The coronavirus pandemic has drawn countless comparisons to the Spanish Flu pandemic a century earlier. But the parallels don’t end with the global pandemic.
As philosopher George Santayana famously put it, “Those who cannot remember the past are condemned to repeat it.”
So what lessons can we learn from the run-up to the Roaring ‘20s, the explosive economic growth during them, and their subsequent collapse? While we all inevitably tint our takeaways from history through the lens of our own political worldview, it’s worth spending a few minutes to understand the economic, political, and social factors that created the initial bust, then boom, then collapse that America experienced a century ago.
The Leadup to the Roaring ‘20s
The boom and bust cycles of the 1920s didn’t occur in a vacuum. To understand what happened, you first have to understand the context.
World War I
Wars are expensive.
Wary of the war from the start, Americans had no appetite to pay higher taxes in order to cover the costs of joining it. So rather than raise taxes, the government simply printed new money.
Not surprisingly, this led to rampant inflation — a bogeyman that would haunt the economy for several years after the war ended. Compounding the inflation was a sudden surge in demand in Europe for U.S. exports, because so much of the continent’s industrial capacity had been destroyed in the war. America’s industrial capacity stretched to its limit, exacerbating price spikes.
To combat runaway inflation, the Federal Reserve raised interest rates over 7%. And it worked — at a cost. But even before that bill came due, the country faced another crisis, in the form of an international pandemic.
The Spanish Flu Pandemic
A shocking 50 million people worldwide died of the Spanish Flu, according to the CDC. America fared better than many nations, but still lost an estimated 675,000 people to the virus.
Businesses shuttered nationwide and commerce ground to a halt. Jobs evaporated. In a quirk of this particular virus, it claimed a high death toll among young, healthy, working-age people between ages 20 and 40. That sapping of the workforce didn’t make the economic recovery any easier.
By the time the pandemic passed, the country sank into an 18-month recession.
The Recession of 1920-21
Rather than slash interest rates or print more money, the federal government took a more hands-off approach to the recession. They feared the additional inflationary impact of another money printing spree so soon, and they instead forecast a relatively short but painful recession.
Here’s how Federal Reserve Bank of New York governor Benjamin Strong put it in early 1919:
“I believe that this period will be accompanied by a considerable degree of unemployment, but not for very long. And that after a year or two of discomfort, embarrassment, some losses, some disorders caused by unemployment, we will emerge with an almost invincible banking position… and be able to exercise a wide and important influence in restoring the world to a normal and livable condition.”
History proved him right, although at great expense to many Americans. Unemployment soared to 19%, and the stock market collapsed to half its former high. Countless U.S. businesses went bankrupt during the recession at the beginning of the 1920s.
But it did lower inflated prices, and fast. That fueled demand for exports, and foreign money flooded the country. In 1921 the new Secretary of the Treasury, industrialist Andrew Mellon, convinced the Federal Reserve to cut interest rates, stimulating the economy with cheap credit.
It was enough to jolt the economy back to life.
What Made the ‘20s Roar
In some ways, the economic expansion of the 1920s was inevitable. The major trends that caused it — innovations in manufacturing, the rise of automobiles, the electrification of America, mass marketing platforms such as radio, and loosening credit markets — were all poised to accelerate in the 1910s. Then WWI interrupted the country’s economic trends, and the aftermath of the war, the pandemic, and the recession all tamped them down further.
So when the country exited recession in 1921, these trends were coiled and ready to spring.
1. The Explosion in Manufacturing
Technically, Henry Ford invented the assembly line in 1913. But the practice didn’t spread and become mainstream until the 1920s.
When it did, it revolutionized manufacturing. Suddenly, factories didn’t rely on a few high-skill workers that were difficult and expensive to train. Combined with the invention of the conveyor belt, the assembly line allowed low-skill workers to each contribute one small, repetitive task to the production of goods. That removed the constraint of high-skill workers, and allowed for much faster mass production.
Instead of a few high-skill workers, factories hired hundreds, then thousands of low-skill workers. These factories cranked out more goods at lower prices, enabling middle-class consumers to afford products previously available only to the wealthy.
Henry Ford also pioneered interchangeable machine parts. That made his Model T and later cars easier to repair and maintain, extending their usable lifespan and therefore making them even more affordable.
The number of registered drivers in the United States roughly tripled over the course of the 1920s, and as the automobile became a mainstay of middle class life in America, it drove many of the other trends in the decade. The country built an interstate highway network, along with gas stations every few miles to keep motorists moving. The oil, rubber, glass, and steel industries all experienced a massive boom. Suburbs became practical, and construction skyrocketed both within and around cities.
2. Availability of Cheap Credit
Yes, car prices plummeted in the wake of manufacturing advances. But to become truly mainstream and affordable, car sellers needed to let buyers spread their payments over time.
With low interest rates and a burgeoning financial system, credit made the leap from business-to-business to business-to-consumer. The business of consumer lending entered the limelight, extending cheap credit for Americans to buy cars, refrigerators, and vacuum cleaners.
The financial industry’s diversification didn’t end at consumer credit. Investment banks such as J.P. Morgan extended easy credit to businesses, and started lending money to both businesses and consumers to buy stocks on margin. Given the newness of such widespread credit to buy stocks, the laissez-faire economic approach (more on that shortly), and the sense of market exuberance, no one gave much thought to the risk involved. Roll the foreshadowing soundtrack.
But in the meantime, the explosion in credit boosted both the consumer economy and all its attendant jobs, and helped small businesses grow to greater heights.
3. The Electrification of America
In 1920, only about one-third of American households had electricity per Gizmodo. By the end of the decade, nearly 70% of households did, and that number jumps to 85% if you exclude farms.
With electricity, Americans could go out and spend money on all those new gadgets and appliances like refrigerators, washing machines, radios, and vacuum cleaners that were just the bees’ knees. That spending fueled the manufacturers of course, but also demand for all the raw goods needed to produce them, the transportation to distribute them, retail jobs, construction of retail stores, and endless other parts of a consumer economy. But the economic implications didn’t end with the rise of the modern consumer state.
Electrification powered restaurants, speakeasies, cinemas, and of course all the factories producing the consumer goods. The movie industry rose to prominence, creating more jobs that hadn’t existed before, from Hollywood key grip to hometown cinema ticket taker. Restaurants became more chic and mainstream.
And, of course, the electrification project itself produced a massive number of infrastructure jobs.
4. The Rise of Mass Marketing
Radio didn’t invent mass marketing. Newspapers and magazines existed long before, but with radio came the rise of efficient broadcast advertising.
Advertising and marketing only added more fuel to the fire of consumer demand in a decade when wages leapt and prices plummeted, and when easy consumer credit became widespread.
The allure of the movies compounded the effect. To look at the silver screen, you’d have thought everyone in America already had a refrigerator, washing machine, and vacuum cleaner.
It’s no wonder that the original “Keeping Up with the Joneses” cartoon saw its peak popularity during the 1920s.
5. Laissez-Faire Economic Policy
The 1920s saw three Republican presidents who all assumed a similar economic strategy.
Known as “laissez-faire economics,” from the French meaning “let it be,” it represented a hands-off approach to managing the economy. President Warren Harding reduced taxes, left interest rates low, and introduced protectionist policies such as tariffs on imports to try and bolster American companies. His successors Calvin Coolidge and Herbert Hoover largely mirrored these policies.
In one sense, they worked like a charm. Businesses thrived, employment reached all-time highs, and the middle class flourished. Unemployment fell from 11.9 million in 1921 to 3.2 million in 1929, representing a 3.2% unemployment rate.
The proliferation of jobs gave rise to a new class of middle-class female workers who lived independently for the first time, smoked and drank in public, and frequented restaurants and speakeasies with or without male companions. Given the full employment level and technology advances of the day, these “flappers” often worked in new jobs such as clerks, switchboard operators, typists, and secretaries.
The protectionist tariffs represented a mixed bag. They did boost domestic consumption and reduce imports, fueling U.S. business growth in a (bygone) era of dominant American manufacturing. Yet they also led to other countries retaliating with tariffs of their own, squeezing U.S. exports.
With the benefit of hindsight and a hundred years’ worth of economic theory, we now know that the extreme version of laissez-faire economics practiced in the 1920s overheated the American economy. Credit stayed too cheap for too long, with no regulatory guardrails in place for new practices like buying stock on margin. Investment banks and other financial institutions overextended themselves, leaning out over the abyss in the absence of those guardrails.
And then they fell.
The stock market did so well in the 1920s that Wall Street became a place of unbridled speculation. Everyone from CEOs to janitors threw their savings into stocks, with no cash emergency fund or preparedness for market downturns. When one finally came in 1929, the world panicked.
Never mind that there had just been an enormous bear market only eight years earlier. Human memory is a short and fickle thing.
Having artificially inflated due to speculation, the stock bubble began to burst. Investors and speculators fled stocks over the next four years, leaving many with devastating losses. Even those who didn’t lose money in the stock market crash felt the sudden financial fear in the air and tightened their spending. America’s new consumer economy lost its luster, as suddenly thrifty consumers sent factory orders dropping.
Public companies saw their share value evaporate. Nearly all companies saw their credit disappear seemingly overnight, and businesses started declaring bankruptcy at an alarming rate.
Unemployment skyrocketed, and wages fell for many of those lucky enough to keep their jobs. Foreclosures and repossessions followed suit.
Bank Runs and Near Collapse of the Financial System
By 1930, the ranks of the unemployed swelled to 4 million. In the fall, a banking panic caused a run on banks, emptying their vaults and tipping many banks over the edge.
Two more mass bank runs followed in the spring and fall of 1931, when the unemployed grew to 6 million. Then a fourth and final major bank run hit in the fall of 1932. By then, 15 million Americans were unemployed — more than 20% of the workforce.
President Hoover tried propping up failing banks with loans, in hopes the banks would then start lending again to businesses. They didn’t, out of fear of more bank runs.
Thousands of U.S. banks collapsed by the low point of the Great Depression in 1933. The U.S. Treasury didn’t even have enough cash to make payroll for federal employees.
After taking office, President Roosevelt stopped the bleeding by ordering a four-day bank holiday, during which Congress passed banking reform legislation and determined which banks were sound enough to reopen. His administration later created the Federal Deposit Insurance Corporation (FDIC), which guaranteed bank deposits to restore faith in the financial system.
The same economic policies that pulled the U.S. out of the post-pandemic and post-WWI recession eventually overheated the economy, creating a financial bubble like the world had never seen.
Economists and laypeople alike continue to argue the role of the government to regulate the economy. How much regulation is ideal? Where’s the balance between keeping taxes low to spur economic growth while still providing key government services?
As an experiment, the economic policies of the 1920s demonstrated that lower taxes and interest rates do fuel the engine of our economy. But they also proved that you can easily overheat an economy when credit moves too cheaply for too long, and with no regulatory guardrails in place. Later generations of economic policymakers have sought to find a balance between giving the private sector and banking industries enough line to expand, but not so much that they can tie a noose around their own necks.
It’s an ever-moving target, as financial markets, economic strength, and geopolitical winds constantly shift. And as the U.S. economy slowly stumbles back to its feet in the aftermath of another pandemic a century later, the disputes over how to manage the economy remain as vehement as ever.