The Not-Great Depression

The Forgotten Depression is a narrative history of the depression of 1920–21. Although it is informed by a very definite theory—the Austrian business cycle theory—it is not a standard work in applied economics. It does not first present the theory in a rigorous formulation and then move on to apply the theory by adducing pertinent qualitative facts and statistical data to explain a complex historical event such as a depression. It instead proceeds by way of anecdotes and contemporary media accounts liberally seasoned with telling quotations from politicians, policy makers, economists, business leaders, and other contemporary observers of the unfolding depression. Data on money, prices, and production are inserted at crucial points to keep the reader abreast of the economy’s precipitous decline, but they do not dominate and weigh down the story. James Grant, a masterful stylist, effectively weaves these disparate elements into a seamless and compelling narrative that never flags in pace or wanders off track. The book should appeal to a wide variety of readers, from college students and business professionals to academic economists and policy makers.

By proceeding anecdotally, Grant gives the reader an intimate “feel” for the intellectual milieu prevailing at the time, offering a bracing immersion into an economic paradigm unimaginably alien to contemporary thinking about business cycles. It is for this reason that the book is especially valuable for academic economists whatever their theoretical bent or policy predilections. Grant conveys to the reader a clear understanding of a policy for curing depressions that was nearly universally prescribed in the era before macroeconomic concepts and formulas fastened themselves upon the minds of economists and media opinion molders. This policy is today derisively referred to as “liquidationist.”

To understand the liquidationist position, one must first grasp its foundational concepts and assumptions. In the world of the early 1920s so richly portrayed by Grant, there was no national macroeconomic entity with which economic theory and policy were concerned: “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” (p. 128; see also p. 67). Economists—with a few notable exceptions—did not think of the “price level” as a unitary statistical construct or worry overmuch about its fluctuations. Nor did they try to calculate “aggregate demand” or total spending or even consider either relevant to economic performance. Indeed, for most economists, the core of the market economy was the interdependent system of money prices, including wage and interest rates. Money prices were seen as the foundation for the calculations of revenues, costs, profits, and asset values upon which entrepreneurs based their resource-allocation decisions. Furthermore, it was widely recognized that money prices were in constant flux as they coordinated economic activities in the face of ceaseless change in consumer tastes, business organization, technology, population, labor skills, and so on. As Grant aptly and incisively expresses his theme in the preface, “The hero of my narrative is the price mechanism” (p. 2).

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The favorable view of liquidation as a cure for depression thus arose naturally out of the belief that the price mechanism, when left undisturbed, benignly adapts resource allocation and production to the underlying economic realities. As Grant points out, to liquidate, as the term was used at the time, simply meant “to throw on the market” (p. 172). In this sense, “liquidating” labor, inventories, farms, and businesses was a call to allow the price system to operate to discover the configuration of wages, prices, and asset values appropriate to the reemployment of idle resources in the production of goods most urgently demanded by consumers. If this price adjustment incidentally resulted in deflation, then so be it. In lieu of the fictitious concept of a unitary price level, inert and resistant to movement, money prices were conceived as naturally and fluidly (but not instantly) moving up and down like a swarm of bees in flight. The fact that the “price swarm” might be ascending or descending would not inhibit and, indeed, might be required to facilitate necessary changes in the relative positions of money prices. (The metaphor of a “price swarm” wasn’t coined until 1942 by Arthur W. Marget in The Theory of Prices: A Re-examination of the Central Problems of Monetary Theory, 2 vols. [New York: Kelley, 1966, pp. 2:330–36], but it aptly describes the earlier classical-liquidationist view of the value of money.) Deflation presented no special problem because the classical view of the value of money still prevailed. In this view, money’s value was simply the unaveraged array of money prices inverted to reveal the alternative quantities of each good or service that exchanged for the money unit—for example, the dollar. Money prices fluctuated freely, so then must the value of money, which was determined in the same integral market process.

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