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Over-Indebtedness and Depressions -- Irving Fisher explains the Kleptastrophe (Part 1)
From: Dick Eastman
To:
Sent: Saturday, December 06, 2008 9:37 PM
Subject: [frameup] Fw: Over-Indebtedness and Depressions -- Irving Fisher explains the Kleptastrophe
Note: If this long letter -- with excerpts from Irving Fisher's very hard to find book on economic Depressions -- is cut short by yahoogroups our your ISP, simply write to me and I will send it in an Open Office attachment. I think it is better to send things like this using Outlook Express HTML format -- since my intention is that it be forwarded a thousand or more times. -- Dick Eastman
"A genuine opening of new opportunities for profitable investment is only the first step. At first, it is the legitimate leaders in the exploitation who are responsible for inducing the public to invest, and to borrow for the purpose of investing. Afterward some people, instead of investing for earnings, merely speculate -- buying in order soon to sell again to others who want to invest or to other speculators. Afterwards come less scrupulous promoters; and finally downright crooks. Probably no great crash has ever happened without shady transactions. Indeed, the disclosure of these is often the last straw which breaks the camel's back and precipitates the calamitous liquidation. Fraud enters as one link or mesh in the network, being both effect and cause -- an effect of genuine opportunities to invest, and a cause of over-indebtedness. No debt is so excessive as one based on mistaken hopes, but when disillusionment comes, the adventure is denounced as a "bubble" that has been pricked, such as the Mississippi Bubble and the South Sea Bubble."
* * *
"When a whole community is in a state of over-indebtedness, the dollar reacts in such a way that the very act of liquidation may sometimes enlarge the real debts instead of reducing them!"
-- Irving Fisher
Introductory note:
Great is bankruptcy: the great bottomless gult into which all Falehoods, public and private, do sink, disappearing. -- Thomas Carlyle
Thieves respect property. They merely wish the property to become their property that they may more perfectly respect it. -- G. K. Chesterton
There was a time when a fool and his money were soon parted, but now it happens to everybody.
I have have typed out some long passages from an old book on economic depressions because I think it provides Americans, more than new books, the analysis they will need to see through the lies of economists, finance journalists and double-crossing presidents who, agreeing with the Marquis de Sade that "It is infinitly better to take the side of the wicked who prosper than of the righteous who fail," have plunged us into helpless babblement.
I don't expect that employers and union bosses will insist that every worker read it, that colleges and high schools will cancel classes and convene colloquiums to discuss it. Even those still willing to think, understand that whatever they know about economics and sociology and government doesn't matter, because the "interests" who have merged the political parties and are now with their new White House team ready, under Geithner's masterful hand, to steer this "Kleptrina" of a depression onto the mainland because we are the targeted victims and not the intended benefactors of their efforts. The Money Power, with their armies of traitor economists, journalists, professors and politicos have bound the might of 300,000,000 people and will have us as their slaves once they have completed the process of robbing us of all we possess.
Nevertheless I still have hope that we can defeat the devices that plunder our earnings, savings and equity and lead us into war and imperialism. But we must know the terrain in which we fight, the weapons of our enemy, and the economic science by which one side or the other gains the upper hand in the political arena.
Three things I would add to Dr.Irving Fisher very helpful explanation of depressions.
1. Debt is the built up potential energy on which the grand Kleptastrophe draws when it is turned loose on us, ripping us out of Kansas, by those who have positioned themselves to profit from it. While increased buying power given directly to households can can prevent the crisis caused by the contraction of an economy with too much debt that is triggered when banks call in their loans -- -- as I was saying, increased purchasing power can be a remedy, but it must be done in the right way. Avoiding a depression or ending one depends on exactly how and where the new purchasing power is introduced to the economy. There is no salvation in any new purchasing power unless the rescue injection goes directly to households -- interest free credit checks to families that come directly from the goverment like a tax return. Only in that wal will increased household demand and and loss of homes and security obtain. Bush-Obama (Geithnerism) works is only going to add more energy to the cyclone being steered this way. The injection of new purchasing power into the hands of the international bankers and their corporations does absolutely nothing, but wind up the over-indebtedness mainspring of the depression through the government borrowing to get money to make the bailout -- like Germany after World War One had to borrow from the U.S. to get the money for reparations to pay to France and England (after its chief industrial region had been given to France) so France and England could pay their debts to the U.S. Only this time -- we are Germany and our factories instead of being annexed by a neighbor simply vanished and rematerialized in Red China.)
The new injection to purchasing power to households must neither be tax financed nor debt financed. Either the government adopts social credit in its monetary reform or it must resort to the printing of its own interest-free treasury credit (the modern version of Lincoln's printed treasury notes.) Nothing is more absurd than what we are doing now, which is borrowing from the international bankers to bail out the international bankers after the international bankers take ownership of all of our foreclosed houses and all of our assets sold to them in our economic distress which has been engineered by them in the first place.
Stiglitz has shown us the magnitude of the "bailout" pledged by Congress to the financial sector -- not to the people, the "rescue" avoids any payments to the household sector -- and does so only after the financial sector has just taken possession of all of our foreclosed properties -- properties in which the "hurt" financial lenders were always "secure" with our home equity and business equity as collateral. In other words, they got our houses from their market and credit manipulaitons, but feel that they have been hurt by the fact that when they steal all of our houses at the same time there is a glut of houses on the market and so they must squeeze the tax payer (whose house and business they just stole) to make up for their loss.
If you think about it long enough it begins to seem unfair.
See from Stiglitz's graph, the potential energy of "Kleptrina" which has yet to come ashore and reach your town. That is a transfusion that must come from your veins. Your blood swept up in the cyclone to rain manna upon the heads of the international financial elites.
The contraction of credit has caused a great deflation - despite the increase in prices the households are seeing at grocery stores, there is a deflation going on as there is in every depression -- so that the dollars that people continue to owe are that much more hard to come by and when used to pay debt represent that much more food, clothing, shelter, education and living foregone. And yes, even with all of the liquidation of debt, with the dollar deflation the burden of debt (of deflation dollars still owed to creditors)is intensified so that people, even though their nominal debt is reduced, actually owe more than ever in terms of how hard and how long they will have to work to pay off the debt that remains.
3. Fisher tells below how bondholders (creditor class) and others profit from depressions that ruin everyone else. Someone gains all of the assets that bankrupt firms lose. Fisher, hints at his awareness that the 1929 crash involved some intention, even as he tells us he will not make any judgement calls on that question. But you should keep in mind that the economic conspiracy is a fact -- and that the plays are from a very old play book.
A conspiracy set up the over-indebtedness and started the present collapse in motion (as in 1929 when the market crash was deliberately brought about by margin calls -- that led to the monetary contraction that created the depression.)
Apart from those omissions, Dr. Fisher opens the curtain on everything we need to know but haven't been shown about the causes and working of depressions, including the Kleptastrophe we are witnessing today.
I present this article from the past to fill the void left by the sorry lot of poorly trained and traitorous economists in failing to give an honest explanation of the causes of the present depression -- economists who as recently as two months ago insisted were are not yet "technically" in a recession.
It is my hope that you and the people you send it to will read it and use it as the textbook for gaining the a "model" of depression with which to interpret the Kleptastrophe. You may not agree with me that in this new "changeling" administration we are embarrassed once again by the favor of having more highly skilled dual-citizenship Zionist Jews controlling our national destiny than perhaps we really deserve. And of course a Harvard lawyer with wall-to-wall Jews (and Hillary Clinton) keeping the gate around him is certainly going to have as much populist and social creditor input as he wants. But what am I thinking! Of course, Jewish-Chinese supremacist world conquest through economic sabotage and frame-up false-flag black-ops has long gone by the polite name of "change" -- and, looking at your new advisors and cabinet choices, I am confident that you have no intention of failing to deliver exactly that to the people you have committed yourself to serve. My prayer for you is that as you learn in your new position that even your concept of what changes are needed will undergo serious change and that somehow you will find a link to the people you have only known impersonally as you addressed large crowds of them to win the great national popularity contest choosing among you, Hillary Clinton and John McCain.
Your fellow citizen, Dick Eastman]
Once again, I hope everyone will look over what I provide below. There never was a clearer explaining economicst than Irving Fisher. You may be surprised at how well you follow everything he has to tell you.
We are an unorganized majority enslaved by an organized minority. The first thing we must do to remedy this is to organize out thinking -- to start looking at the problem with the same tools.
Dick Eastman
Yakima, Washington
Every man is responsible to every other man.
Over-Indebtedness and Depressions
Here is the leading economist of the Harding-Coolidge years, Irving Fisher, writing in 1932.
A depression seems, indeed, to fall upon mankind out of a clear sky. It scorns to choose a moment when the earth is impoverished. For, in times of depression, is the soil less fertile? Not at all. Does it lack rain? Not at all. Are the mines exhausted? No; they can perhaps pour out even more than the old volume of ore, if anyone will buy. Are the factories, then, lamed in some way -- down at heel? No; machinery and invention may be at the very peak. But perhaps the men have suddenly become unable or unwilling to work. The idea is belied by the spectacle of hordes of workmen, besieging every available employment office.
Perhaps, then, the world has become over-populated. But how could that happen in so short a time? When the calamity starts there seems to be (at least in America) enough of every good thing to go around; everybody wants it, and nearly everybody wants it enough to work for it; yet some cannot get it, and many who can get some of it must be content with less.
There are those who ascribe this individual impoverishment to the very fact of collective wealth -- not over-population, but "over-production" -- too much food and too much of all else.
Later in these pages there will be more about this. It is enough here to note that those who, at the beginning of a depression, cry "over-production" and expect recovery as soon as over-production ceases usually become disillusioned when later almost universal poverty appears. If, in 1932, anyone thought there was still over=production, he should follow his own argument all the way through as follows: "How do I know there is over-production of goods? Because more goods are for sale than the public will buy. And why, then, will the public not buy? Because they haven't the money. Why haven't they the money? Because they are not earning it. Why aren't they earning it? Because they are not producing: men and machines are idle!" But if non-production is the trouble, why call it over-production?
Perhaps the secret, then, is to be found in the machinery of distribution. Between the producer and the consumer there must be a chasm in need of a bridge. But no: at this very moment, the Hudson River has a brand new bridge. There are plenty of physical bridges, and the railroads that cross them are in good condition. As for ships and ship-canals, they are as well equipped as ever, and as eager to serve -- only the shippers are few.
There is, however, another distributive mechanism whose name is money. There is no more reason why this money-mechanism should be proof against getting out of order than a railroad or a ship-canal. Moreover, profits are measured in money. If money, by any chance, should become deranged, is it not at least possible that it would affect all profits, in own way, at one time?
I. FIRST THREE OF NINE MAIN FACTORS
1 Over-Indebtedness (The First Main Factor)2 Criteria of Over-Indebtedness3 The Debt Cycle4 Nine Main Factors5 Distress Selling6 Volume of Currency (The Second Main Factor)7 The Price Level (The Third Main Factor)8 "Real" Debts9 The Money Illusion10 Gold and Credit11 The Vicious Spiral Downward12 Two Paradoxes13 The Main Secret14 Summary15 The Dollar Disease is Needless
II. REMAINING SIX MAIN FACTORS
17 Net Worth (The Fourth Main Factor)18 Profits (The Fifth Main Factor)19 Production Trade, Employment (The Sixth Main Factor)20 Optimism and Pessimism (The Seventh Main Factor)21 The Velocity of Circulation (The Eighth Main Factor)22 Hoarding, a Slowing of Velocity23 The Two Paradoxes Again -- Applied to Hoarding24 Possible Consequences of Contraction and Hoarding (The Ninth Main Factor)25 Rate of Interest (The Ninth Main Factor)26 "Real" Rates vs. Money Rates27 Deflation, the Root of Almost All Evils28 Chronology of the Nine Factors29 The Trough of Depression30 The Boom Phase Again31 A Vicious Spiral Upward
III. STARTERS
32 Unproductive Debts33 Productive Debts34 Some Historical Illustrations35 The Shady Side36 Monetary Inflation Alone37 Combined Starters38 Contents of Sections Omitted39 Conclusion to Other Theories Section
IV. THE OVER-INDEBTEDNESS THAT LED TO THE WORLD DEPRESSION
40 The War and the New Era42 Investing in Equities on Borrowed Money43 High-Pressure Salesmen of Investment Bankers44 The Steady Commodity Price Level45 Investing Abroad46 Miscellaneous Borrowing Movements47 Reparations48 Inter-Governmental Debts Payable to America49 International Private Debts50 Public Debts in the United States51 Private Debts in America52 Brokers' Loans53 Totals in 192954 Gold and Debts55 Contents of Omitted Sections56 Summary as to the Nine Main Factors57 The Real Dollar58 Our Dollar's Bad Record59 War, A De-Stabilizer60 Can We Keep Capitalism
I.
THE FIRST THREE OF NINE MAIN FACTORS
1
Over-Indebtedness
(The First Main Factor)
DEBTS are tied in with the money mechanism. In fact, what is called the "money market" is really the debt market. Most kinds of pocket money, such as bank notes, take the form of debts to the bearer. Bank checks, which the depositor thinks of as representing his "money in the bank," really represent a debt of the bank to the depositor, and usually the depositor obtains his checking account by going into debt to the bank.
Debts are essential to both production and distribution. Even in "normal" times, -- that is, in times of neither boom nor depression, -- practically every adult person is in debt, if only for last week's groceries. The primitive notion which associates debt with the pawn-shop, and regards the debtor as a victim of misfortune, is, of course, quite erroneous, especially in this modern world. The really typical debtors of today are the alert business men and corporations. Every business balance sheet has its "liabilities."
Yet for individuals, for corporations and for society as a whole, debts have differences of degree. In each case debts may be too much or too little. The golden mean or point of equilibrium is a matter of balancing opposed considerations. Each person decides for himself how fair it is well to go into debt, or how long it is well to stay in debt, just as he decides how for it is well to save or to spend, or who much of his income it is well to apportion to clothes and how much to food. As in other economic adjustments, so in the adjustment of debts, the individual stops "at the margin" where in his judgment, the desirability of a further expansion of his debts is balanced by the undesirability of further sacrifices and risks. in each case, the point of equilibrium is where opposed considerations balance.
Where do the balance?
Chance is inseparable from life. Every transaction is a taking of chances, and over-indebtedness is whatever degree of indebtedness multiplies unduly the chances of becoming insolvent. Everyone who is not a gambler, provides himself with a margin of safety. He puts a buffer between his debts and the collector. This buffer is the difference between assets and liabilities. Corporations call it "capital and surplus/" But the sufficiency of the buffer is not solely a matter of quantity. It must be varied according to the quality of the assets. It must also be varied according to the quality of the liabilities. Slow assets and quick liabilities (such as call loans) require a larger buffer than quick assets and slow liabilities. The quickest asset, and therefore the safest when pressure comes, is cash. The quickest liability, and therefor the most unsafe in times of pressure, is the call-loan. Over-indebtedness is largely a question of dates of maturity. The entire set-up of assets and liabilities, therefore, has to be considered, -- and not only the ratio between the two sides of the capital account, and between current assets and current liabilities, but the ration between the two sides of the income account; the ratio between the income and the assets, between income and the debts, between the income and the balancing item of capital and surplus. A balance sheet is the result of anxious efforts to weigh correctly these and many other considerations.
2
Criteria of Over-Indebtedness
Banks, in extending credit to different sorts of borrowers, have to consider questions of liquidity and of safe margins on collateral. Credit men, accountants, lenders on real estate, brokers, governments and legislators, all have some sort of standards of over-indebtedness. The standards are somewhat rough. The line of balance is more or less a twilight zone; but an entire book could be written about the history and current practice of stopping the debts at a point which is neither too rash nor too conservative.
Can a more definite criterion be devised for the community than the individual? In any event, such guides will have to be considered as the ration between the nation's income and certain fixed expenses, like taxes, rent, and interest; the ratio between the income and the accumulated volume of outstanding debts; the ratio between debts and the gold on which the banks (in a gold standard country) base their loans. As low income endangers the debtors, low gold endangers the creditor banks, which then begin to press the debtors. On these last two criteria -- national income and national gold reserve -- some interesting remarks have been made by Mr. Warren F. Hickernell. [What Makes Stock Market Prices? by Warren F. Hickernell, Harper Bros., 1932] He concludes that, at a given moment, the outstanding total of bank loans and investments should not exceed one half of the country's income for one year; and that the country's gold should always be equal to 9 per cent of the outstanding bank loans and investments. The over-stepping of either of these limits, Mr. Hickernell regards as jeopardizing the solvency of an undue proportion of the community.
This national gold buffer is exposed to one adverse chance seldom considered by either lender or borrower -- the chance of the mal-distribution of gold internationally. Such mal-distribution may be caused by a one-sided condition of international indebtedness, both public and private, and by tariffs which prevent international payments in goods and compel payment in gold. If these or other causes should drain a country of too much of its gold, the banks of that country would begin to cancel loans, including some which looked conservative enough when made. Thus, what was not over-indebtedness may be transformed into over-indebtedness by depriving the creditor banks of sufficient gold or sufficient access to it. Thus an unexpected rise in the tariff of one country, say the United States, renders unsafe a volume of indebtedness to that country from another country, say Germany, which without that rise would be safe, simply because the creditor has made it hard for the debtor to pay.
Over-indebtedness means simply that debts are out-of-line, too big relatively to other economic factors. If the debts are out-of-line relatively to only a few unimportant factors, little harm may result. The great disturbances come when the debts are decidedly out-of-line with practically everything --including assets, income, gold and liquidities (i.e., quickness or slowness of assets and liabilities.)
3
The Debt Cycle
That, now, are the consequences of a mistake of judgment on the part of debtor or creditor or both? First, consider the individual debtor. If he has not borrowed enough, he can, under normal conditions, easily correct the error by borrowing more. But, if he has good too far into debt, -- especially if he has misjudged as to maturity dates -- freedom of adjustment may no longer be possible. He may find himself caught in a trap. If he cannot pay his debt when it comes due, he will try to put off the evil day. Government and corporations accomplish this by refunding their maturing short-term obligations. But this is not always possible if insolvency threatens the debtor, the creditor often makes matters all the harder by pressing for payment.
Ultimately, of course, the over-indebtedness, whether of one individual or of a whole community, will be wiped out, with or without business failures. But sometimes the liquidation, or the psychology accompanying it, does more than restore a normal debt situation. Those debtors who have burned their fingers by over-indebtedness, and those creditors who have burned theirs by over-lending -- especially if the two groups comprise most of the community -- become over cautious, and end with an undue reaction against borrowing. Then the pendulum may gradually swing back beyond the point of equilibrium, where people will again go too far into debt, but presumably not so much too far as the first time. This swinging back and forth may go on indefinitely, constituting a debt cycle; but unless some outside force intervenes, each successive swing of the pendulum will have less scope than the last.
4
Nine Main Factors
This however, is not the whole story of the expansion and contraction of debts. If it were, no one would think of devoting a whole book to it. But it happens that the cycle tendency of debts is the initiating one of at least nine main cycle tendencies which carry in their vitals much of the tragedy of economic life. The nine are listed here, and each will be discussed on its downswing to Depression, before the upswing of any of them is considered; for the first task is to see how the debt-structure, once erected, may topple into the trough of depression and take us with it.
Following are the nine oscillating factors to which reference has just been made:
1. The Debt Factor2. The Currency-Volume Factor3. The Price-Level Factor4. The Net-Worth Factor5. The Profit Factor6. The Production Factor7. The Psychological Factor8. The Currency-Turnover Factor9. Rates of Interest
The depression tendencies of the first three of these factors (Debts, Currency, and Price-Level) are closely locked together, and the key that locks them is distress-selling.
5
Distress Selling
When over-indebtedness, whether by sheer bulk or by rashness as to maturity dates, is discovered and attempts are made to correct it, distress selling is likely to arise. That is, in order to protect the creditors, some of the possessions of the debtor may have to be sold -- his stocks, his bonds, his farmlands, or whatever his available assets may be. The debtor may choose, on his own responsibility, to facilitate liquidation by selling some of his property, even though he never pledged any of it for the debt; or his bank or his broker may cash in on the debtor's collateral; or the mortgagee may foreclose the mortgage; or the debtor may go into bankruptcy, and the trustee in bankruptcy may then auction off his assets. In short, the debtor becomes the victim of distress selling either on his own initiative or on the initiative of his creditors.
Distress selling perverts the operation of the law of supply and demand. Normally, sales are made because supply-and-demand has worked out a price attractive to the seller; but when the seller is in distress, the sale is made for precisely the opposite reason; not the attraction of a high price, but the compulsion of a low price, which threatens his solvency. The danger or the fact of insolvency is the all-important consideration in distress selling.
When the whole community is involved in distress selling, the effect is to lower the general price level.
6
Volume of Currency
(The Second Main Factor)
This excessive eagerness on the selling side of a market may seem enough to explain how distress selling tends to lower the price level; but it is not the fundamental influence. In fact, the buyer largely gains the spending power which the seller loses, and the spending power is what sustains prices. But the stampede liquidation involved in distress selling has a radical effect on the price level, by actually shrinking the volume of currency -- that is, of "deposit currency."
Deposits are the balances on the stubs of check books -- the "money" which people have in banks and which they transfer by check. A typical depositor deposits neither gold nor silver nor any other money but merely his promissory note. What he thus accomplishes is to trade his debt to the bank for a debt from the bank to himself; the object being that he may get something which will circulate. His own note will not circulate, but the bank's deposit-liability to him will. Against this, he can draw checks which, in his own business circle, will be accepted almost as freely as legal-tender money. In short, he converts his own non-circulating credit into the bank's circulating credit. New "money" is thereby created, not by the mint or the Bureau of Engraving, but merely by the pen and ink of the banker and his customer. But when the customer pays his note, he undoes the whole transaction; that is, he wipes out an equal amount of circulating credit. In this respect, the payment of a business debt owing to a commercial bank involves consequences different from those involved in the payment of a debt owing from one individual to another. A man-to-man debt may be paid without affecting the volume of outstanding currency; for whatever currency is paid by one, whether it be legal tender or deposit currency transferred by check, is received by the other, and is still outstanding. But when a debt to a commercial bank is paid by check out of a deposit balance, that amount of deposit currency simply disappears.
Thus to pay a debt at the bank tends to contract the circulating medium. But this tendency is, in normal times, neutralized by a counter-tendency. For generally, as fast as some bank debtors pay off their debts, the extinguished currency is replaced by new depositors who obtain new credits. When, however, by reason of a general state of over-indebtedness, there is a stampede of liquidation, then the new borrowings will by no means suffice to restore the balance, and there must follow a net shrinkage of deposits, or "credit currency."
In this process of contracting credit currency, commercial bank debts are the only kind of debts directly involved. Yet other debts may aggravate the process of contraction. A man may owe very little to his bank, and yet owe so much in other directions that, in order to reduce the total, he will choose to pay off his bank debt. Or a debtor, without any bank debt at all but owing money abroad, may have a deposit in a bank -- say, a thousand dollars -- and withdraw it in gold to pay some of his foreign debts. When he does this, he deprives the bank of the lawful right to issue credit currency to an amount far in excess of the thousand dollars thus withdrawn.
This sort of contraction by means of cash drawn from banks may be on a large scale, especially if the debtor is a bank or a savings bank, which, in order to replenish its own cash -- gold, silver, or paper -- so as to meet a run by its depositors, may draw on other banks. Even public debts -- debts of city, state or nation -- may have a contracting effect on deposit currency, through the pressure of taxes upon citizens already in debt. This pressure, to be sure, is spread over so many people that its effect is light in proportion to the huge size of the public debts, but the pressure is always there, and often reveals itself, not only in the ways mentioned but in tax-sales with all the usual effects of distress selling.
Credit currency is recorded in the statistics of the Comptroller's Office, under the heading, "Individual deposits subject to check without notice." Its shrinkage is of vast importance; for, in the United States at least, credit currency is the most important kind of Twentieth Century currency. It transacts nine-tenths of the country's business, and, when it is deflated, the general price level tends to fall, because, with less funds less buying can be accomplished. [This is in accordance with the well known principles. See, for instance, The Purchasing Power of Money, by Irving Fisher (Macmillan, New York, 1931).]
7
The Price Level
(The Thrird Main Factor)
Thus, the volume of the most important circulating medium is tied to the volume of debts, especially debts at the banks, one of the most important kinds; so that a sudden disturbance of this debt-volume is passed on to the currency-volume and consequently passed on to the general price level; for, as all authorities agree, an increase in the volume of currency tends, in some degree at least, to raise the price level and a decrease, to lower it. What we now have to consider is the way in which a changed price level changes the burdensomeness of all outstanding debts -- in a word, changes real debts, as distinguished from nominal or money debts.
8
"Real" Debts
There are few people today who do not grasp the difference between nominal or money wages, on the one hand, and "real" wages, on the other. Let money wages remain unchanged, and we all acknowledge that, if the cost of living rises, real wages fall; or, if the cost of living falls, real wages rise. We know that money wages may rise and yet real wages fall, as in the case of Germany's post-war inflation. For real wages are the budget of goods -- the composite of commodities -- the "living" -- which the money wages will buy. Only by translating money wages into real wages can we express the true economic state of the nation.
This same principle applies to debts. Through a debt be paid with the same number of money dollars, yet these dollars, when prices are falling, will cost the debtor more goods. To earn them, he must sell more goods. In other words,when the price level falls, each dollar, to all intents and purposes, is a bigger dollar. [Remember this terminology of Fisher's -- a "bigger" dollar is a dollar that buys more real goods and more work from the laborer -- what you and I would call "deflation".]
For instance, suppose a farmer contracts a debt when wheat is $1.00 a bushel, and pays it when wheat is 50 cents a bushel. Obviously, to him the dollar has doubled in terms of what; he must use twice as much wheat to pay each dollar of his debt. That is, when the price of what is halved, the farmer's real debt is doubled. Likewise, if the general price level is halved, the real debt of the average man is doubled.
And this is but half of the debtor's predicament; for first, he gets fewer of these bigger dollars for his goods (while owing the same number of them on his debts); and second, his security is worth fewer of these bigger dollars in the market, and therefore worth less in the eyes of his creditor. The creditor is unaware of receiving more than he is properly entitled to, and the debtor is unaware of paying more than he properly owes. One gains and the other suffers -- but both suffer from what is about to be discussed as the Money Illusion.
9
The Money Illusion
Few people look at money for the explanation, because most people simply look through money, think in terms of money, take money for granted, assume that a dollar is always a dollar. Since we measure everything else in dollars, it does not really occur to us to measure the dollar itself. Few people realize, for instance, that the depression dollar of 1932, as compared with the pre-depression dollar of 1929, became really a dollar and two thirds; and still fewer realize the tremendous significance of this fact. Yet its significance is all the greater just because it is not clearly realized.
The real meaning of a unit of money is the goods which that unit will buy. Instead of measuring goods by dollars, the economist is accustomed to measure dollars by goods -- not by any one article of goods such as bread, but by the general budget of goods such as food-stuffs, clothing and cloth, furniture and houses, building materials, services, amusements and so on. When the price of bread alone changes, this is presumably due to some change in the quantity or quality of wheat, and not to any change in the dollar. Burt when a thousand other prices change at the same time, and all change in the same direction, or all change on the average in the same direction, we are, in general, justified in saying that the dollar has changed in the opposite direction.
Nevertheless, the Money Illusion [See The Money Illusion by Irving Fisher. (That Adelphi Company, New York, 1928)] goes on telling us that the dollar stands still while other things move. This Money Illusion is analogous to the illusion of a passenger on a train who seems to see the landscape rushing past him. It is analogous to the illusion of sun-rise and sun-set, which make the earth appear fixed with the sun swinging 'round it once a day. So when prices change, we forget the money on which we ride and ascribe the change to something outside -- the goods, the merchant, the consumer, the producer, the fertility of the earth -- anything at all except the money in terms of which we think.
German money, after the World War, furnished a good example. We in America, measuring everything in dollars, said the mark had fallen. But German, measuring everything in marks, said the dollar had risen. In 1922, I visited Germany and took particular pains to learn from many representative citizens how they accounted for the sky-rocketing of German prices. Practically all ascribed it to some misbehavior on the part of commodities, or tot he after-effects of the war, or to the Allied blockade, or to the wastefulness of the new German government, or to almost any cause but the important one; which was, of course, that the German government was paying its debts and other expenses with new paper money manufactured for the purpose.
Yet Germans are no more prone to money illusion than others. Over a generation ago, when England was on the gold standard and India on the silver standard, General Keating, in conversation with an Indian merchant, mentioned the then recent fall in the value of the silver rupee. The Indian merchant was non-plussed. He said that he had never heard of any fall of the rupee, although he had agents all over India. After a pause, he added, "But my agents have mentioned the rise of the pound sterling. Perhaps that is what you are thinking of."
Sometimes both observers (even if one be American) are equally deluded. Before the World War, an American woman owed money on a mortgage in Germany. After the war, she went to the German bank and offered the amount which she conceived to be due -- $7,000. "But," said the banker, "The debt is in marks, not dollars -- it is 28,000 marks; and today that comes to about $250."
"Oh!" she said, "I am not going to take advantage of the fall of the mark. I will pay the full $7,000." The banker, thinking in terms of marks, could not see the point. Indeed, the fair-minded American lady only half saw it, and "cheated" her creditor after all; for even American money was worth less than when the debt had been contracted. To pay the full amount in terms not of marks, or dollars, but in terms of the purchasing power which she had borrowed, the lady should have paid not $7,000 but $12,000. Yet, had the German banker known this and suggested it, the lady's indignation at such an "unfair" suggestion would doubtless have exceeded the bankers astonishment at receiving 28 times as much as he thought was due.
10
Gold and Credit
When it comes to gold money, we are even more apt to be deceived. The reverence for gold, is if it were something ultimately stable, is a form of ancestor worship. Money was invented by primitive man, unconsciously; and modern man has taken it for granted ever since. A certain amount of evolution has been at work upon money, but very little conscious invention. The first great step in its evolution was the unconscious trying-out of one substance after another -- oxen, wampum, silver, gold. Gold finally prevailed, not for any stability of purchasing power, but for sheer physical convenience. Stability was scarcely thought of, until something else came on the scene to afford a means of comparison. That something was paper money. Gold is not so easily inflated as paper; but gold is by no means stable. It comes out of mines, subject to the will of mine-owners and tot he accident of discovery; and if a dozen new gold mines should open at one stroke, the influx of gold would tend to depreciate the purchasing power of each individual gold dollar and of every paper dollar redeemable in gold. And this very thing has sometimes happened -- with serious effects on the price level.
Moreover, and conversely, gold has now become dependent on paper money and checks. When modern man invented the check system, he did not dream that deposits subject to check would come to be regarded as money. But to all intents and purposes they are money, and they largely determine the purchasing power of gold. A gold dollar and a dollar-check and a paper dollar, so long as they are mutually exchangeable, just all have equal purchasing power; but that power depends upon the influence of all, not of gold alone; and the checks, or deposits, furnish so much greater volume that their total effect on the purchasing power of gold, though few people except economists realize this important fact, is incomparably greater than the effect of the gold on the checks. And, by the same token, disturbances of deposit currency disturb the price level far more than do the very considerable disturbances of the gold supply.
The price level aberrations hitherto mentioned were all cases of inflation. But deflation, which furnishes the principal key to a depression, is equally stealthy; and the Americans of 1932 who talked of low prices instead of swollen dollars were just as befuddled as the Germans of 1922 who talked of high prices instead of shrunken marks. It is time that we knew how to detect the dollar when it indulges in either of its stealthy maneuvers -- whether shrinking or swelling.
...
The almost universal failure to distinguish between a price and a price level, or scale of prices, is responsible for untold confusion of mind on the subject of this book. This confusion is characteristic of most speeches and writings on economics, including pronouncements of editors, officials, businessmen, and bankers, and even some who bear the title of economists but who have not, for some reason, separated supply and demand on one had from the "equation of exchange" on the other. The concept of a price level, its measurement by an index number, and its reciprocal the purchasing power of the dollar, are pre-requisites for understanding what happened in 1932.
11
The Vicious Spiral Downward
We are now in a position to explain the statement that a disturbance of the price level -- or (as we now express it) the alterations of "the real dollar" -- reacts on the debt situation which first caused the alteration. When a whole community is in a state of over-indebtedness, the dollar reacts in such a way that the very act of liquidation may sometimes enlarge the real debts instead of reducing them! Nominally, of course, any liquidation must reduce debts, but really (by swelling the worth of every dollar in the country) it may swell the unpaid balance of every debt in the country, because the dollar which has to be paid may increase in size faster than the number of dollars in the debt decreases. [That is, deflation can out pace nominal debt reduction to increase real debt. -- DE] And when this process starts, it may go on and on, much after the fashion of a vicious circle. First, mass payment by the weaker debtors swells the whole community's dollar, and so weakens the position of the still stronger debtors; whereupon many of these in turn rush to liquidate, thus further swelling the dollar and weakening still other debtors -- and so on in a vicious circle; or, rather, in a vicious spiral downward -- a tail spin -- into the trough of depression.
12
Two Paradoxes
After the weak, or rash, or improvident debtors (or their creditors) have started the vicious spiral, we can scarcely blame the others individually for going on with it, through further liquidations, even though every liquidation makes bad matters worse -- accelerating the tail spin. For, granting that mass liquidation has once started, each individual who does not join in will come off still worse. For, even if he stays out, his ten thousand neighbors will liquidate just the same, and thereby swell his dollar -- and thereby swell his whole debt instead of part of it.
The same principles apply to creditor banks. When a bank calls a loan, it helps deflate the credit currency; but other banks, equally scared, would deflate it anyhow, and if one bank stayed out, its debtors would go insolvent before they could be dunned. In a word, the banks, too, are forced into cut-throat competition for cash or "liquidity."
13
The Main Secret
When over-indebtedness thus goes so far that the resulting mass liquidation defeats itself, we have the paradox which, as I think, explains the so-called mystery of depressions -- at least of many depressions. It is more than the fact that the dollar, when thus expanded, adds to the burden of very debtor. It is rather that this expanding dollar may (and sometimes does) not only grow, but grow faster than the reduction of the number of dollars of debt. When this happens, liquidation doesn't really liquidate, so that the depression goes right on -- until there are sufficient bankruptcies to wipe out the activating cause -- the debts.
14
Summary
We have mentioned on their depression side, the cycle-tendencies of three of our eight economic factors.
1. Debts (their liquidation)
2. Volume of Currency (its contraction)
3. The Dollar (its swelling -- usually considered in terms of a shrinking scale of prices).
Of these three depression tendencies, the second (currency contraction) is important only as a connective process between the other two -- which should be called
The Debt Disease (too much debt)
The Dollar Disease (a swelling dollar)
That the dollar disease -- falling prices -- is the main secret of great depressions is confirmed by the observations of Professor Wesley Clair Mitchell and Dr. Thorp to the effect that depressions last three or four times as long when prices are falling and are very short when, by some good fortune, an up-tide of prices intervenes.
15
The Dollar Disease is Needless
But the mere fact that the debt disease may lead to the dollar disease does not prove that it must do so. The dollar disease will be unavoidable only "if other things remain equal." Should other elements in the body of the currency not remain equal -- should gold coin, for instance, become copious in the nick of time -- this gold inflation might counteract the credit deflation. Prices might even go up instead of down; that is, the dollar might dwindle instead of swell. And the same result might come from paper inflation -- for instance, by way of financing a war.
And it should be equally clear that deflation, or dollar bulging, is not an "Act of God" with special mandate to baffle the human race. We not wait for a happy accident to neutralize deflation. We ourselves may frustrate it by design. Man has, or should have, control over his own currency.
Such control, so exercised as to neutralize the influences which tend to swell the dollar, would, of course, not avert from any rash initial debtor the measured consequences of his own rashness; but his punishment would be due to the nature of his separate debt and would therefore, be chiefly confined to himself and perhaps a small circle of associates. The rest of the commuity would not suffer from any vagaries of the universal dollar. And even the rash debtor has a right to pay his debt in the same dollar in which he contracted it. It is manifestly unfair to require even a rash debtor to pay $1.50 or $2.00 for every dollar he really owes. The principle of simple justice implied in the term "real wages" is no more applicable to wage earners than it is to debtors.
In a word, if we must suffer from the debt disease, why also catch the dollar disease? If we catch coled, why let it lead to pneumonia?
II.
REMAINING SIX FACTORS
17
Net Worth (The Fourth Main Factor)
BUT, assuming for the present, that neither accident nor human currency-control has forestalled the Dollar Disease, let us trace its further consequences through the series of economic factors, of which we have thus far discussed but three:
1. Debts -- their liquidation
2. Currency -- its contraction
3. The Dollar -- its swelling (Usually considered in terms of a falling price level).
The fourth factor is Net Worth.
The fall of prices reduces the money value of a business man's assets (except case and debts due from others), while his liabilities, being debts, remain "fixed." Therefore his net worth, which is the excess of assets over liabilities, must shrink. Indeed, it will shrink faster than the assets do, because net worth is smaller than the assets, and yet takes the entire loss. Net worth is squeezed between the upper and the nether millstone; and often it passes below the zero mark, pushing the owner into business failure.
18
Profits
(The Fifth Main Factor)
Profits are, in the same way, squeezed between the upper and a nether millstone. Profits are the spread between the receipts which fall when prices fall and the expenses which are, if not quite fixed, at any rate less responsive to the assault of deflation than prices are. These relatively unyielding expenses in the profit account include interest, taxes, rent, salaries, and to a less extent wages. he more unyielding the expenses the worse they pinch. [If follows that the pinch is especially felt by moder business because of its greater proportion of overhead and fixed expenses. If, as seems likely, business organization continues its tendency toward more fixed charges and less running expenses, its profits will be more and more sensitive to changes in the price level.] In this way, profits are reduced, [This effect may be mitigated or escaped when through inventions, technological improvements and improved scientific management, expenses are greatly reduced.] and often turned into losses -- just as net worth is reduced and sometimes turned into failure and bankruptcy.
A depression might be defined as the contraction of net worths and profits.
Our list lengthens to:
1. Debt Liquidation
2. Currency Contraction
3. Dollar Swelling
4. Net Worth Reduction (turned sometimes to failure)
5. Profit reduction (turned sometimes to losses)
But once more it should be noted that the dorp, both in net worths and in profits, will be largely forestalled if the drop inthe price level is forestalled.
19
Production, Trade, Employment
(The Sixth Main Factor)
In a capitalistic, or private profit, system, it is the profit taker who usually makes the decision as tot he rate at which his enterprise is to be run. Therefore, variations in profits, or in the expectation of profits, lead the business man to vary correspondingly the general policy of his enterprise.
When his profits are squeezed too thin for comfort, naturally he will cut his production and release some of his employees, so that the community's general out-put, trade and employment will take a slump.
That is, current out-put varies with current profits.
Thus, currency contraction reduces out-put by reducing prices and so reducing profits.
There is a special category of producition, namely construction --or production of new equipment, such as buildings and machinery, intended to increase the capacity for current out-put. Construction is much more sensitive to changes in profits than is ordinary production or current out-put. Construction is much more sensitive to changes in profits than is ordinary production or current out-put. Construction is much more sensitive to changes in profits than is ordinary production or current out-put. Construction increases fastest with the approach of a peak load, or a strain upon existing equipment. And it is not much more sudden in starting than it is in stopping. Right amid the new-equipment fever, at almost the first sign or forecast of impending trouble, new construction may abruptly fall. It falls earlier and faster than current output; and it produces a greater reaction in employment. In fact, construction affects the slump in profits, employment and so on, like an amplifier.
The derangement of this group of factors (production, trade, and employment) covers the most obvious and commonly recognized symptoms of a business depression. In fact it is often called a depression of trade.
Again our list grows.
1. Liquidation
2. Currency Contraction
3. Dollar Growth
4. New Worth Reduction
5. Profit Reduction
6. Reduced Production (especially of equipment) along with reduced Trade, and reduced Employment.
But once more be it noted: if something will only forestall the price deflation (the Dollar Disease), thus largely forestalling eh reduction of New-worths and of Profits, then the slump in Production, Trade and Employment will also, to a large extent, be forestalled.
In passing it may be noted that currency contraction also reduces the demand for goods by reducing purchasing power; thus demand and supply shrink together. That is, currency-contraction not only acts indirectly on production and trade through the above series of steps but also acts directly by reducing the wherewithal for buying goods. This effect (of Factor 2 on Factor 6) would be felt even if there were no fall of prices; in fact, it would be greater. Also unemployment means reduced purchasing power.
20
Optimism and Pessimism
(The Seventh Main Factor)
All of the down movements thus far mentioned -- especially the down movements of Net Worth, Profits, and Employment -- have psychological effects. Already we have seen that shrinking net-worth leads to distress selling. But distress selling implies distress. A conscientious business man, caught too deeply in debt and forced into bankruptcy, may become despondent, even to the point of suicide. Distress also occurs when profits merely decline, through there may still be hope for a better future.
Yet those who reckon their net-worths and their profits are a very small class compared with those whose employment is affected by a depression; and to be employed or unemployed is, to the employee class, a question almost of life or death. Therefore, a depression affects the moods of that class with especial force.
There are, of course, some persons whose incomes run opposite to the general trend. That is,certain bondholders and salaried folk have fixed and same money incomes; and whenever prices fall, these incomes will buy more. In terms of real income, there fortunes have actually improved. But even most of these people share the general fears. In fact, they are the very type most accustomed to play safe and are, therefore, the most easily alarmed by general conditions. They begin to wonder if their incomes are safe after all. Indeed, they see some of their own class either out of employment or ruined by the ruin of the enterprises on which they had depended for their supposedly safe incomes. In a word, pessimism, in a depression, becomes practically universal.
Nor is this psychological movement only emotional. Partly it is intellectual as well; for it involves illusion and misjudgment. During depressions, the sober judgment of many people gives way to over-estimates of the degree and permanence of "hard times." And, as our estimates are largely guesses -- guesses as to what other people will do or think, and as to what and how much they will buy or see -- there enters the element of mass psychology. Everybody's opinion is largely guided by the opinion of everybody else; even the people with the coolest heads will at least "fear the fears of other men" and contribute to the panic of which such fears are a part.
Our list now is:
1. Liquidation
2. Currency-Contraction
3. Dollar Growth
4. Reduced Net-Worth
5. Reduced Profits
6.Reduced Production
7. Increased Pessimism and loss of confidence.
But here again, if (by checkmating of deflation) the failures and the unemployment be forestalled, pessimism and loss of confidence will also be forestalled.
21
The Velocity of Circulation
(The Eighth Main Factor)
Hitherto, under the head of deflation, we have considered only the contraction of currency (meaning deposit currency). But now we come to the slowing of currency through pessimism. For, while distress liquidations contracting deposit currency, the loss of confidence that accompanies the distress slows down all currency, bank deposits included; for scared people hold on to their money (of all kinds) a little longer -- they spend it a little more slowly.
And here again, all kinds of debts (including public debts through the pressure of taxes) have their effect in slowing the turnover of currency, because all kinds of debtors (including taxpayers) are especially subject to caution and fear. Even buyers at distress-sales, who gain the buying power that the sellers lose, will be cautious and postpone their buying and hold on to their money a little longer.
It takes contraction and slow turnover together to make up the full dose of deflation. Suppose, for instance, the currency, besides being contracted 50 per cent is slowed another 50. This means that there is only half the currency moving half as fast. Therefore, the currency as a whole will do only a quarter of its former work. Either Prices must drop three-quarters, or Trade must contract three-quarters, or else both Trade and Prices must drop in some degree. And this combination effect is what usually happens.
No one incident unites both contraction and slowing so effectively as a stock market crash. A stock market crash wipes out great masses of credit currency with unusual suddenness; and, at the same time, it so stirs the cautious side of human nature that men hang on harder than ever to their available money of very remaining sort. In combination, these two sequels of a stock market crash (contraction and slowing of currency) constitute a dose of deflation almost as good (or as bad) as a bonfire of a large part of the nation's cash. A stock market crash is evil enough in itself; but it is not confined to itself. Through its double effect on the currency in which commodity prices are registered, it sets commodity prices sinking in sympathy with the stock prices -- more slowly but also more injuriously to the foundations of the economic structure. And at last, something like a panic develops in the commodity market.
22
Hording, A Slowing of Velocity
Hording is a slowing of currency turnover of the extremist kind. It is the supreme manifestation of popular moods in a depression. Housewives and their breadwinners then become distrustful of everything except money. Bills and coins are confided to stockings or mattresses, or are put underground, or (in a larger way) stored in safety deposit vaults. Credit deposits may be hoarded too. In such banks as are considered safe, large credit deposits will be kept, but kept idle. Checking accounts, based on cash deposits will often be changed into time deposits, bearing more interest than checking accounts. Finally, if there be any reason to fear for the solvency of a bank, it will be subjected to a "run"; and the money, after it is withdrawn, will be hoarded at home.
It should be clear that hoarding, once introduced, becomes a tremendous factor in the vicious spiral, and can continue it with or without over-indebtedness. Hoarding lowers the price level. The lowered price level hurts business (debts or no debts); hurt business increases fear, and the fear increases the hoarding.
23
The Two Paradoxes Again -- Applied to Hoarding
We have seen, with respect to the contraction of the currency by mass liquidation, how debtors and their creditor-banks, by making, or trying to make, things better for themselves individually, make things worse for themselves collectively. The same applies to the slowing of the currency by hoarding. Every man who hoards does it for his own protection; yet by hoarding, he aggravates the very condition that started his fear. This is especially true when his panic puts panic into the banks. They sometimes make runs, so to speak, on their customers before the customers can make runs on them.
In fact, banks find themselves engaged in a race for "liquidity." They begin to call their loans; but by calling loans, they help further to extinguish deposit currency. This hoarding of money by banks has a magnified effect on deposit currency; for every dollar of reserve in a bank may support, say, ten dollars of loans. When, therefore, one bank forces another bank to surrender one of its physical reserve dollars, it forces a potential reduction of ten dollars of deposit currency. Even the bankers often fail to appreciate this ten-fold effect, because the initial effect of a physical dollar withdrawn is only one dollar of deposits withdrawn. [The details of the magnifying process have been set forth by Dean Chester Phillips of Iowa University in his Bank Credit (Macmillan, 1920) and have recently been further worked out mathematically by Professor James Harvey Rogers of Yale University.]
24
Possible Consequences of Contraction and Hoarding
IF all deposits were thus extinguished, as is not impossible theoretically, then the only circulating medium remaining would be physical, hand-to-hand, or pocket, money. There would then be a 90 percent shrinkage in the circulating medium, and a slowing down of such currency as remained. The price level might readily sink to less than one-tenth of what it had been, despite a reduction in the volume of trade. Then almost all business men in debt, including farmers, would be completely ruined.
We thus add to our list:
1. Liquidation
2. Contraction
3. Dollar Growth
4. Reduced Net-Worth
5. Reduced Profits
6. Reduced Production
7. Pessimism
8. Hoarding and a general slackening in the velocity of circulation, both of deposits and of physical money.
But here again, if deflation -- or the swelling of the dollar (due to both the contraction and the retardation of the currency) be checkmated, the slowing of velocity and hoarding will be checkmated too. For instance, an increase in volume, if sufficient, may conquer a decrease in Velocity.
25
Rate of Interest
(The Ninth Main Factor)
Debts bear interest. Consequently, a cyclical tendency in debts will involve a cyclical tendency in interest rates. In a word, as borrowers grow discouraged and therefore scared, interest (in the large centers at least) tends to go down. Nor can we say of this disturbance of interest rates, as we have said of other cycle-tendencies, that if the deflation were annulled, the disturbance of interest would be entirely forestalled. For the cycle-tendency of debts carries with it directly and necessarily a corresponding tendency in interest rates. This, however, is relatively harmless.
26
"Real" Rates" vs. Money Rates
But here enters another paradox: the inconsistency between this nominal or money interest and real interest. If, last year, I borrowed 100 dollars and am to pay 105 this year, my nominal or money rate of interest is 5 per cent. But if, meanwhile, the dollar has swollen so that, when the due date arrives, 105 dollars have become worth 106 of last year's dollars, my real interest is not five percent but six percent. [ The distinction between the money rate of interest and the real rate of interest is like the distinction between money wages and real wages, and between money debts and real debts. Burt it is more complicated, and so more often overlooked. We translate money wages into real wages or money debts into real debts at one point of time. But to translate money interest into real interest we must take account of at least two points, namely the time when the debt is contracted and the time (or times) when it is repaid. For further analysis, see Chapter XIX of The Theory of Interest by Irving Fisher (Macmillan, 1930). ] In a depression, therefore, when interest is meant to be low, the real interest amounts, sometimes to over 50 percent per annum! [ But the various themselves move unequally. The pessimism of the lenders causes them, for inferior borrowers, to raise their rates, instead of lowering them -- at least to raise them relatively to the rates allowed on safer loans. That is, in a Depression, any natural divergence between the two classes of loans is increased. ] The really important turbulence is this discrepancy between real interest and money interest; and this would be forestalled if the deflation were annulled.
27
Deflation the Root of Almost All the Evils
We see, then, that if the liquidation were prevented from bulging the purchasing power of the dollar -- that is, if the dollar was safe-guarded -- all the other depression consequences in our list (except as to money interest) would be forestalled, and the consistency between money interest and real interest would be preserved.
Practically the only evils would then be the disturbance in the debts themselves and in their money interest; and these would be relatively tame affairs. Of a depression as we know it, there would be little left.
28
Chronology of the Nine Factors
Our nine factors have been set forth in the following order:
1. Debt Liquidation
2. Currency Contraction
3. Dollar Growth
4. Net-Worth Reduction
5. Profit Reduction
6. Lessened Production, Trade, Employment
7. Pessimism and Distrust
8. Retarded Circulation
9. Lowered Money Interest -- but raised real interest.
But while the order of the nine major events as above set forth is a good pedagogical order, it is not a strictly chronological order. Its principal departures from chronology lie in the items of interest and pessimism, both of which, if treated chronologically, should come earlier. Pessimism was purposely delayed in the exposition until all the chief reasons for it had been cataloged. It was then inserted once for all. Perhaps, more than any of the other factors, it really comes in progressively all along the line. The first touch of liquidation has a depressing effect on moods; and this first approach of the pessimistic mood retards circulation.
Even the very start of the liquidation may be psychological discouragement -- either of the debtor or the creditor -- from a realization that the debts they owe, or the debts owing to them, are too high and should be reduced. This realization may be borne home by many causes; but the chief cause may well be that earnings, current or expected, have begun to disappoint the excessive expectations which originally let to the debts. It is often said that the "turn of the cycle" may be due to a very trivial precipitating cause. Anything which causes a slight revulsion of mood may be the last straw. Then, with liquidation and distress selling, the depression spiral begins its tail spin.
So the slowing of circulation may show itself statistically in advance of the credit contraction, though the contraction was listed first for convenience of exposition and the retardation of velocity was not mentioned until the full reasons for it had come into view.
Not only may the retardation of currency begin before its contraction, but there may be at first an actual expansion of currency, if enough cautious people set about accumulating cash studiously.
Nor are these the only chronological complications. Our Nine Factors are only a part of the whole complex picture in any depression, and their many effects on each other have not been exhaustively stated. If we may mix our metaphors, a depression may be said to be full of tangles and cross-currents. Moreover, dislocations may occur through a great variety of interferences.
29
The Trough of Depression
But no downswing goes on forever. Let us trace the first factor, debts. The process of liquidation may persist until at last it overtakes the swelling of the remaining debts, and begins to reduce not only their number but their real size. Every business failure, every bankruptcy, every reorganization grimly speeds the liquidation by striking off a certain proportion of the world's debts without even paying them; so that these failures may prevent the vicious spread of liquidation from swelling the dollar to ten fold dimensions. Moreover, the reduction in the volume of trade caused by the fall of prices, tends to check that fall. That is, the shortage of money and credit relatively to the needs of commerce becomes a less serious shortage when the needs of commerce have also shrunk. Thus, through real liquidation, or failures, or both, and a diminution of Trade, the bottom of the descending spiral is finally reached.
The time comes when the business world is left in a state of under-indebtedness. Then the Debt Cycle (or cycle tendency) will be, so to speak, at the zero hour, ready for a recovery which may merge again into a Boom phase, similar to that from which it fell. At this zero hour the world is full of bargain prices -- including, of course, investments, and including interest rates for those who would borrow in order to invest. And since each dollar of debt no longer grows during the life of the debt, the nominal interest is not belied by the real interest, but both are, for the time being -- for short-term loans -- one. All that is then needed for an upswing is some left-over individuals, still possessed of resources enough to enable them to take advantage of these bargain prices.
The downswing has itself tended to produce such individuals. They are the prosperous residue of the creditor and salaried classes -- the unharmed bondholders and the unharmed salaried folk. To them, as already noted, a higher dollar spells a lower cost of living, and encourages the buying up of the wreckage after the storm. Moreover, the hoarders, when convinced that the bottom has been reached and that they are safe in returning their hoards into circulation, become important buyers.
The Boom Phase Again
The upswing is helpful at first. It begins as a recovery all along the line, reversing each of the nine factors. Distrust and gloom gradually give way to confidence and then to enthusiasm. Hoards come out of hiding. Deposits cease to be idle. The rush includes commodity investments and new loans. For this very reason the nominal rate of interest rises; but it does not check the tide because the real rate falls. That is, the new buying and borrowing reflates the deposit currency, that is expands and speeds it, thus raising the price level (that is, shrinking the dollar), so that debts, through nominally increasing, diminish in real burden per dollar. The burden per dollar may even diminish faster than the nominal amount of the debts increases, thus diminishing the total real burden of the debts, despite their accumulating numbers. Thereafter, buying and borrowing become still more aggressive. They buyers rush still faster, so that their purpose may be accomplished while the buying is good. At the same time, the reflation, by raising prices, raises net worth, thus dispelling fear of business failure. Profits, too, are raised, thus encouraging the profit-takers to increase their out-put, their construction, and their pay-roll. Trade grows.
A Vicious Spiral Upward
If only the movement would stop at equilibrium! But our narrative in the last paragraph already implies a vicious spiral upward, the counterpart to the vicious spiral downward. It involves, like the downward spiral, three of the nine oscillatory factors, namely, Debts, Circulation, and Real Dollars. As reflation lightens the burden of the debts, the debtors, including new and weaker borrowers, are lured into further extending their enterprises, and, for that purpose, into incurring more debts, which further dilute the real dollar and so further lighten the real debt-burden, and so still further tempt the business world (including new and still weaker borrowers) to incur still more debts, and so on and on -- until again, after the number of dollars of debt grows faster than each dollar grows smaller, there comes an awakening to the fact that there is an over-indebtedness which must be corrected. Then borrowing diminishes, liquidation sets in; and once more we are headed for depression.
III.
STARTERS
32
Unproductive Debts
We began the discussion at the crest of the wave, with a state of over-indebtedness presupposed. But what started the debts?
First, as an approach to the problem of the origin of over-indebtedness, let us classify our debts.
Chiefly, there are two general classes of debts; productive and unproductive. [ For fuller discussion see The Theory of Interest by Irving Fisher (Macmillan, 1939) ]
An unproductive debt is incurred after some misfortune has cut a hole in the borrower's income stream; and the loan partially fills up the hole, while the borrower awaits better times. Thus if a workman falls ill and cannot, for a while, earn wages, he gets a loan to tide him over; and with its proceeds he ekes out the straitened family income, repaying the debt later when that income is increased by the resumption of wages. Occasionally, of course, such mischances may affect great numbers of people at one time, and so result in general over-indebtedness. A great earthquake, conflagration, flood, drought, pestilence, or war may result in unproductive debts on a large scale. Farm depression is often aggravated, if not caused, by drought, and crop failures. A war will create huge debts which are not only unproductive but devoted to destructive purposes.
Unproductive debts, however (except in war), are likely to be sporadic; and, since the borrowing in each case is reluctant and often cautious, it is likely to be limited by the available security. On the whole, therefore (except in war), this kind of indebtedness is not apt to be greatly overdone.
33
Productive Debts
As an explanation of economic crises, or of most economic crises, productive debts are far more important than the unproductive -- except war debts. In the case of productive borrowing, as in unproductive, there has been a hole cut in the income, but this hole is no accident. It has been deliberately cut by the borrower. A man who sees an opportunity to invest at a tremendous profit would be quite willing, if he could not get a loan, to sacrifice the enjoyment of a large part of his present income , in order to invest in the supposed bonanza, even if, for a while, he must live on bread and cheese. That is, he saves instead of spends. But if he can get a loan, he may fill up the hole which he cut in his enjoyable income. That is, he will sacrifice little if at all on his current spending. And if he finds that he can borrow very freely, he may be tempted to go still further into debt, and spend even more than before the loan, relying on the expected returns from his investment to repay both his investment and his extravagance. His psychology is not that of the unfortunate. His mood is not fear, gloom or caution. It is enthusiasm and hope.
Often, if not usually, the opportunity to invest is the result of new inventions, new discoveries, or new business methods. When inventors or their backers or exploiters, think they can, by borrowing at (say) 6 per cent, make profits of 100 per cent, why should they hesitate to borrow, and keep borrowing? Examples of such lures are the opening of the Erie Canal, the building of new railways, the exploitation of the Bessemer steel process, new uses of electricity, and new industries, such as automobile, airplane and radio.
34
Some Historical Illustrations
In 1792-93, in England, the lures were canals, real estate and machinery. In 1814-16, when Napoleon's interference with international trade had been broken, the lure, in England, was the prospect of renewed trade with the Continent. English speculation in exportable commodities became a stampede. In 1825, in the same country, there were various lures: mines and other commercial enterprises in Mexico, South America, and other foreign parts -- what G. H. Powell calls "exaggerated views of coming prosperity," through the profits to be had by investing. Says Tooke:
"This possibility of enormous profit by risking a small sum was a bait too tempting to be resisted; all the gambling propensities of human nature were constantly solicited into action; and crowds of individuals of every description -- the credulous physicians, divines, philosophers, poets, intermingled with women of all ranks and degrees (spinsters, wives, and widows) -- hastened to venture some portion of their property in schemes of which scarcely anything was known except the names."
In America, the chief depressions were 1819, 1837, 1857, 1873, and 1893. In most of these there was inflation beforehand and then deflation through contraction of the currency and bank credits. In 1819 and 1837 there had been wildcat banking causing inflation. In all cases there was speculation in real estate; for, as Victor Clark points out, a new country like America offers its opportunities for big profits largely in connection with the exploitation of new areas of land. In 1819 the land boom and collapse was in the east. In 1837 it was in the west and southwest. Whenever and wherever new lands were opened there was land speculation, the latest case being the Florida land boom of 1926. The crisis of 1837 followed land and cotton lures, and the lure of the canal building, steamboats and turnpikes. The speculation was led by Biddle, the great Philadelphia banker of that day. The result was to open up each side of the Appalachians to the other. The opening of the Erie Canal had profound economic effects. The investments in these internal improvements, were made possible by large loans from Europe.
The crisis of 1857 followed the exploitation of trans-continental railways, and western farms through the Homestead Act. These new farms were mortgaged to Eastern lenders.
Preceding the panic of 1893, in America there was an over-exploitation of farm implements resulting in over-production of farm products, pointed out by Professor Bogart. But the main cause appears to have been destruction of the monetary situation due to the injection of too much silver into our currency. The gold base was too small.
35
The Shady Side
A genuine opening of new opportunities for profitable investment is only the first step. At first, it is the legitimate leaders in the exploitation who are responsible for inducing the public to invest, and to borrow for the purpose of investing. Afterward some people, instead of investing for earnings, merely speculate -- buying in order soon to sell again to others who want to invest or to other speculators. Afterwards come less scrupulous promoters; and finally downright crooks. Probably no great crash has ever happened without shady transactions. Indeed, the disclosure of these is often the last straw which breaks the camel's back and precipitates the calamitous liquidation. Fraud enters as one link or mesh in the network, being both effect and cause -- an effect of genuine opportunities to invest, and a cause of over-indebtedness. No debt is so excessive as one based on mistaken hopes, but when disillusionment comes, the adventure is denounced as a "bubble" that has been pricked, such as the Mississippi Bubble and the South Sea Bubble.
36
Monetary Inflation Alone
As debt starters, we have considered (1) Unusual Debts of Misfortune, including War (that is, decreased present income), and (2) Unusual Debts for Investing (when there are prospects of increased future income). But we also have to consider: (3) Monetary Inflation without any unusual debts to begin with.
Such monetary inflation, whether designed or accidental, begins directly on the currency, without unusual debts, but presently reacts on the debt situation, by pouring into business such unwonted profits that business men begin to extend themselves in new enterprises, requiring more debts. There are many historic instances of this sort of thing. In 1849 California flooded the world with gold. Again between 1896 and 1913, new gold mines poured out their injurious treasures from South Africa, Colorado, and Alaska; and at about the same time, the weaker mines were revived by a cheaper process of extracting gold from low grade ores. The world had suffered also from many great paper inflations, especially in war time. These inflations have all led to debt over-extension, which has there-upon set in motion the eight other cyclical tendencies.
37
Combined Starters
Sometimes we find Inflation and Great Expectations joining forces. Such was the case in the crisis of 1857. Men had been over-borrowing in order to invest in mines. This would have been enough if the mines had produced only copper; but the mines produced gold, whose inflationary out-pour was added to the influence of the debts; that is, the inflation of god currency and the inflation of credit currency interlocked.
On the other hand, instead of intentional or accidental inflation, there might be intentional or accidental deflation. After the Civil War, when the greenback inflation of the 60's was replaced by the resumption of gold payments in 1879, thee was a case of intentional deflation; moreover, this was followed up by accidental exhaustion of gold mines in the face of expanding business. Such may have been among the important causes of the depression which culminated in 1893.
In the vicious spiral the debt factor and the inflation-deflation factor pursue each other, and either may be the starter of the pursuit. The greatest of all starters is war, including the rebound from war. War is the greatest inflater; and war's aftermath is the greatest deflater, because war is the greatest of all debt-makers, both public and private -- and of both productive and unproductive debts.
And, finally, war stimulates other starters, such as invention.
Sometimes, by coincidence we get all conceivable sorts of starters working in the same direction -- such as war, gold discoveries and new processes, new banking systems, with capacity for great credit expansion, great inventions and the rebound from a recent depression. Many of these coincided in the United States in the period 1913-1919 and many also in 1926-29.
38
Contents Topics omitted from this posting:
"The" BUSINESS CYCLE?
The Development of the Cycle Idea"Forced" CyclesFree CyclesAny Unbalance may cause Cyclical TendenciesBut These tend to die Down"The" Business Cycle Myth?Cycles as Facts or Tendencies
OTHER THEORIES
Many Theories Mutually ConsistentPrice-Dislocation TheoryInequality-of-Foresight TheoryChanges-in-Income TheoryFluctuations-Discount TheoryVariations-of-Cash-Balance TheoryOver-Confidence TheoryOver-Investment TheoryOver-Saving TheoryOver-Spending TheoryDiscrepancy-between-Savings-and-Investment TheoryOver-Capacity TheoryUnder-Consumption Theory
39
Conclusion to "Other Theories" Section
As to over-construction and over-capacity, these are natural consequences of over-investment, whether the over-investment be caused by too much debt or otherwise. And sudden cessation of construction, as Professor J. M. Clark so well shows The Economics of Overhead Costs, by J. M. Clark, University of Chicago Press, 1923) ], causes very violent oscillations. These are still further magnified if the over-construction is financed with borrowed money. ... As to the theory of "under consumption," and changes in the demand for "consumer goods," these mal-adjustments must have at least some oscillatory effects. But under-consumption appears to be much the same thing as over-production. ... The over-production theory, despite the skepticism of most economists, seems to me to have, at least in the boom period, some theoretical possibilities. I do not accept the hoary tradition that "general over-production is impossible and inconceivable." . . . According to the important statistical researches of Car Snyder, production seems to have progressed with such steadiness that it seems difficult to imagine how it could become a leading cause of major depressions; and the large inventory accumulations which have characterized many depressions (like that of 1920-21) seem to be rather symptoms of depression, or incidental consequences, than important causes.
Certainly many debts are contracted for production purposes; and if the judgment of the debtor is wrong as to what is a safe margin for his debts, this may be because his judgment was first wrong as to how much of his commodity would find a profitable market. Over-production can scarcely be itself the lasting force which keeps a depression going year after year. Where it merely a matter of over-production, it would seem to be to be likely to correct itself more promptly and almost automatically. But it still may be true that over-production [under-consumption] may precipitate liquidation of debts. The borrower's disappointment in the market for his goods may be one of the first symptoms to alarm both him and his creditors, as to the state of his debts. Perhaps that is why, in 1929, as we shall see, production and payroll and transportation began to slacken two or three months before the debt-structure crumbled. But thereafter the wisest producers were hit -- not by over-production, but by the liquidation spiral into which they were sucked; so that they were compelled, for the sake of liquidation, to turn all production into under-production.
The foregoing theories have been but barely mentioned, and are only a few of the theories which relate themselves to over-indebtedness, or deflation, or both, and which may, of course, contain important truth independently. I have devoted my effort in this book (Booms and Depressions, 1932) to nine tendencies -- merely "some" of the "first principles" underlying business disturbances. Others may be shown to have an equal right to be called "first principles." It remains a question of fact how important the truth may be of the few principles here presented as compared with those in other theories. Any decisive conclusion must await intensive statistical and historical studies. Further studies are also needed to complete, in quantitative terms, even the picture of the nine-fold cycle tendencies here discussed. ...
[Next follows] a very brief study of the facts of 1929-32, with special, but not exclusive reference to the principles selected for study in this book.
III.
THE OVER-INDEBTEDNESS THAT LED TO
THE WORLD DEPRESSION
40
The War and the New Era
To support the most colossal of all wars required prodigies of finance. And after the cost of the war came the cost of reconstruction. In both destruction and reconstruction, private financing as well as public was involved; for, in modern war, non-combatants exist only in name. Almost every private industry is, in effect, drafted into the service. Many of these must borrow, and after the war, many of them require readjustments which also involve borrowing.
After the World War, there was a joyful rebound. Europe appeared to be recovering. There were to be no more wars. Everybody was encouraged about everything. The war, moreover, had promoted endless new inventions, some of which were not merely destructive and could afterwards be applied to peaceful service. So the war gave a great new impulse to the spirit of invention. In America, invention became almost a trade, and something like mass production was brought to bear upon it. Captains of industry who had held the academic life in low esteem began to install laboratories. A questionnaire which was sent to some 600 industrial concerns brought back replies indicating that a majority had such installations. Accordingly, in the decade 1920-1929 more patents were granted in America than in its entire first century -- the peak years being 1926 and 1929.
There were also innumerable technological improvements not recorded in the patent office. Great strides were taken by the electrical, chemical and transportation industries. Road building became active. Scientific management struck a new tempo. Efficiency engineers came into their own. People began to talk of a New Era.
42
Investing in Equities on Borrowed Money
Meanwhile, there was a new trend in corporate financing. From 1921-1929, as the boom developed, the new corporate issues took more and more the form of stocks instead of bonds. This policy of reducing the proportion of bonds had one good effect: It left the corporations less encumbered with debt; so that, despite the depression, many corporations kept in a strong position throughout the whole of the depression. This advantage, however, was more than offset by shifting the debt burden from the corporations to the stockholders. That is, in order to buy the stock, many persons borrowed, so that, instead of being indebted collectively in the form of a corporation, they became indebted individually. Moreover, their borrowing was of the most dangerous type: largely margin accounts with brokers, whose loans were call loans. Thus, upon the corporate equities represented by common stocks was superimposed a structure of equities represented largely by margin accounts and brokers' loans.
This preference for investing in equities instead of bonds was fostered by a number of statistical studies, published in books and articles, which showed that almost always in the past, bonds had produced less income for the investor than had been (or should have been) produced by a diversified assortment of common stocks. [Edgar Lawrence Smith's excellent book, Common Stocks as Long Term Investments, had a great influence. ] Had the idea stopped at that, the effect of these studies would have been wholly good, for the total burden of debts would have been less than if bonds had continued to be the favorite investment; but, as things turned out, the volume of debt was made greater in size and more unstable in kind.
The new trend was further intensified by the formation of investment thrusts whose express business was to invest the money of their clients in diversified stocks. These trusts began to spring up like mushrooms, and presently became a mania. Many of them operated on borrowed capital, leaving precarious equities; and the individual owners of these equities borrowed in turn, thus still further pyramiding the debt structure -- equity upon equity.
43
High-Pressure Salesmen of Investment Bankers
Among the chief inciters to over-indebtedness for investments were the high-pressure salesmen of investment bankers, including bank-affiliates. One of the best informed students of this aspect of the problem writes as follows:
"I should make American investment banking the chief villain of the piece. In just what proportion inexperience, incompetence, negligence and shear bad faith have figured in the ballooning of debts by them I am not prepared to say, but I incline to think they are all well represented in the financings through American houses throughout the post war years. In seeking new issues to feed to a ravenous public, disregard for the debtor's ability to pay, for the possibility of effecting payment by willing and able foreign debtors, and for the existing interests of security holders in concerns to be reorganized or consolidated, mark a major portion of the financing during the period. The governing consideration seems to have been 'can the issue be sold at a handsome profit.' "
And, of course, there was an admixture of fraudulent enterprise, characteristic of boom periods.
Moreover, the inexperienced American public had been prepared for an investment fever by the financing of America's share in the World War. Unlike previous wars, this one was not financed exclusively by bankers and people of wealth. Nearly everybody had invested in it, even if only to the extent of a "baby bond," which was also a new idea. Millions of people, who before the war had never known what an "investment" was, suddenly became the proud possessors of securities, often bought with borrowed money.
Then there was the capital gain tax, improperly included in the income tax. During the rising market, this capital gain tax deterred many a holder of rising stocks from selling then and reinvesting the gains; for the holder knew that if he sold, he would be penalized by having a large share of his increased capital taken away from him by the Internal Revenue office. Here therefore hung on to his stock; and, in order to invest the increased worth, he borrowed -- using his appreciated stock for security.
The effect of this borrowing fever was steadily and enormously to inflate the deposit currency. Corporate profits rose, and the price level in the stock market rose. These were ominous signs.
44
The Steady Commodity Price Level
One warning , however, failed to put in an appearance -- the commodity price level did not rise.
The index of wholesale commodity prices, therefore, is not always an infallible index of monetary and business trends. In 1923-29, an index half-way between the level of commodity prices and the steep up-tilt of stock market price categories, including stock and bond prices, wholesale commodity prices, retail food prices, rents, and wage rates. This is an excellent index, but, necessarily, for the present, it is based on somewhat unreliable data and "weighting." For the present, therefore, the wholesale price index, despite its theoretical imperfections is generally accepted as the best. During and after the World War, it responded very exactly to both inflation and deflation. If it did not do so during the inflationary period from 1923-1929, this was partly because trade had grown with the inflation, and partly because technological improvements had reduced the cost, so that many producers were able to get higher profits without charging higher prices. For instance, from the third quarter of 1925 to the third quarter of 1929, the quarterly profits of 163 industrial and miscellaneous corporations rose by 75 per cent. In such a period, the commodity market and the stock market are apt to diverge; commodity prices falling by reason of the lowered costs, and stock prices rising by reason of the increased profits. In a word, this was an exceptional period -- really a "New Era."
45
Investing Abroad
Meanwhile, the investing and speculating Americans were by no means content with the home market. Foreign countries, European and South American, in the throes of reconstruction and elated like ourselves, were soliciting capital; and Americans furnished much of it -- to governments, to municipalities and to private corporations. Already, in the 60 years preceding 1931, according to a member of the British Parliament, British investors had lost 10 billion dollars by such loans. [ United States Daily, March 16, 1931, "Foreign Lending in 1930." ] Yet after the World War, American investors, with inadequate experience, marched into this field and took the lead. During the war, Americans had lent a great deal to the Allies. After the war, we kept on lending and included Germany, who in effect, borrowed to pay reparations.
In this way, America promoted or aggravated abroad the same unhealthy boom which was putting both our neighbors and ourselves in position for a slump. The reconstruction to which we contributed included much extravagance. Even though the municipal stadiums and swimming pools of Central Europe were not, as often charged, specifically financed with borrowed money, they necessitated borrowing for the other municipal purposes. In 1927, the reparation agent for the Allies, S. Gilbert Parker, protested Germany's excessive borrowing and the raising of governmental salaries; and Dr. Schacht, the head of the Bank of Germany, scolded his countrymen. "With borrowed American money," he said, "you live like rich people. With borrowed dollars you go every winter to the Riviera. If you borrow to improve productive equipment it is all right, but when you use American dollars for luxury expenditure, you act like fools. It would bankrupt private individuals, and it is just the same for the country." [ See What Makes Stock Market Prices, by Warren F. Hickernell. ]
But the lending can be an extravagance, too; and, in this sense, America was extravagant, and our bankers and investors might well have been scolded for it; instead of which our financial and political leaders proudly boasted that New York was supplanting London as the world's financial center.
46
Miscellaneous Borrowing Movements
The American farmer had long been over-extended. Already, on the slogan "Win the war with wheat" and on the tide of war inflation, he had financed his growing operations with borrowed money; and then, on the tide of post-war inflation, he kept on buying machinery and otherwise extending himself with borrowed money.
Finally, installment buying was promoted on an unprecedented scale by dealers in houses, automobiles, radio sets, furniture, refrigerators, vacuum cleaners, washing machines, and even fur coats and other clothing.
47
Reparations
[On German reparations, see Keynes' Economic Consequences of the Peace and A Revision of the Treaty; James W. Angell, The Recovery of Germany (Yale University Press, 1929); New York Times, June 14, 1931, "German Reparations and Allied War Debts" by Edwin L. James; November 1, 1931, "The War Debt Puzzle" by Charles Merz. ]
After the armistice in 1918, as the time approached for the peace conference at Versailles, the plan most popular among the Allies was to take all that the defeated powers could pay; and "defeated powers" meant, to all intents and purposes, Germany,whose wealth and resources were so much greater than those of Austria, Bulgaria and Turkey. It was rumored that one British financier predicted a German indemnity of between 100 and 200 billion dollars. [ See Keynes, J. Maynard, Economic Consequences of the Peace, p. 141 (American Ed.). ] Even after the treaty, but before the assessment by the Reparations Commission, Allied finance ministers talked of 74 billions. [Keynes, J. Maynard, A Revision of the Treaty, p. 39 (American Ed.). ] The actual assessment (in 1921) was 33 billions -- still a mammoth amount and one which, according to Mr. Keynes, involved a breach of the armistice agreement. It proved unmanageable; and after several conferences between the Allies and Germany, and then after the several consultations of the Dawes and the Young Commissions, a schedule of payments was drawn up to begin with 1939 and last 58 years. The total payments, if made, would come to about 27 1/2 billion dollars. At 5 percent the discounted value would be about 9 billion dollars as of 1930. [Large confiscations and payments in kind had already been taken from Germany. ] Down to 1932 Germany borrowed in order to pay; and even so, a moratorium was required. [On July 12, 1932, at Lausanne this situation was changed (after the Reparations had helped to build the crisis). ]
48
Inter-Governmental Debts Payable to America
[See Annual Report of the Secretary of the Treasury, 1927, p. 630, and subsequent reports; also in New York Times, June 14, 1931, the article by Edwin L. James on 'German Reparations and Allied War Debts," and New York Times, November 1, 1931, article by Charles Merz on "The War Debt Puzzle." ]
Up to 1920, the loans by the American government to 22 nations aggregated nearly 10 billions. In 1929, the principal and arrears (counting out five nations with which no debt "settlements" have been made) amounted to about 11.6 billions. By spreading both the principal and interest -- 22 billions -- over a period of 62 years (and also by reducing the interest), we have, in effect, reduced the debt to a much smaller present value -- about 5.9 billions, if discounted at 5 percent. But nominally the principal remains unchanged at about 11.6 billions, as of 1929.
The reparations and these inter-governmental debtors could be paid only in goods; but America deliberately and intentionally made such goods-payments enormously difficult, if not impossible, by erecting tariffs against hem -- and then granted a moratorium!
The condition in 1932 was that American private interests had lent Germany the money with which to pay the Allies the money with which the Allies were supposed to be paying the American government.
49
International Debts
These were loans made by American private interests to foreign borrowers, both private and public, American foreign investments of this sort began their phenomenal growth about 1912, increasing eight-fold from 1912 to 1931, and 89 per cent from 1922 to 1931. The total grown of these foreign debts did not stop with 1929. In 1931 they passed 15 billions. In 1929, however -- the crisis year -- the amount was about 14 billions, which, added to the lendings of our government, made a total foreign investment in 1929 of well over 25 billions.
50
Public Debts in the United States
These not only grew but went on growing after 1929. The total federal, state and local debts increased from 1915 to 1919, 5 1/2 fold, and then, up to 1932, they further increased by 14 per cent. [ Measured per capita, however, the increase was finished in 1919. ] At the end of 1931, the sum was nearly 34 billions, or over $271 per capita. But in 1929, the crisis year, it was about 30 billions: the state and local debts amounting to 13.4 billions; the federal, to about 16.9 billions.
Other countries also had great public debts, largely left over from the war. Even the neutral countries were not free of such debts.
51
Private Debts in America
From 1910 to 1928, farm mortgages rose over 2 2/3-fold; and in spite of a net increase in farm valuation for that period (including an inflation as well as a deflation period) the net equity of both the mortgaged and the unmortgaged farms descended from 90 percent of the gross valuation, in 1910, to 78 percent in 1928; the aggregatge burden being (in 1928 and 1929) about 9 1/2 billions.
Other agrarian debts in 1929 came to about 1.9 billions.
As roughly estimated on the basis of incomplete data, urban mortgages, from 1920 to 1929, increased more than three-fold, reaching, in 1929, about 37 billions.
Debts on life insurance policies in 1929 were about 2.4 billions.
Corporate long and short term debts in 1929 came to about 76 billions.
As to installment buying, only the roughest guesses are available. Professor Seligman guesses about 2.2 billions outstanding in 1926. The 2.2 billions would be about 3 billions by 1929.
Bank loans and discounts for all banks in the United States increased from June, 1914, to October, 1929, by nearly three-fold; from June 1917, two-fold; from 1922, 50 per cent; from 1926, nearly 15 per cent. Deducting brokers' loans from the total loans and discounts reported by the Comptroller of the Currency, we have 39 billions for the peak of commercial bank loans, in 1929.
52
Brokers' Loans
The year 1921 was the trough of a shot depression. The stock market was full of bargain prices. About 1923, the bull market began its unprecedented climb. An ideal investor, buying an average assortment of stocks in 1926 and holding them till September 7, 1929, could have turned every $100 investment into $200 -- all in three years. By starting in 1913, he could, by the same policy of holding on, have turned every $100 into $400. It was during substantially this period that investment trusts, having been a mania, became a full-blown bubble. During the first nine months of 1929 they rose from 200 to 400 in number, taking in a billion of their clients' money, to add to the two billions previously absorbed. During July they issued 222 millions of securities; during August, 485 millions; and September, 643 millions.
Naturally, brokers' loans kept pace with these opportunities. From October, 1928, to October 4, 1929, they increased by 50 per cent, reaching the record peak of nearly 9 1/2 billions. This included "bootleg" loans which at the peak were by far the larger part. [All security loans increased from October 3, 1928, to October 4, 1929, by 36 per cent and reached on that date a peak just under 17 billions. ]
53
Totals in 1929
Brokers' Loans 9.5 billions
Commercial Bank Loans 39
Total of all separable debts which
(mostly) create credit currency 48.5 billions
Other domestic private debts 129.8
Total domestic private debts 178.3 billions
Our public debts and all foreign
debts owing in America 55.6
Grand total owing in America 234. billions
As to the rest of the world, their domestic and international debts, including reparations, were vastly more burdensome than our own.
54
Gold and the Debts
But mere totals do not tell the whole story. It will be remembered that over-indebtedness may be alarming to the debtors or the creditors (the chief creditors for our purpose, being commercial banks). The important signal that may alarm the debtors is a fall in the price level which limits his ability to pay; the important signal that may alarm the creditor-bank is a curtailment of the gold supply which limits the bank's lawful ability to extend the debtor's time. Gold is the only international money; and during the war the inflation of paper and credits drove gold out of these paper currency countries and forced them to abandon the gold standard, while a serious gold inflation was produced in the United States by the flood of gold driven from Europe by the "cheaper" paper currencies. The complaints of a gold shortage which began to be heard soon after the war really meant that the price level had not sufficiently receded to permit a general return to the gold standard. Indeed, the attempts to return caused a "screaming for gold" which kept it scarce, or made it scarce, in many countries -- especially in the debtor countries.
The creditor countries were more fortunate; and one of them, at least -- France-- doubtless became possessed of a gold surplus. here is a prevailing opinion that the same was true of America. But this was only partly true, through it was fully believed by many Americans, including some American bankers. Gold came to America during the war because other countries were off the gold standard. But upon this gold we speedily built such a credit structure and raised the price level so high as to require almost all of the gold as a base. It is true that after the price level fell in 1920-2 there was temporarily an excess of gold in the United States, but soon both our business structure and our credit structure expanded so much as to make our unused or so-called "sterilized" gold more or less of a myth. The fact that we were a creditor nation was offset by the fact that we had collected very little from our debtors, and, on the contrary, had made new loans to them in excess of what they had paid us. Much of the gold in America was either ear-marked as belonging to Europe or was at any rate known to be subject to sudden withdrawal, as the result of short term credits held abroad.
If all this money, which had fled from Europe to America but was destined to return, could have been segregated as "refugee" money and sent home or even ear-marked, they myth of American excess gold would not have arisen. We would not have done so much financing of Europe, to the disadvantage of both parties -- or else we would have done it under contracts properly safeguarding us against gold withdrawal.
Thus, through our gold was great in quantity, the amount of it that was free was not great enough to justify much more than the credit currency erected upon it.
In 1924-5, the Federal Reserve authorities adopted a policy which had the effect of deliberately sending some of our gold away. Britain wanted to get back to the gold standard from which the war had forced her; and to do this, the Bank of England tried to attract gold by raising its interest rates; and the Federal Reserve authorities obligingly cooperated by lowering interest rates in this country. In this way, from 1925 to 1928, America lost 422 millions of its gold, and it the same period increase its ear-marked gold from 13 to 35 millions.
Moreover, this lowering of our interest rates stimulated speculation on the New York stock market. In a word, we dismissed some of our gold foundation and at the same time built a debt structure over the place where the gold had been.
Billions of debts and a gold base that was slippery -- these two conditions had now set the state for the collapse of 1929.
55
Contents of the omitted remainder of this book
The World Depression of 1929-32
In General
The American Stock Market
The Panic
Preliminaries in the Commodity Market
The Commodity Market
The Currency
Trade and Profits Upturns
International Accelerators of the Vicious Spiral -- 1931
Balancing the Budget
Summary as to the Nine Main Factors
The Real Dollar
Palliatives vs. Remedies
When Form is Substance
First Aid
Reducing Cost
Retarding the Debt Disease
Replacing Inflexible Bonds
Other Measures of Debt Flexibility
Debt Sealing
The International Debts in 1932
Remedies
Credit Control
The Mandate to Treat the Dollar Disease
The Equation of Exchange
The Quantity Theory
Adjusting Credit to Business
Reflating and Stabilizing the Price Level
Regulation Through the Rediscount Rate
The Federal Reserve System
Regulations Through "Open Market Operations"
What is Traded in Open Market Operations
Automatic Regulation of Reserves
Adjustments to Facilitate Open Market Operations
Conflicts of Function
A Unified Banking System Stabilization Properly a Government Function
A Bond Secured Deposit Currency
Gold Control
The Surplus Reservoir Plan
The Lehfeldt Plan
The "Compensated Dollar" Plan
Velocity Control
Confidence in Banks
Stimulating Borrowers and Buyers
The World Movement for Stable Money
Not Altogether New
The Present World Movement
The American Legislative Movement
The Federal Reserve Efforts
The Goldsborough Bill of 1932
Opposition ot the Goldsborough Bill
"What's in a Name?"
Our Dollar's Bad Record
War, a De-stabilizer
Can We Keep Capitalism?
56
Summary as to the Nine Main Factors
From 1929 to 1932, the nine main factors which have been discussed in this book behaved as follows:
1. Debts: The liquidation of brokers' debts had cut the figures by 94 per cent; of commercial bank loans by 22 per cent; of all debts due in America, by 23 per cent, except those (like public debts) which increased.
2, 7, 8 Money; its velocity; pessimism: Judging by the records of the Federal Reserve member banks, deposit currency had lost 21 per cent of its volume and 61 per cent of its velocity; the remaining efficiency for business purposes being only 31 per cent of its efficiency in 1929. The growth of pessimism is sufficiently indicated by this record.
3. The price level: industrial stocks had lost 77 per cent; and the descending commodity price level, instead of righting itself, lost 35 per cent. By the third week of June, 1932, this loss had become some 38 per cent.
4. Net worths: Their behavior is best indicated by the record of commercial failures, including bank suspensions. In 1929, 1.04 per cent of our firms had failed (22,909 in number); in 1931, 1.33 per cent (28,285 in number) -- in increase of 28 percent in the yearly rate of failures. Bank suspensions, in 1929 were 642 in number, in 1930, 1345, and in 1931, 2,550.
5. Income: the net profits of 163 industrial and miscellaneous corporations became a loss.
6. Production, trade and employment: All kept falling. According to a Federal Reserve index, industrial production [adjusted for season changes ] having fallen from June, 1929, to October 1929, by 5.6 per cent, instead of righting itself, registered 39 per cent additional fall from October, 1929 to January 1932.
The indexes show the construction fell earlier than out-put and much faster, just as indicated in Part I.
9. Interest: The various rates acted according to type. For instance, the rediscount rate, the call loan rates, and the 60 to 90 day time loan rates on mixed collateral, all rose with the boom and fell with the depression. The chief misfortune is that the rediscount rate rose too late to restrain those who borrowed in order to speculate on the bull market, and fell too late to check the stampede of liquidation by the same borrowers. That is, the real rate had been allowed to get so far away from the money rate -- so light on the way up and so heavy on the way down -- the borrowers were insensitive to the nominal rates.
57
The Real Dollar
The whole tragedy is summed up in what happened to the Real Dollar. From 1929 to March 1932, by reason of the lowering price level, the real dollar measured by 1929, became $1.53 -- later (third week of June, 1932) 1.62.
Thus all the liquidation that had been accomplished down to 1932 left the unpaid balances more burdensome (in real dollars of 153 cents apiece) than the whole debt burden had been in 1929, before liquidation began. Only one category of debt seems to have been reduced in fact as well as in name. This was brokers' loans, which were reduced, in name, 94.4 per cent, and in fact, 91 per cent. On the commercial bank debts of 39 billion, though 8 1/2 billions had been paid to 1932 -- nominal a reduction of 21.8 per cent -- the burden had not decreased but actually increased by 20 per cent. On the intergovernmental debts of 11.6 billions, 400 millions had been paid up to 1932 -- nominal a reduction of 21.8 per cent -- the burden had not decreased but actually increased by 48 per cent. On farm mortgages of 9 1/2 billions, 1.9 billions were paid -- nominally a reduction of 20 per cent; yet the real burden had increased by 22 per cent; If we exclude public and other debts which grew even nominally after 1929, the total is 187 1/2 billions on which the payments of 43 1/4 billions were made -- nominall a reduction of 23 per cent; yet the real burden had increased by 17 per cent. If we take everything, the grand total is 234 1/4 billions, on which net payments of nearly 37 billions were made -- nominally a net reduction of 15.7 per cent; yet the net real burden had increased 29 per cent.
In a word, despite all liquidations, the 234 1/4 billions of 1929 became over 302 billions in 1932, if measured in 1929 dollars. [ Of course, the figures merely compare valuations at two specific dates. They do not and cannot compare the various dates when loans were contracted and the dates when they were paid. ] By the end of the third week in June 1932, the business dollar had grown to $1.62 in terms of the 1929 dollar debts, the total would be equal to 319.8 billion of 1929 dollars, or an increase of 36 per cent. Even assuming liquidation by failure and foreclosure amounting to 10 billions, the real debts would have remained stationary at 302.9 billion dollars in 1929. ... This growth of real debt burden, despite huge efforts at liquidation, which, in my opinion, constitutes the master fact of the depression of 1929-32.
58
Our Dollars Bad Record
The greatest absurdity of all, however, is the claim ... that sound money is the kind of money we have been having for all these tortured generations. The first requirement for soundness is stability; and the purchasing power of a dollar is stable in proportion as the price level is stable. How stable that has been may be judged from the following chart of its history from 1860 to 1932 ...
This crooked line should some day serve as an inscription on the gravestone of unstable money. It is largely responsible for countless gravestones of children starved and of men killed in wars between capital and labor; for these wars were generated in large part by this crooked line. Every dip in the line, including the numberless minor jogs, means thousands of debtors cheated (unconsciously) by their creditors; and every climb of the line means thousands of creditors cheated (unconsciously) by their debtors. In both the debtor and the creditor camps there have been both rich and poor. A poor debtor, for instance, builds a cabin with the help of a mortgage. He borrows $1,000 in 1865; and in 1869, having paid all the interest, he pays the principal -- $1,000 that are worth over 3,000 of the 1865 dollars which he had borrowed. And for an example of a poor creditor, take a person who in 1896 put $100 in a savings bank, and in 1920 draws out (including compound interest) $256 that are worth 77 of the 1896 dollars which he had deposited.
If we treat the 1913 dollar as 100 cents, then the following schedule shows the various buying powers which the dollar has had at various times since 1860.
in 1860, it was 96 cents
in Jan. 1865, " " 47 cents
in 1896, " " 150 cents
in 1913, " " 100 cents
in May 1920, " " 45 cents
in 1922, " " 72 cents
in 1923, " " 81 cents
in 1924, " " 70 cents
in 1929, " " 71 cents
in 1930, " " 81 cents
in 1931, " " 98 cents
March 19,1932, " " 111 cents
third week of June, 1932, " " 118 cents
Or, if the 1929 dollar was 100 cents, then the dollar of the third week of June, 1932 was $1.62.
Nor does this take into account what happened abroad, in and after the World War, in the way of "calamity booms," as the Germans called them -- which wiped out the middle classes -- many by death, including suicide, because their incomes (consisting on salaries or of interest on bonds) did not rise when the price level did. In Britain, between 1913 and 1920, the price level rose more than 3 fold; in France, ore than 5 1/4 fold; in Italy, more than 6 1/2 fold; in Austria, between 1914 and 1922, more than 17,000 fold, which in 1925, became more than 21,000 fold; in Russia, by 1922, over 4,000,000 fold, and this, in 1923, became more than 6,000,000,000 fold. In Germany, for 1920, the rise was only 15 fold, but at the peak of inflation in 1923 it want far above the astronomical figure of a trillion fold.
59
War, A De-Stabilizer
In its relation to monetary derangements (which are themselves almost as cruel as war) war is the greatest obstacle to the movement for stable money. There is no money device which war will not wreck. War debts, war inflation, and post-war deflation are all on too large a scale to be checked by delicate machinery.
But there is no reason why the same cure that was effectively applied to war -- that is, judicial machinery; for war, like the frontier gun-play, is a crude form of litigation, which must always go on so long as there is anything to litigate and nothing else to litigate it with. War guilt is not my department, but I believe that no scholar now assigns entire guilt of the World War to any one nation. Some assign it almost or quite entirely to what G. Lowes Dickinson calls "The International Anarchy," under which nations had to conduct their commercial rivalry. To avoid war, the balance of power became a sort of insurance policy; and, for a time, it did preserve the peace; but sooner or later it had to turn bad -- no balance of power can stay put; and, when it began to slip, all the great powers of Europe, according to this view, reluctantly chose war as the less of two evils.
Since the international forms of litigation are a thousand years behind the municipal forms, the first step for the purpose of superseding war must, of course, be quasi-judicial -- not yet fully judicial.
60
Can We Keep Capitalism?
The threat of Socialism (if it deserves to be called a threat) is, of course, often made by those who would stir people to the need of making things better. But the threat seems to become more logical very year; witness Russia since 1919, and Chile in 1932.
Both war and the unstable dollar (with its hunger and its strikes) play into the hands of Socialism. What we call the Capitalistic System might better be called the System of Private Profits; and a depression, being a profit disease, is one to which Capitalism is peculiarly liable. So typical an exponent of Capitalism as Nicholas Murray Butler has recently affirmed that the system is on trial today. His remark, if he is right, can only portend that, unless Capitalism shall clean house by taking the dirt of depression out of profits, some form of Socialism may tear the house completely down. For profits are always at the mercy of the unstable dollar, -- always in danger of disappearing en masse whenever the price level shrinks, while debts and debt service do not.
Socialistic thinkers of all degrees make common cause against private profits, and add that, without such profits, crises would disappear. Accordingly, in 1929-32, the plight of the capitalistic world drew a good deal of derision from the Russians, who, though not prosperous, were apparently going up while we were going down. I shall not here debate the comparative merits of the two systems. Capitalism boasts of its rewards for initiative; Socialism claims a less selfish stimulus for the same virtue. But, for the present purpose, suffice it that each system has been compelled to borrow from the other. The capitalistic system, for instance, is not wholly capitalistic: witness government itself; witnes public schools, the post office, and the Panama Canal. On the other hand, Russia, which furnishes the only large-scale example of a socialistic experiment, has, in ten years, drifted perhaps as far toward Capitalism as we, in a thousand years, have drifted toward Socialism.
Meanwhile, -- to close this book with the quotation with which it began -- Sir Josiah Stamp, in the introduction which he was so kind to write to the English edition of my little book, The Money Illusion, buts it thus: "Money, as a physical medium of exchange, made a diversified civilization possible . . . and yet it is money, in its mechanical even more than its spiritual effects,which may well, haveing brought us to the present level, actually destroy society."