A Short History of Depressions

“Recessions are common; depressions are rare,” writes Nobel Prize-wining economist Paul Krugman in a recent New York Times column.

Though historians judge otherwise, Krugman believes, “as far as I can tell,” that there have only been two depressions in American history, “the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-1931.”  Current conditions, he notes, might just bring on the “third depression.”

Krugman may be an economist of note, but a historian he is not.  He certainly cannot tell very much.

Major economic depressions, called “panics” in the 19th and early 20th centuries, occurred in approximate 20-year intervals throughout American history – 1819, 1837, 1857, 1873, 1893, 1907, and 1929.  There have also been numerous recessions on a much smaller scale, especially in the 20th century.

Why do we have periodic panics and economic disruptions?  They are simply economic storms, not unlike meteorological ones.

In a borrowed line from the Hollywood film, The Day After Tomorrow, Dennis Quaid’s character, Professor Jack Hall, explains the workings of a physical storm:  “The basic rule of storms is that they continue until the imbalance that created them is corrected.”  A great line that can accurately explain economic tempests. 

Most of the depressions in our history have been caused by imbalances in the currency.

Too much cheap money and lax credit have been the chief faults in causing many economic storms, as is the case with our current mess.  Too much money and too much credit cause reckless speculation, which leads to over-expansion and over-valuation.  The economy can only take so much.  Eventually the bubble will burst, as it did in the fall of 2008 with land and home values, causing millions to go under.

Two 19th century panics, in 1837 and 1893, can also be attributed to imbalances in the currency.

A massive panic struck in 1837, the first year of Martin Van Buren’s presidency.  Andrew Jackson had waged war on the Bank of the United States, killing the renewal of its re-charter in 1832.  To further weaken the bank, the president withdrew the government’s deposits, placing them in smaller state banks, called “pet banks.”  These banks, flush with substantial amounts of cash, began loaning it to businesses and individuals as fast as possible.  All the new money, along with cheap credit, led to wild speculation, mainly in land, causing the values to soar.  When the bubble popped in 1837, it sent the economy crashing.

Van Buren faced mounting pressure by his Whig opponents to raise tariffs and taxes, as well as federal spending, particularly for internal improvements projects like roads and harbors.  The president resisted and, instead, cut expenditures by 21 percent.  The economy recovered, though not quite in time for Van Buren to be re-elected.

In 1893, the nation suffered the worst panic up to that time.  The government, in 1890, had passed a law to purchase all of the domestic silver supply each year, up to 4.5 million ounces.  To make the buy, the Treasury issued new Greenback notes, redeemable in gold.  The new paper notes, along with all the new cheaper silver, flooded the country.  The money caused a massive boom period that saw unemployment drop to just 3 percent.  Every sector of the economy seemed to be doing well, even farmers. 

With the over-expansion, namely in railroad building, the bubble popped in 1893, and by 1894 the unemployment rate reached 18.5 percent and the economy had contracted by nearly 10 percent.

But within two years of the economy bottoming out, President Grover Cleveland, called “the Ron Paul of his day” by economist Tom DiLorenzo, employed conservative policies and oversaw an economic expansion.  By 1897, the year he left office, the economy had grown by 20 percent and the unemployment rate had been slashed to 14.5.

In both cases, 1837 and 1893, the federal government stayed out of the storm and allowed the economy to correct itself, making the crisis short-lived.  This is the reason Krugman does not include 1837 and 1893 in his analysis of depressions.  They were so short that they could not possibly qualify, at least in his way of thinking. 

But the reason earlier depressions did not last long is because the president overseeing them did not use a Paul Krugman remedy – massive government spending.  Krugman, a Keynesian economist, is so convinced that using government spending as an effective economic stimulus that he criticized Obama’s spending plan as too small.  Krugman wanted a stimulus bill twice as large as the $787 billion plan passed in the early part of 2009 and is, even today, pushing for more government spending.

Earlier Americans believed in using laissez faire methods rather than spending.  President Martin Van Buren used retrenchment – the cutting of taxes and spending.  President Grover Cleveland, in 1893, stopped the inflation, reduced tariffs, and sliced expenditures.

By contrast, FDR used the Krugman solution, and as a result, the depression worsened and lasted until the 1940s.  In fact, the Great Depression did not abate until after the war.  It was not until Congress cut personal and corporate taxes in 1945, and discontinued price controls in 1946 that the economy revived.  True economic growth began producing surpluses, which had not happened since 1930, and brought unemployment down to less than 4 percent.

The nation faces two choices – the Roosevelt-Krugman-Obama remedy, or the policy of Van Buren-Cleveland-Ron Paul.  Let history be the judge.