A neglected point in connection with crises

Front matter

Book Jj^_

Copyright W...

COPYRIGHT DEPOSIT.

Chapter II. How Are Savings Invested At Times Of

DEPRESSION? 11

Do they accumulate in the Money Market"/. . . 14 Do they go into Temporary Investments?. ... 16

Do they become Liquid Capital? 18

Are they absorbed when used for paying

debts? 20

Are they used to relieve over-strained

credits ? 22

Do they serve to increase the expenditures for

commodities ? 26

Are they used for the creation of "unproductive capital " ? 27

Do they find investment in the purchase of

mortgages, securities, etc. ? 28

Do they go abroad ? 28

Do they fall off in the same proportion as the

opportunities for new constructions fall off? 30 Recapitulation 32

Chapter III. The Investment Of Savings At Times Of

DEPRESSION 34

Explanation of the chart 34

Impair Investments 38 ri Contents.

Basic Calculation 40

Impoverishment of the masses 42

How is the impoverishment brought about ? . . 43

Multiplying Principle 43

The impoverishment of "others" the basis for

the investment of Excess Savings 47

Recapitulation 52

CHAPTER IF.

Lack-of-funds theory 55

Excessive profits 66

Disproportions between economic factors.... 69

Summary 76

Chapter VI. Pros And Cons 89

Investment demand not necessarily a demand

for working forces 89

The three phases of the saving process 92

Tables showing Debit and Credit of Supply

and Demand 96

Are the nations of greatest saving propensity

the wealthiest? 100

Interest as indicative of a demand for cash

capital 106

Interest as indicative of a need of money 107

Why the demand for working forces should be

measured in terms of money 108

The purchase of commodities as rewarding

past labor 109

Contents.

VII

Squandering HO

Other forms of investment, besides the Capitalistic and the Impairing 113

The extent of the country's saving power. . . . 114 A positive proof of the existence of Impair

. Savings 118

Recapitulation 123

Chapter VII. Various Factors Affecting Prosperity 126

The money supply 126

Industry 130

Enterprise 131

Foreign trade 133

Minor factors 137

Chapter VIII. Recent Ups And Downs Of Prosperity

IN THE UNITED STATES 139

Causes of the Panic of 1893 140

Leading features of the Panic of 1893 and of

the subsequent depression 141

The Return of Prosperity 145

Complications due to Foreign Trade 147

Relative Scarcity of Currency 150

Unhealthy Basis of the Bank Money 154

Excessive Volume of Bank Money, yet a

Dearth of Cash Capital 156

Causes of the Dearth of Cash Capital 158

Inflation and Depreciation 160

Inflation the moving factor 161

The Panic of 1907 163

The Subsequent Depression 165

What of the Future ? 168

In Conclusion 171 viii Contents.

CHAPTER IX. A brief review 175

The three degrees of business activity 180

Economic fallacies 184

Once more, the "Neglected Point" 190

EXPLANATORY NOTES 192

A NEGLECTED POINT

IN CONNECTION WITH CRISES.

Chapter I. The Apparent Cause Of Crises And Depressions

(The small figures throughout the book refer to Explanatory Notes at the end of the volume.)

MODERN economists make a sharp distinction between crises and depressions, the one designating the shock which marks the end of a reign of prosperity, the other the period of stagnation in trade which follows. In common usage, however, when we speak of a crisis, such a distinction is not made, and a theory purporting to throw new light on the subject is expected not to confine itself to the initial stage, the crisis proper, but to deal largely with the subsequent depression of business — a usage which has been adhered to in selecting the title of this book. In fact, the "neglected point" which I am going to reveal is primarily a factor connected with depressions. At times, however, it has also been the governing factor in developing a crisis. Despite the common usage of treating crises and depressions as practically one and the same thing, we are justified in distinguishing between the two, for there is a radical difference not only in their outward manifestations but often in their origin. Our economists have hardly gone far enough in this respect, They have

The Apparent Cause dwelt much more upon the difference in the manifestations than upon the difference in the underlying causes. Indeed, the more important crisis theories now extant assume practically one and the same fundamental cause as governing both crises and depressions. Let us see if this assumption can stand scrutiny, and let us inquire into some of these theories in order to ascertain how far the apparent cause of the one will answer to explain the phenomena connected with the other.

The theory most widely accepted holds that a crisis must be attributed to overtrading, too much speculation, extravagance, etc., these various causes absorbing too much of the country's cash capital; and that a period of restriction in enterprise and of retrenchment in expenditures must follow to allow of building up fresh funds of liquid capital. This theory, no doubt, is captivating on account of its simplicity and apparent common sense. It seems plausible that inasmuch as the crisis is marked by a decided money famine, and inasmuch as before the setting in of the crisis there must have been an exhaustion of the country's cash capital, a period of repose and of commercial depression becomes necessary, to permit of recuperation. So it is the dearth of cash funds, occasioned by overtrading, etc., which really would stand as the cause of both — of the crisis as well as of the depression. But do we not here encounter an absurdity? Can the dearth of cash funds be the cause of the depression where as a matter of fact there is no such dearth while the depression exists and where, on the contrary, we witness an excess of idle cash funds? To get around this difficulty the theory had to be enlarged by taking in a new element — the loss of confidence incident to the panic and continuing during the subsequent depression, in consequence of which merchants and manufacturers do not carry on trade and enterprise to the same extent of Crises and Depressions.

as formerly. This new element, however, does not cover the point either, for confidence is really not lacking and would manifest itself at once wherever an opportunity for a profitable undertaking would offer itself. The fact is, such opportunities are scarce, owing to the prostrate state of trade and the lack of demand; and this lack of demand, which forms the gist of the depression, is neither explained by the loss of confidence nor by the scarcity of cash funds which originally engendered the crisis. The "lack-of -funds" theory, therefore, though fully explaining the setting in of a crisis, and thus accounting for the initial stage of a depression, will not explain why the depression should continue for years in succession. A depression may be started by a lack of funds and a loss of confidence; but if it were dependent only upon these two factors, it ought to disappear as soon as these two factors disappear. When the scarcity of cash funds gives place to a plethora, and when the general distrust ceases, the cash funds coming forth from their hiding-places, ready to engage in any promising undertaking, then those two factors which started the depression exist no longer, and the depression itself should cease. And as it does not do so, there must be some other factor at work not covered by said theory.

The latter, therefore, though accounting for the phenomena of a crisis, does not account for the phenomena of the depression.

Another theory, more in accord with the facts, has of late years found many adherents. It hinges on the investment process, and is based on the observation that wherever that process leads to new constructions and to the creation of new productive capital and wealth, the degree of business activity, and therewith of prosperity, bears an almost exact proportion to the extent of such new constructions. Thus, the continuous avalanche of

The Apparent Cause new undertakings and extensions as witnessed in the United States in the years 1905, 1906 and 1907 was coupled with an unprecedented degree of prosperity; ten or twelve years ago, when new enterprises were launched only to a limited extent, business languished; and if we extend our inquiry to unprogressive countries, like China and India, where there are practically no new constructions beyond the replacements necessary to keep up the status quo, we shall find a chronic stagnation of trade accompanied with great poverty of the masses. Wherever we look, we find almost invariably a close proportion between the degree of business activity and the extent of new constructions and enterprises. The funds required for the latter are furnished principally by the saving process — the savings and surplus earnings of individuals all over the country. So long as these savings 1 are invested in new constructions and enterprises, they will give employment and income to the working men and business men engaged in these new constructions, and by means of the well-known process of action and reaction the activity created in these special lines of business will spread to other lines and stimulate demand and activity also among all the numerous trades which are engaged in the broad field of production of commodities — resulting in general business prosperity. But if the savings are not so invested they can not give employment to the working men and business men ordinarily engaged in new constructions, and the lull thus originating in the building lines will react upon general production and trade, and engender a depression.

The foregoing theory, so long as it goes no further than developed above, is undoubtedly correct, and has been accepted by most of our economists, to that extent. But the disagreement begins when considering the quesof Crises and Depressions.

tion, What hinders the savings 1 from continuing to be invested in that beneficent way, i. e., in new constructions 3 and enterprises? Many explanations, differing more or less from each other, have been put forth to answer that question.

Judging this question from my own point of view, I can state two specific causes for the stoppage of new constructions, the one the very opposite of the other: first, The extension of new constructions, like railroads, factories, houses, etc., may have been carried on to such an extent as to satisfy the demand for this kind of capital goods for the time being, thus causing a scarcity of opportunities for investment in this direction; second, the demand for new constructions may become so insatiable as to exhaust the funds of the money market and over-strain the credit facilities of our financial institutions.

The first-mentioned cause became operative with us in 1903 and 1904. In the years immediately preceding, lavish expenditures had been incurred in all sorts of new constructions, or in the extension of old ones, bringing the country's productive power up to a standard much beyond anything previously known, so much so that the demand for productive capital seemed to be satisfied for the time being. In consequence, the pace of new constructions slackened. The trades engaged in new constructions began to suffer, notably the iron and steel trade, and, by means of the well-known process of action and reaction, the dullness in the one line of trade created dullness in most other lines also — all due to the primary cause that the undertaking of new constructions was checked through the abundance of productive capital (railroads, factories, etc.) already in existence.

The second of the two causes above mentioned may seem paradoxical, namely, that an excessive, insatiable

The Apparent Cause demand for new constructions should engender a lull of that demand. But the process is not difficult to understand. An excessive amount of new constructions will absorb an excessive amount of cash capital and will cause a stringency in the money market, so much so that the latter is constantly kept on the verge of a general collapse. If on top of this stringency anything should occur that shakes confidence, all entrepreneurs will take flight at once, and the rush for new constructions will suddenly change to the contrary. If it does, the final result will be the same as in the former case, namely, a lull in new constructions. As soon as this lull sets in, the working forces 6 ordinarily engaged in creating new productive capital and wealth are thrown out of employment, and the loss of income and of buying power on the part of these forces will react upon the forces engaged in the broad lines of production and trade, and engender the depression. Then a new factor sets in. While before the crash the country's productive capital was not large enough to fully meet the great demand for commodities, it is now too large for the reduced demand, so the stimulus for new constructions ceases. Thus we arrive at two factors causing the depression, first, the loss of confidence ; second, the shrinkage of the general demand, due to the lull in new constructions. The one factor initiates the depression, the other gives it continuity. The one ceases to operate after the panic is over; the other operates as long as the depression lasts, generally for years in succession. This being so, it is evidently the second factor, the lull in new constructions, which must be considered as the real basis of the depression. And it should be noted that this factor is entirely different from the one which originally gave rise to the crisis.

The foregoing will explain how a stagnation in business may be brought about by either one of two factors.

of Crises and Depressions.

the one the very opposite of the other — a lull in the demand for new constructions on the one hand, and an excessive, insatiable demand for such on the other. In either case we arrive at the same final result, namely, a check to enterprise and to new constructions — the very thing which, according to the view of most economists, forms the governing factor of all depressions.

This view, however, that the degree of business activity largely depends upon the extent of new constructions that happen to be under way for the time being, is not exactly shared in by all of our economists,, some of them holding that it looks like putting the cart before the horse. According to their view the demand for new productive capital and for new constructions, such as we witness in seasons of booming business, must be attributed to the great demand for commodities, this being the governing factor; not that the heavy demand for commodities should be brought about by the great extent of new constructions under way. The fact is, we have here a case of reciprocal action. An augmentation in the rate of new constructions brings with it an augmentation of the country's business activity; and an increase in this activity, in turn, will increase the demand for new constructions ; the one factor constantly invigorating the other. The governing factor, however, and the one that starts this reciprocal action, must be found in enterprise and new constructions. Suppose a railroad be built in an unprogressive country like China; this will give employment and income to many persons who would otherwise remain idle ; these persons, when expending their income for commodities, give employment to other people, those who produce these commodities, and these people in turn, when expending their earnings, will furnish employment to still others, and these again to others, thus giving rise to a chain of action and re-

8 The Apparent Cause action resulting in an enlargement of the community's total business activity — all of this being due to the building of the railroad.

It seems hardly necessary to adduce further argument to prove how largely prosperity depends upon this important factor: enterprise and new constructions. All experience confirms the fact that wherever the country's savings and surplus earnings are promptly invested in this direction, there business will be active and labor well employed. And experience equally confirms the fact that wherever that all-important factor is dormant, there depression prevails. Such being the case, we are evidently justified in concluding that the theory is correct which holds that the subsidence of enterprise and new constructions, and the causes (whatever they may be) to which the subsidence is due, must constitute the true source of the depression.

This theory seems quite plausible, being sustained by logic as well as by the facts. Nevertheless, it does not cover the ground. It gives only the apparent cause of depressions, not the real one. While we can take it for granted that the presence of the above-named factor, enterprise and new constructions, will stimulate business activity and prosperity, it does not necessarily follow that its absence must entail depression and stagnation in trade.

There is a flaw in the theory. It does not sufficiently consider the question as to what becomes of the country's savings and surplus earnings if they are not invested in enterprises and in the creation of new productive capital and wealth. Why do they, in that case, fail to stimulate trade and prosperity? If they were not invested at all, they would accumulate in the money market, to an immense aggregate, which as we know is not the case. They are evidently invested nearly as fast as they accrue.

of Crises and Depressions.

And in the course of such investment they return into the channels of general trade, finally becoming scattered in the purchase of commodities. Why does not this sort of investment stimulate prosperity as well?

Let us clearly define the point at issue. If the country's savings and surplus earnings become invested in new constructions, they give employment to a certain class of working forces 6 , and business prospers; if invested in a different way, why do they not give employment to some other class of working forces, and why do we see, on the contrary, a general lack of employment? If we could point out the reason why, in the latter case, their investment does not give employment to working forces, might we not fairly hope to obtain new light on the subject of depressions?

Let us follow up this question. We may arrive at conclusions which shall show the existence of a factor, heretofore unknown, that is responsible for the unemployment and the lack of demand prevalent at times of slack business.

The factor considered by many present-day economists as all-important in bringing about a stagnation in trade- -the subsidence of enterprise and of new constructions — is only the apparent cause of depressions. A factor more potent than this has escaped their attention. Once we understand the nature of this hidden factor and find means for checking its activity, enterprise and new constructions may practically come to a standstill, and yet business would prosper.

In the foregoing, as well as in what follows, attention has been given primarily to the subject of Depressions, rather than to Crises. The latter are not so difficult to

10 The Apparent Cause of Crises and Depressions.

understand, in fact their cause is generally well known, so it would be unprofitable to enlarge upon their discussion. Not so with depressions. Their origin is still so much enveloped in mystery as to justify the conclusion reached above, that there must be factors at work whose existence has heretofore remained unsuspected.

Chapter II. How Are Savings Invested At Times Of Depression?

MOST economists hold that in times of depression the savings and surplus earnings of individuals, then accruing, will largely remain in the money market 4 , staying there, for years in succession, in the shape of "liquid capital."

Is this view consistent with the facts? When considering the stupendous annual aggregate of savings made in a country like the United States, the retention of any large portion thereof in the money market would represent a huge sum, entirely out of proportion to the amount of liquid capital actually found there at any one time. When further taking into account that every year of depression ought to increase that huge sum and ought to add to the stock of idle cash funds, while no such increases are revealed by the actual trend of the money market, the above view seems to be quite untenable.

The behavior of the money market, far from showing a growing accumulation of liquid capital at such times, will rather impart the impression that the savings funds flow out about as fast as they flow in, and that a steady absorption of these funds goes on, nearly as fast as at times of prosperous business. True, they are not invested in the field legitimate for savings funds, i. e., in the formation of additional wealth or capital goods, such as railroads, houses, factories, etc., for there is but little of this kind of capital 2 built up in times of depression. But they are surely absorbed in some way.

How this absorption is taking place ; how those funds can be invested and transformed into capital 2 without the concurrent creation of new capital — this subject, though of vast practical importance, has not received the attention which it deserves.

Let us, first of all, form an idea of the approximate extent of the country's saving power.

Between the years 1890 and 1900 the wealth of the United States increased about 23 billion dollars, or 2,300 millions per annum. Considering that during the four years of depression from 1893 to 1897 the accumulation went on at a slower rate, the increase must have averaged, for the remaining six years of the decade, as much as three billions. In the recent highly prosperous years, since 1900, it may have averaged not less than four billions.*

Of the latter amount we may safely assume as much as three-fourths to represent savings, i. e., surplus earnings;! ar, d we thus arrive at a total of, say, three billions per annum as approximately representing the country's saving power.

Having thus approximated the saving power, let us see to what extent these savings can find investment in

* A recent Government publication states the increase of the country's wealth for the four years 1900 to 1904 to be about 19 billions — almost 5 billions per annum.

t Not all of the country's annual increase of wealth represents surplus income. Part of that increase is the result of appreciation of property, due to a rise in market value; another part may be the result of personal efforts, for instance, where a farmer improves his property by his own toil. If we figure the increase of wealth resulting from these and other sources to be one-fourth of the total increase of four billions, this would leave three billions to represent the wealth derived from surplus income.

All of these figures are guesswork and on that account may not be considered a reliable basis on which to build up an important economic principle. Still, if they are only roughly correct, they answer the purpose of this discussion. Exact figures are neither available nor necessary.

A further discussion of this subject will be found in the footnote on page 115.

the creation of new wealth (i. e., in new constructions) at a time of prosperity and again at a time of depression. It is well known that under prosperous conditions practically all of the savings are so invested. Taking this for granted we would arrive at the following equation:

Saving power of the people, per annum $3,000,000,000

Savings invested in building up new capital, or in creating additional wealths, per annum 3,000,000,000

Now, suppose a period of depression sets in, equally severe as the one witnessed in the years 1893 to 1897. Our capitalists will not go then into new enterprises to such an extent as they did of late, and will not continue to build up new capital at the rate of three billions a year ; perhaps not even at the rate of one billion. Assuming the latter amount to be sufficiently near the correct figure, and assuming further that the people's saving power will be reduced by as much as one billion dollars, owing to the depression, our equation would be changed as follows:

Saving power of the people UNDER FAVORABLE

CIRCUMSTANCES, per annum, same as above $3,000,000,000

Saving power, at a time of depression, reduced to, say 2,000,000,000 Savings actually invested in building up new capitals,

At times of depression only a part of the people's surplus earnings can still be employed in the creation of wealth ; according to the above equation only one billion out of two billions of savings. What becomes of the balance?

That balance, whatever it amounts to, is by no means barred from finding profitable investment, and is surely turned into capital 2 . Evidently, if one field of investment becomes closed, another one opens. But how this is done; how savings can be turned into capital without at the same time forming new capital, this question has not so far been treated in a conclusive manner.

A number of theories have been advanced to explain what becomes of savings funds in times of depression. Let us review these explanations, including the one already referred to, and let us see whether they can stand scrutiny.

EXPLANATION NO. 1.— If savings do not find immediate employment, they will find it later on, after the depression is over; the final investment, such as leads to the formation of new capital, being simply deferred, and the savings meanwhile remaining in the state of "liquid capital." Thus they provide part of the cash funds needed at the time of subsequent recovery in trade. For instance, the savings made during the years of depression from 1893 to 1897, so far as not absorbed at the time, constituted part of the cash capital which was utilized later on for the numerous enterprises launched at the time of the ensuing "boom".

REPLY.— If the savings made between 1893 and 1897, or a large part of them, were really left unabsorbed for the time being, where were they to be found? Did they stay in the money market? 4 As is well known, savings gravitate toward the latter, appearing there as employment-seeking funds. But even if only one billion dollars per annum, i. e., only one-third of what the savings at the present prosperous time (1907) amount to, had stayed in the money market in the shape of "liquid capital seeking investment," a four years' accumulation would have amounted to four billion dollars of idle cash funds, a sum larger than the whole supply of money in the United States. As a matter of fact, the money market took an entirely different turn. If we take the surplus funds of the commercial banks as a gauge by which to judge the amount of unemployed cash capital extant, we find indeed that a moderate accumulation took place soon after the panic of 1893 had set in, amounting to a few hundred millions; but this accumulation gradually disappeared, so that around 1897 hardly any of it was left — showing that all surplus earnings had been absorbed in the meantime. Do these facts confirm the above "Explanation"?

It may be held that the course which the money market took during those years of depression in the United States was exceptional, and that in other periods of depression the superabundance of liquid capital has been more pronounced. But the principal sign which naturally ought to accompany the steady accumulation of savings funds, viz., the constant growth of unemployed cash funds in the money market, augmenting from year to year while the depression lasts, has never been observed. As a matter of fact the general drift of the money market has not varied much in other depressions, whether in Europe or America, from the course above described. And in none of them has there been an accumulation of funds at all commensurate with the vast amount of savings which flowed into the money market and were not absorbed in new enterprises, and which according to Theory No. 1 should have accumulated there.

Much has been made of the fact that the rate of interest shows a tendency to decline in periods of depression, thus betraying a greater pressure of cash capital to find employment. This pressure no doubt exists ; but to deduce therefrom, or from the declining rate of interest, (the cause of which will be explained in a subsequent chapter) that there must be exceptional accumulations of cash funds, although statistics fail to reveal them, is an unwarrantable conclusion. If such idle cash funds, running into billions, really existed, they would first of all appear in the commercial banks. But inasmuch as the weekly bank statistics disprove the existence of these huge idle funds, Theory No. 1 cannot be true.

16 Hon) Are Savings Invested

EXPLANATION NO. 2.— The surplus earnings find temporary employment, say in the shape of loans, and in many other ways, until the return of activity in trade ushers in a new demand for liquid capital, and opens up opportunities for permanent investment.

REPLY. — It would not be an easy matter to point out many instances where surplus earnings, or, as it were, the cash funds representing them, find investment of a merely temporary nature. In most instances the supposed temporary investment will either prove to be a peimanent one, or will prove to be no investment at all, so far as the funds as such are concerned. A real, genuine investment of cash funds will lead them to be split up into hundreds of fragments; they will go in payment for goods or services, will lose the character of cash capital, and will leave the money market. If they do that, they generally have found permanent investment. If they do not come to be scattered, they most likely have found no investment at all, but have only changed owners — a subject which will be treated more fully further on. (See "Explanation No. 8.")

Let us analyze a case of what may seem to be a temporary investment. Suppose A saves $1000 and lends the money, for the term of one year, to B, who uses it to extend his factory. When so employed the money is turned into "fixed capitaV and, though loaned out temporarily only, is permanently invested. By the end of the year B will not be able to return the money, except with the help of new savings, or with the help of fresh funds procured elsewhere. He may have saved up that amount of $1000 himself in the meantime; but then the money returned to A represents B's savings, not A's any more ; or he may make a new loan elsewhere, and procure the money from C, to pay off A ; then the amount represents C's or somebody else's savings. In either case the original funds saved up by A remain permanently invested in the factory.