Readings in Money and Banking Part 76

The close of a panic is usually followed by the reopening of numerous enterprises which had been shut during the weeks of severest pressure.

But this prompt revival of activity is partial and short-lived. It is based chiefly upon the finis.h.i.+ng of orders received but not completely executed in the preceding period of prosperity, or upon the effort to work up and market large stocks of materials already on hand or contracted for. It comes to an end as this work is gradually finished, because new orders are not forthcoming in sufficient volume to keep the mills and factories busy.

There follows a period during which depression spreads over the whole field of business and grows more severe. Consumers' demand declines in consequence of wholesale discharges of wage-earners, the gradual exhaustion of past savings, and the reduction of other cla.s.ses of family incomes. With consumers' demand falls the business demand for raw materials, current supplies, and equipment used in making consumers'

goods. Still more severe is the shrinkage of investors' demand for construction work of all kinds, since few individuals or enterprises care to sink money in new business ventures so long as trade remains depressed and the price level is declining. The contraction in the physical volume of business which results from these several shrinkages in demand is c.u.mulative, since every reduction of employment causes a reduction of consumers' demand, and every decline in consumers' demand depresses current business demand and discourages investment, thereby causing further discharges of employes and reducing consumers' demand once more.

With the contraction in the physical volume of trade goes a fall of prices. For, when current orders are insufficient to employ the existing equipment for production, compet.i.tion for what business is to be had becomes keener. This decline spreads through the regular commercial channels which connect one enterprise with another, and is c.u.mulative, since every reduction in price facilitates, if it does not force, reductions in other prices, and the latter reductions react in their turn to cause fresh reductions at the starting point.

As the rise of prices which accompanied revival, so the fall which accompanies depression is characterized by certain regularly recurring differences in degree. Wholesale prices fall faster than retail, the prices of producers' goods faster than those of consumers' goods, and the prices of raw materials faster than those of manufactured products.

The prices of raw mineral products follow a more regular course than those of raw forest, farm, or animal products. As compared with general index numbers of commodity prices at wholesale, index numbers of wages and interest on long-time loans decline in less degree, while index numbers of discount rates and of stocks decline in greater degree. The only important group of prices to rise in the face of depression is that of high-grade bonds.

Of course the contraction in the physical volume of trade and the fall of prices reduce the margin of present and prospective profits, spread discouragement among business men, and check enterprise. But they also set in motion certain processes of readjustment by which depression is gradually overcome.

The prime costs of doing business are reduced by the rapid fall in the prices of raw materials and of bank loans, by the marked increase in the efficiency of labor which comes when employment is scarce and men are anxious to hold their jobs, and by close economy on the part of managers. Supplementary costs also are reduced by reorganizing enterprises which have actually become or which threaten to become insolvent, by the sale of other enterprises at low figures, by reduction of rentals and refunding of loans, by charging off bad debts and writing down depreciated properties, and by admitting that a recapitalization of business enterprises--corresponding to the lower prices of stocks--has been effected on the basis of lower profits.

While these reductions in costs are still being made, the demand for goods ceases to shrink and then begins slowly to expand--a change which usually comes in the second or third year of depression. Acc.u.mulated stocks left over from prosperity are gradually exhausted, and current consumption requires current production. Clothing, furniture, machinery and other moderately durable articles which have been used as long as possible are finally discarded and replaced. Population continues to increase at a fairly uniform rate: the new mouths must be fed and the new backs clothed. New tastes appear among consumers and new methods among producers, giving rise to demand for novel products. Most important of all, the investment demand for industrial equipment revives; for though saving may slacken it does not cease, with the cessation of foreclosure sales and corporate reorganizations the opportunities to buy into old enterprises at bargain prices become fewer, capitalists become less timid as the crisis recedes into the past, the low rates of interest on long-term bonds encourage borrowing, the acc.u.mulated technical improvements of several years may be utilized, and contracts can be let on most favorable conditions as to cost and prompt execution.

Once these various forces have set the physical volume of trade to expanding again, the increase proves c.u.mulative, though for a time the pace of growth is kept slow by the continued sagging of prices. But while the latter maintains the pressure upon business men and prevents the increased volume of orders from producing a rapid rise of profits, still business prospects become gradually brighter. Old debts have been paid, acc.u.mulated stocks of commodities have been absorbed, weak enterprises have been reorganized, the banks are strong-all the clouds upon the financial horizon have disappeared. Everything is ready for a revival of activity, which will begin whenever some fortunate circ.u.mstance gives a sudden fillip to demand, or, in the absence of such an event, when the slow growth of the volume of business has filled order books and paved the way for a new rise of prices. Such is the stage of the business cycle with which the a.n.a.lysis began, and, having accounted for its own beginning, the a.n.a.lysis ends.

MOORE'S "RAINFALL" THEORY

[246]To Professor Moore the fundamental problem of economic dynamics is to formulate the law governing the "ebb and flow of economic life" which is "the most general and characteristic phenomenon of a changing society." The motto of the department of agriculture of the United States--"Agriculture is the foundation of manufacture and commerce"--is significant and that the farmer is at the mercy of the weather is proverbial. There may be such a close connection between the weather, the crops, and crises that we shall be able to find in weather changes the cause of crises.

An examination of all the numerous factors involved in the problem would be a stupendous task and Professor Moore limits himself to a consideration of a selected few. "The variation in the quant.i.ty of the rainfall is one of the weather changes known to have a marked effect upon the yield of the crops." Hence the inquiry is directed to an examination of the "appropriate data with reference to three things: (1) the periodicity of rainfall; (2) the effect of rainfall on the crops; (3) the relation of the yield of the crops to economic cycles." The study is a statistical one conducted with the greatest of care to avoid error and the conclusions are deserving of the most careful consideration. All generalizations are made carefully and used cautiously with a full realization that a limited area--the upper Mississippi Valley--has been used and a period of only seventy-two years surveyed. Of the numerous climatic factors only rainfall has been examined.

Remembering that these limitations are fully realized we may state the conclusions in Professor Moore's own words: "The fundamental, persistent cause of the cycles in the yield of the crops is the cyclical movement in the weather conditions represented by the rhythmically changing amount of rainfall; the cyclical movement in the yield of the crops is the fundamental, persistent cause of economic cycles." This should be supplemented with a statement of the law that has been sought and which may be formulated thus:

The weather conditions represented by the rainfall in the central part of the United States, and probably in other continental areas, pa.s.s through cycles of approximately thirty-three years and eight years in duration, causing like cycles in the yield per acre of the crops; these cycles of crops const.i.tute the natural, material current which drags upon its surface the lagging, rhythmically changing values and prices with which the economist is more immediately concerned....

In conclusion we may merely observe that many theories are obviously presented to defend some of the other views of their advocates. The connection of the socialist theory with the socialistic idea of value is an obvious one. It may also be true that interest in some particular phase of study may cause the investigator to overlook the importance of other elements in the problem. Thus to Professor Moore climatic conditions seem of great importance, while Professor Mitch.e.l.l relegates them to a very minor position. As time pa.s.ses it will doubtless be possible to estimate the significance of each factor with more accuracy.

When this is done a more satisfactory theory can be formulated and methods of prevention and alleviation employed to better advantage.

STRINGENT MONEY AND FINANCIAL PANICS[247]

Is there any tendency for financial panics to occur more frequently in the seasons of the year when the money market is normally stringent? It has been found that the two periods of the year in which the money market is most likely to be strained are the periods of the spring trade revival (about March and April) and that of the crop-moving demand in the fall; and that the two periods of the easiest money market are the "readjustment period," extending from about the middle of January to about the first of March, and the period of the summer depression, extending through the summer months. Of the eight panics which have occurred since 1873, four occurred in the fall or early winter (_i. e._, those of 1873, 1890, 1899, and 1907); and one (_i. e._, that of 1903) extended from March until well along in November. Out of a total of twenty-one minor panics or "panicky periods" occurring between 1876 and 1908, inclusive, nine occurred during the fall and early winter, eight during the spring, one began in May and extended into June, three occurred during the summer months, and one occurred in February. The evidence accordingly points to a tendency for the panics to occur during the seasons normally characterized by a stringent money market.

HOW BANKS SHOULD HANDLE PANICS

[248]Whatever persons--one bank or many banks--in any country hold the banking reserve of that country, ought at the very beginning of an unfavourable foreign exchange at once to raise the rate of interest, so as to prevent their reserve from being diminished farther, and so as to replenish it by imports of bullion....

A domestic drain is very different. Such a drain arises from a disturbance of credit within the country, and the difficulty of dealing with it is the greater, because it is often caused, or at least often enhanced, by a foreign drain. Times without number the public have been alarmed mainly because they saw that the banking reserve was already low, and that it was daily getting lower. The two maladies--an external drain and an internal--often attack the money market at once. What then ought to be done?

In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of every one is the contrary. There being a large demand on a fund which you want to preserve, the most obvious way to preserve it is to h.o.a.rd it--to get in as much as you can, and to let nothing go out which you can help. But every banker knows that this is not the way to diminish discredit. This discredit means, "an opinion that you have not got any money," and to dissipate that opinion, you must, if possible, show that you have money: you must employ it for the public benefit in order that the public may know that you have it. The time for economy and for acc.u.mulation is before. A good banker will have acc.u.mulated in ordinary times the reserve he is to make use of in extraordinary times.

Ordinarily discredit does not at first settle on any particular bank, still less does it at first concentrate itself on the bank or banks holding the princ.i.p.al cash reserve. These banks are almost sure to be those in best credit, or they would not be in that position, and, having the reserve, they are likely to look stronger and seem stronger than any others. At first, incipient panic amounts to a kind of vague conversation: Is A B as good as he used to be? Has not C D lost money?

and a thousand such questions. A hundred people are talked about, and a thousand think--"Am I talked about, or am I not?" "Is my credit as good as it used to be, or is it less?" And every day, as a panic grows, this floating suspicion becomes both more intense and more diffused; it attacks more persons, and attacks them all more virulently than at first. All men of experience, therefore, try to "strengthen themselves,"

as it is called, in the early stage of a panic; they borrow money while they can; they come to their banker and offer bills for discount, which commonly they would not have offered for days or weeks to come. And if the merchant be a regular customer, a banker does not like to refuse, because if he does he will be said, or may be said, to be in want of money, and so may attract the panic to himself. Not only merchants but all persons under pecuniary liabilities--present or imminent--feel this wish to "strengthen themselves," and in proportion to those liabilities....

A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to "this man and that man," whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the pa.s.sage has become cla.s.sical. "We lent it," said Mr.

Harmon, on behalf of the Bank of England, "by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every a.s.sistance in our power." After a day or two of this treatment, the entire panic subsided, and the "City" was quite calm.

The problem of managing a panic must not be thought of as mainly a "banking" problem. It is primarily a mercantile one. All merchants are under liabilities; they have bills to meet soon,... are dependent on borrowing money, and large merchants are dependent on borrowing much money. At the slightest symptom of panic many merchants want to borrow more than usual; they think they will supply themselves with the means of meeting their bills while those means are still forthcoming. If the bankers gratify the merchants, they must lend largely just when they like it least; if they do not gratify them, there is a panic.

On the surface there seems a great inconsistency in all this. First, you establish in some bank or banks a certain reserve; you make of it or them a kind of ultimate treasury, where the last s.h.i.+lling of the country is deposited and kept. And then you go on to say that this final treasury is also to be the last lending-house; that out of it unbounded, or at any rate immense, advances are to be made when no one else lends.

This seems like saying--first, that the reserve should be kept, and then that it should not be kept. But there is no puzzle in the matter. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting of a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An "alarm" is an opinion that the money of certain persons will not pay their creditors when those creditors want to be paid. If possible, that alarm is best met by enabling those persons to pay their creditors to the very moment. For this purpose only a little money is wanted. If that alarm is not so met, it aggravates into a panic, which is an opinion that most people, or very many people, will not pay their creditors; and this too can only be met by enabling all those persons to pay what they owe, which takes a great deal of money. No one has enough money, or anything like enough, but the holders of the bank reserve....

... Before 1844, an issue of notes [of the Bank of England], as in 1825, to quell a panic entirely internal did not diminish the bullion reserve. The notes went out, but they did not return. They were issued as loans to the public, but the public wanted no more; they never presented them for payment; they never asked that sovereigns should be given for them. But the acceptance of a great liability during an augmenting alarm, though not as bad as an equal advance of cash, [_i.

e._, specie] is the thing next worst. At any moment the cash may be demanded. Supposing the panic to grow, it will be demanded, and the reserve will be lessened accordingly....

"On extraordinary occasions," says Ricardo, "a general panic may seize the country, when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realizing or concealing his property--against such panic banks have no security on any system." The bank or banks which hold the reserve may last a little longer than the others; but if apprehension pa.s.s a certain bound, they must perish too. The use of credit is, that it enables debtors to use a certain part of the money their creditors have lent them. If all those creditors demand all that money at once, they cannot have it, for that which their debtors have used, is for the time employed, and not to be obtained. With the advantages of credit we must take the disadvantages, too; but to lessen them as much as we can; we must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm.

FOOTNOTES:

[231] E. M. Patterson, _The Theories Advanced in Explanation of Economic Crises. Annals of American Academy of Political and Social Science_, Vol. 59, May, 1915, pp. 133-6.

[232] Address by Edwin R. A. Seligman, _The Crisis of 1907 in the Light of History_, in _The Currency Problem and the Present Financial Situation_, A Series of Addresses Delivered at Columbia University, 1907-1908, ix-xxv. The Columbia University Press, 1908.

[233] Wesley Clair Mitch.e.l.l, _Business Cycles_, _pp._ 5-19. The University of California Press. Berkeley, 1913.

[234] The not infrequent statement that prosperity sometimes merges into depression without the intervention of a crisis means simply that the writers understand by crisis a violent disturbance of business conditions. It is in closer accord with every-day usage to call such occurrences "panics," and to apply the term "crisis" to the transition from prosperity to depression even when accomplished quietly. On closer inspection, a business cycle is often found to be complicated by minor changes, such as the interruption of depression by a premature resumption of activity, the occurrence of a pause or even a slight crisis in the midst of prosperity, and the like. But for the present it is wise to confine attention to the broadest features of the cycle.

[235] Compare W. Sombart, _Versuch, einer Systematik der Wirtschaftskrisen_, Archiv fur Sozialwissenschaft, 1904, pp. 1-21.

[236] The first type of theories mentioned in the preceding section.

[237] W. H. Beveridge, _Unemployment_, ed. 3 (London, 1912), chapter iv.

[238] R.E. May, _Das Grundgesetz der Wirtschaftskrisen_ (Berlin, 1902).

[239] I have followed Mr. Hobson's latest exposition, _The Industrial System_ (London, 1909), chapters iii and xviii.

[240] George H. Hull, _Industrial Depressions_ (New York, 1911), p. 218.

[241] W. Sombart, _Die Storungen im deutschen Wirtschaftsleben_, Schriften des Vereins fur Socialpolitik, vol. 113, pp. 130-133.

[242] T. N. Carver, "A Suggestion for a Theory of Industrial Depressions," _Quarterly Journal of Economics_, May, 1903, pp. 497-500.

[243] Irving Fisher, _The Purchasing Power of Money_ (New York, 1911), chapter iv, and chapter xi, ---- 15, 16, 17. Compare the same writer's summary statement of his theory in _Moody's Magazine_, February, 1909, pp. 110-114, and H. G. Brown's paper "Typical Commercial Crises _versus_ A Money Panic," _Yale Review_, August, 1910.

[244] Adapted from Wesley Clair Mitch.e.l.l, _Business Cycles_, pp.

571-579. The University of California Press. 1913.

[245] The extract here reproduced is from the concluding chapter of the work indicated.--EDITOR.