasn’t?


  13. 13 Mike Sax February 2, 2012 at 8:57 pm

    Bob, I’m pretty sure David means 1920 was the canonical one. Austrians often do point to that as how a recession is supposed to work, and supposedly if the same policy had been pursued in 1929 it would have also lasted one year.

    It seems that what was “purely monetary” about 1920 is that it was deliberately caused to whip the WWI inflaton.


  14. 14 David Glasner February 3, 2012 at 12:14 pm

    Daniel, You’re welcome. I haven’t read Romer’s article, but will try to have a look at it soon. Sorry for the mixup of the links; I think I have them straight now.

    Invisible Backhand, On principle, I don’t try to discredit an argument based on the motivation of those advancing it. I think that is an illegitimate way to argue. You, of course, are free to use whatever arguments you please.

    David, I think that Daniel has answered the question as well as I could. I actually don’t think that the debt overhand is irrelevant, and I think reducing the burden of debt is a valid argument in favor of inflation in some cases. I think ours is one of them.

    Lars, Thanks. And thanks as well for the post on your blog.

    Mike, You are misunderstanding me. I think that the Great Depression was somewhere between 98 and 99 percent a monetary phenomenon. I was saying that in Austrian economic historiography, the Great Depression is treated as a real phenomenon (i.e., produced by real distortions of the capital structure that made existing production processes physically unsustainable) that resulted from inflationary monetary expansion. This is in contrast to the view I attributed to Rothbard that the 1920-21 Depression did not involve a real distortion of the capital structure simply the imposition of deflation by the monetary authority.

    JP, The legalities of the gold standard are complicated. In my view after the US entered WWI, the dollar became effectively inconvertible, because any attempt to redeem dollars would have been construed as a disloyal act on the part of any American citizen, so that it was impossible for commodity arbitrage to equalize dollar prices of commodities with their gold equivalents.

    Bob, I think that my answer to Mike Sax above should clarify for you the point of confusion.

    Mike, No that’s not what I mean. In my view both recessions were purely monetary, i.e, there was no distortion of the real capital structure that required rectification through the wholesome purgatory process of deflation and liquidation. Both were produced almost entirely by monetary causes, but the 1920-21 episode was produced by a deliberate and calculated decision of an (effectively) unconstrained monetary authority while the Great Depression was produced by the perverse monetary dynamics associated with the reestablishment of the gold standard combined with the monetary policy of the insane Bank of France and the clueless Federal Reserve.


  15. 15 Bob Murphy February 3, 2012 at 9:28 pm

    Invisible Backhand wrote: You and Daniel are much more gracious and charitable to the Austrians than I am. I think it’s economics bought and paid for by the rich to give justification to what the wants of the rich.

    So rich people are writing big checks to the Mises Institute, to get the Fed shut down?

    (And thanks Daniel Kuehn for sticking up for the Austrians in the face of Invisible Backhand’s attacks. I’m glad to know you’ve got my back.)


  16. 16 Daniel Kuehn February 4, 2012 at 8:13 am

    Bob – I should collect all the times I’ve shut down IB on this argument in the past. I do it regularly, and he knows how I feel about it!!

    I thought my response to him in this case was pretty funny! I can’t wag my finger at him all the time.


  17. 17 Bob Murphy February 4, 2012 at 2:43 pm

    Well then you are to be congratulated Daniel that you defend the Austrians, even when they’re not looking.


  18. 18 JazzBumpa February 5, 2012 at 2:03 pm

    The short 1920-21 depression and the long 1929 depression occurred in vastly different circumstances, a couple of which have been pointed out here.

    I’ve been able to uncover these differences:

    1920 preceded by large deficits, 1929 preceded by surpluses.
    1920 preceded by inflation, 1929 preceded by no inflation.
    1920 preceded by war, 1929 preceded by peace.
    1920 depression possibly softened by export strength, 1929 ???
    1920 evidently not near the 0-interest rate bound, 1929 probably approaching it.
    1920 gold standard not in force, 1929, gold standard in force.
    1920 deflation a local U.S. phenomenon, (in fact,there was hyperinflation soon after in Austria and Germany, an experience that deeply informed von Mises’ views) 1929, deflation wide spread around the world.

    The U.S. debt overhang in 1929 was far greater, as well.

    My problems with the Austrian view are 1) their insistence that the 1920 paradigm is applicable in all times and places, and 2) their stretch to claim that 1921 refutes Keynes and FDR in the 30’s, when the entire situation was different.

    Also, if they claim that there was no intervention, that isn’t right. As you point out, the interest rate was manipulated.

    One might also consider what the much maligned Herbert Hoover was doing in 1921 as Secretary of Commerce, with relief to the unemployed and organized cooperation between federal and local governments – to increase public works, and devise work sharing programs.

    Those last bits of information come from none other than Murray Rothbard.




  19. 19 gliberty February 10, 2012 at 10:07 am

    “notwithstanding the characteristically exaggerated, if not delusional, Austrian rhetoric about the inflationary excesses 1920s, there was in fact no previous inflation to unwind. As long as a country remained on the gold standard, there was no escape from deflation caused by an increasing real value of gold.”

    I wonder then, about this, which I just saw written about in the WSJ:

    ‎”Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.
    … In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming “A great crash is coming, and I don’t want my name in any way connected with it.”

    We all know what happened next. Pretty much right out of Mises’s script, overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. The brittle tree snapped. Following Mises’s logic, was this a failure of capitalism, or a failure of hubris?

    Mises’s solution follows logically from his warnings. You can’t fix what’s broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don’t encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts. (You see where I’m going with this.) The distortions must be removed or else the precipice from which the system will inevitably fall will simply grow higher and higher.”



  20. 20 Bob Roddis February 23, 2012 at 9:37 pm

    Kuehn’s first paper is addressed quite well here:


    His second paper demonstrates the Rothbardian claims that:

    a) The Fed facilitated the slaughter of WWI;

    b) The Fed and the government caused the wartime inflation and distortions; and

    c) The Fed and government’s attempts to return to a postwar “normalcy” triggered a severe depression with rather extreme price and wage reallocations that occurred without much in the way of traditional Keynesian “stimulus”.

    The second paper is an excellent demonstration a) that there is no evidence whatsoever that the 1920 depression (or any depression) was caused by the free market; b) there is no evidence that the free market suffers from any inherent tendency towards unemployment absent “stimulus” and c) that Fed and governmental interference in the market results in significant distortions that must be (but can be) painfully but quickly excised by the market.

    ( Note that the NY Fed discount rate was still at 7% in early 1921 during a period of significant deflation).

    Discount Rates 1921-1927

    And, like all Keynesian analysis of Austrian positions, Kuehn ignores the central Austrian concept of economic calculation and its distortion by Keynesian and interventionist policies and which is a much broader and all encompassing concept than just the ABCT.


  21. 21 David Glasner February 24, 2012 at 11:46 am

    Bob, Thanks for the reference to the discussion of Kuehn’s paper. I’m not sure how you think the Fed was responsible for World War I or the slaughter that took place. The US did not enter the war until 1917, four years after the war started. It is possible that the Fed and the government actually helped end the slaughter. The Fed had no control over inflation until 1917. The US was still on the gold standard before entering the war, so the inflation reflected the declining value of gold as a result of the demonetization of gold coinage by the belligerents. I agree that the post-war depression was caused by monetary policy and came to an end when monetary policy changed without much in the way of fiscal stimulus.


  22. 22 Sean Kennedy December 18, 2016 at 12:05 am

    Invisible Backhand says: “… I think [Austrian] economics [is] bought and paid for by the rich to give justification to what the wants of the rich. As such I believe the conclusions come first and the evidence comes after with them.”

    Ah, yes, the (political) economist as sycophant of capital. Spoken like a true Marxist. Congratulations. Nevermind the possibility of Austrian economics being correct, nor the possibility that its conclusions definitively prove the superiority of the classical liberal doctrines of sound money, private property, and laissez-faire for the flourishing of human living standards and human freedom—and by extension the flourishing of human self responsibility and morality. No, nevermind these things. Austrians are as Marx would, and you do, imagine them.

    To which Daniel Kuehn replies: “In the case of the really strict a priorists, of course, the evidence never comes!”

    Mr. Kuehn, you fundamentally misunderstand the methodological issues involved with Austrian apriorism. Fundamentally. Read anything by Mises, Rothbard, or Hoppe regarding economic method. The methodological arguments are ubiquitous in the Austrian literature, and these writers are the clearest, most insightful, and most accurate you will find on Austrian apriorism.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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