Lessons from the 1920s Depression

U.S. soldiers returning from World War I were greeted by an economic recession almost as severe as the Great Depression that would occur a decade later. Starting in 1920, markets experienced a drastic decline causing unemployment to rise from 5 percent to as high as 12 percent. The rate of business failures tripled, and in less than a year the national economy shrunk by 6 percent. To top it off, the government had been running a deficit to help fund the war efforts and was staggering under an enormous debt.

Throughout this crisis, the U.S. Government remained committed to downsizing. In his inaugural address, President Warren G. Harding assured the American people that his administration would work for “[an end to] unnecessary interference of government with business, for an end to government’s experiment in business, and for more efficient business in government administration.”

A flurry of intentional inactivity followed Harding’s inauguration. Instead of attempting to use government spending to spur economic growth, the Administration allowed markets to work themselves out. Secretary of Treasury Andrew Mellon spearheaded one of the few bills — the Revenue Act of 1921 — which eliminated the excess profits tax, and lowered the top marginal tax and capital gains tax rates. This act allowed individuals and businesses to keep and reinvest their hard-earned profits instead of having it siphoned away through burdensome taxation.

The economy quickly rebounded — unemployment fell 6 percent by 1922 and plunged below pre-depression levels by 1923. By continually cutting government spending, the Harding Administration halved the government budget and reduced the national debt by one-third by 1922. Furthermore, the Dow Jones Industrial Average rallied from 63.90 points in July of 1921 to more than 100 points by the end of 1922. Businesses were recovering profits, stocks were bouncing back, and a major financial crisis was brought to a close.

The 1920s Depression demonstrates how real economic growth begins and ends in the private sector. Instead of competing with businesses or imposing stifling regulations, the government should allow for an environment of economic freedom which encourages business investment and ventures. By lowering taxes and reducing government size, President Harding, and especially his vice president and presidential successor Calvin Coolidge, opened space for entrepreneurial individuals to discover market demands and create value for society. In the end, it was the effort and creativity of ordinary individuals responding to increased economic freedom that ended the depression of 1920.