Warren Harding ended a deep depression in 1921 without a stimulus bill

Nothing in Washington is harder than restraint. The federal government faced a sharp, ugly depression, did not pass a rescue package, cut its own spending nearly in half, cut taxes, and watched the economy turn around in about a year and a half. You will not find that sentence in your child's history textbook.

It happened. It happened in 1920 and 1921, and the President who presided over it, Warren G. Harding, is mostly remembered as a punchline, a smiling Ohio newspaperman with a fondness for poker and a cabinet that included some crooks. The scandals are real and I'll get to them. But the economics of his first years deserve a hearing, because they offer the strongest case in American history for a virtue that Washington finds almost impossible to practice: patience.

I want to make that case fairly. That means giving you the part that favors my side, the part that doesn't, and the part where the evidence is just uncertain. Let me start at the beginning.

The bust after the boom

The First World War ended in November 1918. The war economy did not unwind quietly. Prices had been pushed up during the war, there was a brief post-war boom, and then the bottom fell out. The National Bureau of Economic Research, the private group that dates American business cycles, puts the peak of the expansion in January 1920 and the trough in July 1921. Count the months: January 1920 to July 1921 is eighteen months. That is the length of the downturn in question.

It was no mild dip. Prices for farm goods collapsed from their wartime highs, and farmers who had borrowed to buy land and equipment found themselves underwater. Factories cut shifts, businesses failed, and unemployment shot up. A key ingredient was the Federal Reserve, which had raised its discount rate to seven percent in 1920 to cool the inflation of the war years. That was the policy that popped the boom.

The party in the White House took the blame at the ballot box. In November 1920, Harding won in a landslide on a promise to bring the country back to what he called "normalcy" (he had used the word in a May 1920 speech in Boston, and the language-minded mocked him for it). The line people remember is "not nostrums but normalcy." A nostrum is a quack remedy. Harding was telling voters that Washington did not have a magic potion for what ailed them. He was inaugurated on March 4, 1921, with the downturn still under way.

What Harding did: three decisions

Calling this a "do nothing" response is wrong. Harding's government did several things, and all of them pointed in one direction.

One: a real budget

Think about how odd it sounds, but before 1921 the federal government had no unified budget. Each department sent its requests to Congress separately, and the President did not present a single plan. William Howard Taft had asked for an executive budget in 1912 and been brushed off. Congress passed a version in 1920, and President Wilson vetoed it over a provision about removing the head of the new accounting office. Harding signed a corrected bill into law on June 10, 1921: the Budget and Accounting Act of 1921.

It did two big things. It required the President to submit a single annual budget for the whole government, and it created the Bureau of the Budget to prepare it, and the General Accounting Office, headed by a Comptroller General, as an independent auditor for Congress. Harding named Charles G. Dawes, a Chicago banker, as the first Director of the Bureau, and Dawes proved a ferocious saver. He later became Vice President under Calvin Coolidge. For the longer history of how the country went from that law to the modern budget fights, see How Washington learned to budget, from the 1921 act to the 1997 deal.

The Act also set a precedent: the President is responsible for the whole of the government's spending plan, and he has to answer for it. A conservative should like that. It is hard to hold anyone accountable for a pile of separate requests.

The numbers in the following years show the effect. Federal spending in the fiscal year 1920 was roughly $6.4 billion. By fiscal 1922 it was about $3.3 billion. That's nearly half, and by 1923 it was lower still. I want to be careful, though, because I told you I'd be fair: much of that drop was the war ending. The army was demobilizing, and the war bills had come due and been paid. So not all of that decline was policy. Some of it was simply the end of a war. What the policy did was refuse to let wartime spending become peacetime habit.

Two: a tax cut

The man at the Treasury was Andrew Mellon, a Pittsburgh banker, who served from 1921 to 1932. Mellon's argument was that very high top tax rates drove capital into tax-exempt bonds and away from productive business, and that lower rates would draw money back out into the economy. Congress passed the Revenue Act of 1921, signed on November 23, 1921. It repealed the wartime excess profits tax, cut the top income tax rate from 73 percent to 58 percent beginning with 1922 income, and created a lower rate for long-held capital gains.

Do the arithmetic on what that means for the last dollar earned by a high-income taxpayer. At a 73 percent top rate, a person who earns another $1,000 pays $730 and keeps $270. At a 58 percent top rate, that person pays $580 and keeps $420. The difference is $150 on every extra $1,000. Put another way, $420 divided by $270 is about 1.56, so after the cut the taxpayer kept more than half again as much of each additional dollar. Whether that changes behavior is the question the whole debate turns on, and economists have fought about it for a century. But you can see why Mellon thought a person might work, invest or take a risk differently at one rate than at the other. For how this fits in the long line of Republican tax cuts, see Republican tax cuts side by side, from Harding all the way to Trump and The Mellon Tax Cuts of the 1920s and What Happened to Revenue.

Three: letting prices fall and the Fed do its job

The most important decision was a negative one. Neither Harding nor Congress tried to stop the fall in prices and wages with price supports, public jobs programs or large new federal spending. Prices and wages adjusted fast, business inventories cleared, and the market found a floor. Meanwhile the Federal Reserve, an independent body, began to lower its discount rate in the spring of 1921 after holding it high, and kept lowering it.

If you want a plain-English look at what the Fed does and why it matters here, our primer is The Federal Reserve in plain English and the levers it really holds.

The strongest objection: the Fed deserves the credit, not Harding

Now the hard question. Did Harding end the depression? Or was he lucky?

Here is the strongest version of the opposing case, the way a smart economist would put it.

One. The downturn turned in July 1921. The Revenue Act that cut taxes was signed in November 1921 and took effect for 1922 income. The tax cut therefore could not have started the recovery. At most it helped it continue.

Two. The Budget Act was signed in June 1921, one month before the trough. It could not have ended the depression either. A budget bureau takes time to produce results.

Three. The Federal Reserve was the big actor. It raised rates to cause the downturn and cut rates to end it. A monetary authority that controls the supply of credit will usually be able to end a short, sharp contraction, whether or not Congress lifts a finger.

Four. Prices and wages were flexible in 1921. They fell fast, and as they fell, the economy cleared. That's a statement about the economy in 1921, not about Harding.

This is a good argument and I accept most of it. The timing points are accurate, and I will not claim that the tax cut turned the economy around. The honest version of the conservative claim is narrower, and, I think, stronger. It goes like this: whoever gets the credit for the turnaround, the government did not interfere with the process. It did not freeze prices, it did not try to prop up wages or to rescue every failing business, and it did not pile on a spending program that would have to be paid for later. A deep downturn that ended in eighteen months is evidence that markets can heal quickly when they are allowed to, especially when the central bank is helping rather than hurting.

You may still be unpersuaded, and that's fine. Reasonable people look at the same eighteen months and draw different conclusions. What you should not do is accept the claim that "doing nothing" is the only alternative to a large rescue plan. Harding did a number of things, and he kept them modest. There was also a National Conference on Unemployment in September 1921, organized by Secretary of Commerce Herbert Hoover, which urged local public works and cooperation among employers. Hoover took that approach much further in the next depression, which brings me to the contrast worth drawing. The downturn that began in 1929 lasted far longer than eighteen months, and what governments and the Federal Reserve did and did not do in that one is its own story, told in Seven myths about Herbert Hoover the do-nothing president. Anyone who uses 1921 to say "see, nothing works" should be asked to explain 1929 too.

A man of a different kind of mercy

One more decision of Harding's tells you about the man. In 1918 the Socialist leader Eugene V. Debs had been sentenced to ten years under the Espionage Act for giving an antiwar speech in Canton, Ohio. Debs had run for President from a prison cell in 1920. On December 23, 1921, Harding commuted his sentence, and Debs walked out. It was an act of mercy, and a reminder that the Espionage Act prosecutions of 1917 and 1918 put the First Amendment under hard pressure. Harding was a man who liked people, even his opponents, and it showed in this.

The scandal that ate his name

Now to the part of the Harding story that everyone knows. Harding died of a sudden illness on August 2, 1923, while on a trip to the West Coast. Within months, the nation began to learn about the Teapot Dome affair. His Secretary of the Interior, Albert Fall, had secretly leased the Navy's petroleum reserves at Teapot Dome in Wyoming and Elk Hills in California to oil men, Harry Sinclair and Edward Doheny, without competitive bidding, and had taken large loans and gifts from them. A Senate investigation led by Senator Thomas Walsh of Montana exposed the arrangement. Fall was later convicted of bribery and sent to prison, the first Cabinet officer to serve time for crimes committed in office. There were other scandals too, including corruption at the Veterans' Bureau.

Nothing I've written excuses any of that. Harding's weakness was that he trusted friends, and a few of them betrayed him and the country. The evidence that he profited himself is not strong. The evidence that he picked some terrible people for important jobs is overwhelming. Both things are true, and it is possible to say so while also saying that the budget law he signed and the economic path he chose were better than his reputation.

Two lessons from the scandal belong in any conservative's notebook. First, the party that preaches limited government should never be shy of oversight of its own; the Teapot Dome probe was driven by a Democrat, Senator Walsh, and by Republican Robert La Follette's 1922 resolution calling for an investigation, so oversight crossed party lines, and the tradition of honest oversight is covered in Howard Baker asked what the president knew and why oversight is conservative. Second, a good policy record does not excuse a bad appointment record. If you hire carelessly, you will pay for it.

What the 1921 case does and doesn't prove

Let me close the argument with a verdict I can defend.

It does not prove that government should never act in a downturn. Plenty of economists and politicians argue that a deep decline calls for a response, and that the 1921 episode was shorter and shallower than later ones, which makes it a poor template for every crisis.

It does not prove that tax cuts alone cure recessions. The timing makes that claim weak.

It does prove, or at least strongly suggest, three things. A flexible economy with a cooperating central bank can recover fast. A government can cut its spending after a war and survive, which is something Washington has rarely tried. And a President who submits an honest budget and a Congress that has to vote on it are better placed than a government that spends first and counts later.

And it carries a lesson about the kind of patience that voters seldom reward. Politicians are punished for doing nothing and rewarded for doing something, even when the something is a mistake. Harding's greatest virtue in 1921 was the discipline to keep his government's hands modest during a hard time. The family at the kitchen table understands this instinctively. When money is tight at home, you do not borrow your way into a bigger house.

The bottom line

• The depression of 1920 and 1921 lasted eighteen months, from January 1920 to July 1921 by the NBER's dating. Federal spending fell by roughly half in the same period, partly because a war ended and partly by choice.
• The Budget and Accounting Act of 1921 made the President answer for one unified spending plan. That accountability is worth defending whoever is in office.
• Be honest about causation. The Fed gets major credit for the recovery, and the 1921 tax cut came after the turn. The conservative claim that holds up is that government stayed out of the way, not that it worked a miracle.
• Hold your own side to account. Teapot Dome shows what happens when a President's friends are in charge of public property, and oversight is a conservative value.
• Next time someone says there is no alternative to a trillion-dollar rescue, ask them to explain 1921, and then ask them to explain 1929. Both answers are worth hearing.