Lessons from The Forgotten Depression

A Book Review

by Chris Mayer, Daily Reckoning

[“History, n. An account, mostly false, of events mostly unimportant, which are brought about by rulers mostly knaves and soldiers mostly fools.” – Ambrose Bierce, The Devil’s Dictionary]

Jim Grant’s The Forgotten Depression is a history, and as with all history, it has an agenda. Here Grant puts forward the thesis that the 1921 crash cured itself. The economic ship of state righted itself without aid from government bailouts, stimulus and the like. The implied lesson is that perhaps we moderns would be wise to follow suit.

Whether or not you believe his thesis is beside the point of what follows. But I will say this about drawing lessons from history: Don’t.

I don’t quite go all the way with Henry Ford when he declared, “History is bunk!” But I do think history proves virtually nothing. It is a tangle of details that needs a human being to sort it into a tale. And that tale will be reflective of the human being doing the sorting. All history is a kind of autobiography.

The historian sees what he wants to see. Objectivity is a phantom. Truth, as far as history goes, is elusive. There is only perspective and what the historian chooses to leave out.

A few simple thought experiments will show how I think about it. What caused the American Revolution? When did it begin, exactly? Why, on that day in July, in that year, 1776, did those American rebels declare independence? It is not so easy to answer. There are many interpretations. Final causes remain a matter of debate.

The same goes for almost any historical event of reasonable complexity. Even small questions remain somehow mysterious. Why did the market crash in October 1987? Theories abound, but I find them all on the level of speculation. There is no good answer why it had to happen on that day, in that year. Why not the next month or the previous month? Why 1987?

And so I look at history with the eye of someone transacting with a shady merchant in Istanbul’s famed bazaar. I don’t trust a thing he says. (Bierce was on to something.)

History can rarely, if ever, prove anything – the efforts of historians notwithstanding. Grant is not unaware of the historian’s conceit. At one point, addressing the idea that it is best to leave an economy to heal itself, he writes:

“Whatever might be said about that proposition in general, the American experience in 1920-21 and 1929-33 does not disprove it.”

Agreed. As Karl Popper taught, there are only provisional truths, truths that have yet to be falsified. History’s particular challenge is that we can’t repeat the experiment. It is impossible to roll back the tape, change one detail and see what happens. Therefore, one can only guess.

As skeptical as I am about history, I still love the subject. I still draw insights from history, but of a different kind than most. And so it is with Grant’s book. I think it teaches history’s best lesson: No one knows what’s coming next.

Though it is not the focus the author intended, Grant’s history shows again and again how life humbles us all. I give you four anecdotes from the book. (I could’ve chosen more.)

• The Income Tax

In 1913, a Progressive congressman proposes an income tax amendment. The proposed tax rate topped out at 68% on incomes above a million dollars. Grant quotes The New York Times of the day: “The amendment was, of course, beaten.”

It is the “of course” that resonates. No way, contemporary thinking went, would that ever pass.

Yet by 1918, the U.S. Treasury was taking 77% of incomes above $1 million.

• National City’s Mistake

And here is another revealing anecdote.

National City Bank. Conservative. Safe. Enormously profitable. And by 1905, the nation’s largest bank.

“It was not infallible,” Grant writes. On the eve of the Bolshevik Revolution of 1917, City was busy building branches, gathering Russian deposits and investing in Russian bonds.

Grant quotes Frank Vanderlip, second in command at the bank: “Of all the foreign countries, there is none that offers a more promising outlook than Russia.” That was in 1916. One year later, it was game over.

• World War I Surprised the Market

World War I was a total surprise to the market. “To judge by the action of the world’s stock market, not even the money men saw it coming,” Grant writes. More than a surprise, contemporaries seemed to think such a general war was not even possible.

Grant wrote:

“As the impossible proceeded to unfold, the belligerents abandoned the gold standard, declared debt moratoria and closed stock exchanges.”

The war was one of the great disasters of that century. And no one saw it coming.

What is the Income Play Rich Investors Love? (Hint: It’s Tax-Free)

As I say, history teaches humility. That is its first and greatest lesson.

• The Unexpected Post-WWI Boom

One more: There is the postwar boom in 1919. WWI was over, and everyone thought the market and economy would suffer. Yet the economy boomed.

Grant wrote:

“Doomsayers could hardly believe their eyes, Surely, they reasoned, a postwar boom was a contradiction in terms. What was needed – and what was, on form, inevitable – was a bust.”

They were wrong… for a while.

The 1921 Depression

When the 1921 depression did come, it was nasty. To show this, we can use a variety of statistics. Here we face yet another problem. Which statistics? Some are better than others.

Gross national product, for example, fell 24% from 1920-21. But that is a horrible abstraction. What is GNP? It is something made up. And anyway, you have to adjust it for changes in the value of money. Then you open another box of problems. What was the change in the value of money? Or, as we more commonly pose the question: What was the inflation (or deflation) rate?

The problem again is that inflation and deflation are ideas in the mind. They are not real. They are not something we can just grab. They are assumptions. They are ideas people create. As with gross national product, they are a guess.

Even unemployment is hard to figure. Grant writes that “a crude measure of unemployment” might indicate a 15.3% rate in 1921. But he adds many caveats about what that figure includes and doesn’t include. “The data are, at best, indicative,” he writes. And I would agree heartily on that point.

In tending to his statistical portrait, I was glad to see Grant cite the economist Oskar Morgenstern. He is the author of one of my favorite economic essays, “Qui Numerare Incipit Errare Incipit” (a Roman maxim meaning “He who begins to count begins to err”). Morgenstern makes a convincing case that economic statistics are guesses with wide error rates, and should be treated as such.

Nonetheless, some stats are concrete, where others are abstract. Auto production is concrete. It fell 23% in 1920-21. The number of companies reporting a profit in excess of $100,000 – also a concrete figure – fell by 45%. Commercial failures tripled from 1919-21, to 19,652. These kinds of figures are more tangible. They all paint a portrait of a harrowing depression.

The stock market, too, draws a clean picture. The Dow Jones industrial average hit a high in January 1920, at 109.88. By September, it was 88.63 – a drop of 19%. By Dec. 21, it was 66.75 – a drop of 39% drop from the high.

It was rough, yet the government stood by with relative indifference, as Grant tells the tale. President Harding’s inaugural address in March 1921 – with the depression already 15 months old – barely acknowledged the collapse.

“Neither did he propose a government plan to stop it. Rather, he seemed to trust in the curative powers of supply and demand.”

That view was the mainstream one at the time. Grant’s Chapter 11, titled “Not the Government’s Affair,” seems to say it all. In fact, the idea that an “economy” existed was still not yet formed. It would have to wait until the 1930s. Today, we talk about the economy as if it were a real thing, with a life and health of its own. (And we are worse off because of it.) People before 1930 did not think in such terms.

Thus, Grant:

“As far as the political-economic mind of 1920 was concerned, there was no ‘U.S. economy.’ And as the economic totality was yet unimagined, so too was the government’s role in directing, managing and stimulating it.”

The reward for such inaction, he says, was that the depression was over in 18 months.  Grant concludes:

“The depression of 1920-21 was terrible in its own way. In comparison to what was to follow, it was also, in its own way, a triumph.”

Perhaps. I’m an anti-government man myself, in the tradition of H.L. Mencken and Albert Jay Nock, of Henry David Thoreau and Lysander Spooner. So I know how I would like to read the events of 1920-21. But with history, you can never really know… and that is its greatest lesson.

In any case, if you enjoy financial history, you will enjoy Grant’s book.