The Economics of Inflation: The Basis of Contemporary American Monetary Policy 9780231893466

Table of contents :
Preface
Contents
Tables
Part I. Contemporary Aspects of American Inflation by H. Parker Willis and John M . Chapman
I. The Idea of Inflation
II. Inflation and Its Relation to Banking
III. Inflation and Money
IV. Inflation and Industry
V. Inflation as a Contemporary Problem
VI. Inflation in the United States
VII. The Price Controversy
VIII. Speculation and Prosperity
IX. The Farmer and Inflation
X. The Business Man and Inflation
XI. Inflation and Investment
XII. Some Conclusions: The Nature and Effect of Inflation
Part II. Supplementary Essays
1. Inflation in Current Economic Literature
2. Inflation and the Distribution of Income
3. Inflation and Overproduction
4. Inflation and Decreasing Costs of Production
5. Inflation in Securities
6. Inflation and the Stock Market
7. Inflation and Bank Portfolios
8. Inflation and Public Works
9. Inflation and Foreign Trade
10. Inflation and the Structure of Production
11. Price Reflation
Index

Citation preview

THE ECONOMICS OF

INFLATION PREPARED UNDER THE AUSPICES OF THE

COLUMBIA UNIVERSITY COUNCIL FOR RESEARCH IN THE SOCIAL SCIENCES

THE ECONOMICS OF

INFLATION THE BASIS OF CONTEMPORARY AMERICAN MONETARY POLICY BY

H. P A R K E R

WILLIS

PROFESSOR OF B A N K I N O COLUMBIA UNIVERSITY

AND

JOHN

M.

CHAPMAN

ASSISTANT PROFESSOR OF BANKINO COLUMBIA UNIVERSITY

NEW YORK : MORNINGSIDE HEIGHTS

COLUMBIA UNIVERSITY PRESS 1935

W I T H T H E C O L L A B O R A T I O N OF A. A. Beaujean D. J. Leahy Schroeder Boulton Fritz Machlup M. A. Heilperin A. Wilfred May V. D. Kazak£vich Anatol Murad Chas. P. Kindleberger E. A. Radice Erik T . H. Kjellstrom E. F. Schumacher John F. Van Deventer

Copyright COLUMBIA

1935

UNIVERSITY

Published

PRESS

1935

PRINTED IN THE UNITED STATES OF AMERICA BY QUINN fc BODEN COMPANY, INC., RAHWAY, NEW JERSEY

PREFACE the years 1932-33 the Banking Seminar of Columbia University conducted an investigation into the current position of banking in the United States, which has since been published as The Banking Situation. T h i s work was undertaken and carried through with the aid of a special grant made by the Columbia University Council for Research in the Social Sciences, for the purpose of furthering and supporting economic inquiry. T h e present monograph is a companion volume and, like its predecessor, embodies the work carried on by the Banking Seminar of die School of Business, Columbia University. T h e basic statistical and other incidental costs have been borne by the Council for Research in the Social Sciences. While Part I of the monograph has been prepared by the instructors in charge, Part II is the contribution of the various members of the Seminar, each working upon a. designated specialized topic believed to have an important bearing on some phase of the inflation problem, as developed during recent years. These studies necessarily, in many cases, depend upon background data covering a period of years prior to the year »933; which, so far as herein given, are intended primarily as explanatory of the current situation. T h e monograph itself is designed as a study of contemporary practice viewed in the light of economic theory. Inasmuch as each contributor to the volume is specifically named and his contribution definitely ascribed to him at the point where it appears, no acknowledgments are here necessary, except to say that the editors have enjoyed the collaboration, assistance, and valuable suggestions of the members of the Seminar throughout the entire course of the work and have profited materially from their criticisms. DURING

NEW MAY,

YORK 1935

H.

PARKER

J

M

O H N

WILLIS C H A P M A N

CONTENTS P A R T

I

C O N T E M P O R A R Y ASPECTS O F A M E R I C A N

INFLATION,

BY H . P A R K E R W I L L I S AND J O H N M .

I. II. III. IV. V. VI. VII. VIII. IX. X. XI. XII.

CHAPMAN

The Idea of Inflation Inflation and Its Relation to Banking Inflation and Money Inflation and Industry Inflation as a Contemporary Problem Inflation in the United States The Price Controversy Speculation and Prosperity The Farmer and Inflation The Business Man and Inflation Inflation and Investment Some Conclusions: T h e Nature and Effect of Inflation PART

3 >9 39 59 8o 108 131 150 163 176 190 206

II

SUPPLEMENTARY

ESSAYS

1. Inflation in Current Economic Literature BY Anatol Murad 2. Inflation and the Distribution of Income BY E. A. Radice Inflation and Overproduction 3BY M. A. Heilperin 4- Inflation and Decreasing Costs of Production BY Fritz Machlup 5- Inflation in Securities BY A. Wilfred May 6. Inflation and the Stock Market BY Schroeder Boulton

221 237 268 280 288 309

viii

CONTENTS

7. Inflation and Bank Portfolios BY John F. Van Deventer 8. Inflation and Public Works BY V. D. Kazakévich 9. Inflation and Foreign Trade A. The Theory of Inflation and Foreign Trade BY Chas. P. Kindleberger B. Sterling Exchange BY A. A. Beaujean C. Dollar Exchange BY D. J. Leahy D. Stabilization BY A. A. Beaujean 10. Inflation and the Structure of Production BY E. F. Schumacher 11. Price Reflation BY Erik T. H. Kjellstrom

331 344 371 379 387 395 398 417

TABLES PART I I. Movements of Price Indexes in the United States and England II. Foreign Trade and Changes in Monetary Factors Prior to the Entry of the United States into the World War III. Price Changes in the United States Prior to the Declaration of War IV. Changes in Bank Credit and Gold Movements After the United States Had Entered the World War V. Amount and Percentage Distribution of Long-Term Debts By Class and Year VI. Changes in the Composition of Assets of All National Banks, igig to 1932 VII. Investment Experience of the Holders of Common Stock Outstanding on January 1, 1922 VIII. The Growth of American Agriculture, 1850-1930 IX. Prices Received and Prices Paid by Farmers X. Investment Quality of Bonds, Preferred and Common Stocks for Last Year of the Trusts, Based on 184 Trusts XI. Foreign Exchange Prices, Currency and Cost of Living in Germany During the Inflation Years XII. Effect of Inflation on Insurance in Germany

57 81 82 83 117 124 126 163 167 192 195 201

PART II 1. Index of Wholesale Prices, Cost of Living and Bank Clearings outside of New York, 1914-20 244 2. Individual Incomes 245 3. Indexes of Real Incomes, 1914-20 247 4. Money Incomes, 1914-20 248 5. Annual Earnings and Income Indexes of Wage Earners and Salaried Employees, 1914-20 248 6. Interest Payments, 1914-20 249 7. Indexes of Wholesale Prices, Cost of Living, and Bank Debits, 1923-28 250 8. Distribution of Individual Income, 1923-28 251 9. Percentages of Components of Individual Income, 1923-28 »51

X

TABLES 10. Indexes of Cost of Living and Incomes of Wage Earners and Salaried Employees, 1923-27 11. Dividends and Profits, 1923-29 12. Indexes of Prices of Goods Sold and Bought by Farmers, 1 9 1 4" 8 9 13. Labor Costs and Overhead Costs, 1914-29 14. Distribution of Individual Incomes, by Groups, 1929-32 15. Indexes of Individual Incomes, 1929-32 16. Per Capita Income Indexes, 1916-26 17. Percentage of Total Incomes, 1916-26 18. Corporation Savings, 1914-28 19. Net Increases in Government Debt and Net Expenditures on Public Construction, 1923-28 20. Expansion of Government Credit, 1917-19 s i . Volume of Government Securities Held by Banks 22. Security Loans by Classes of Banks 23. Security Loans 24. Total Loans and Investments of Banks by Classes 25. New York Times Index of Fifty Stocks 26. Yearly Average of Monthly Volume of Stock Sales 27. Index of Changes in Output of Nondurable Consumption Goods, 1922-29 28. Index of Physical Volume of the Production of Finished Goods 29. Index of Raw Materials, Semifinished and Finished Goods 30. Index of Productive Activity Manufacturing 31. Clearings Index of Business 32. Dun's Commodity Price Index 33. Annual Dividend Payments of Reporting Corporations 34. Total New Security Offerings, 1924-34 35. United States Common-Stock Prices, Industrial Production, and Commodity Prices 36. Net Incomes and Net Deficits of All Corporations 37. Loans on Securities, 1929 38. Stock Prices, Brokers' Loans and Call-Loan Rates 39. Brokers' Loans, Monthly Averages of Weekly Figures 40. Stock Prices and Corporate Earnings 41. Common Stocks and the "New Deal" Inflation 42. Net Earnings of Leading Companies 43. Earnings and Stock Prices, by Groups 44. Loans and Investments of All Member Banks 45. Composition of the Portfolio of All Member Banks

252 252 254 255 256 257 261 262 264 265 289 289 295 296 296 297 297 298 298 298 299 299 299 300 301 311 312 314 316 318 319 322 325 329 334 336

TABLES

xi

46. Portfolio of All Member Banks in 192g and 1933 337 47. Changes in the Composition of Loans of All Member Banks 338 48. Distribution of Investments Among All Member Banks 340 49. Distribution of Investments Among Various Groups of Member Banks 341 50. T h e Decline of Income and Employment During the Depression 347 51. Comparison of Total Construction Estimates 366 52. Allocation of Construction by Types 367 53. Percentage Distribution of the Estimated Total Volume of Public Works 369 54. Wholesale Prices in Great Britain and the United States 380 55. Raw Materials, Value 381 56. Total Foodstuffs, Value 382 57. Total Exports, Manufactured Goods, Value 383 58. Foreign Exchange Rate, United Statesand Great Britain 384 59. Price Level of Great Britain Expressed as Percentages of the United States Price Level 384 60. Changes in Wholesale Commodity Prices, 1932 and 1933 389 61. Exchange Position, United States, England and France 391 62. Index of Prices in the United States, 1933-34 428

PART I

CONTEMPORARY ASPECTS OF AMERICAN INFLATION

I T H E IDEA O F I N F L A T I O N

1

IN every study of contemporary economic or financial policy, a beginning is best made by attempting to relate the subject to the body of economic theory and to designate the group of general considerations which should govern it. T h e study of inflation is no exception to this rule; rather it affords a conspicuous exemplification. Most of those who speak of inflation at the present time fail to define their use of the term, and are disposed to leave the reader to draw his own inferences from the text, both as regards the principal meaning of the language used and the implications which depend upon it or grow out of it. It is, undoubtedly, owing to this lax use of the term that so many of the misunderstandings and controversies of the present time have arisen. Indeed, a large part of the differences of thought regarding the subject can be eliminated by reaching a consensus of opinion regarding the exact scope to be assigned to the term inflation, and the conditions under which it may be considered appropriately applied. T h e first task, accordingly, in any study of inflation is to attempt an analysis of current usage and to note, if possible, the various steps by which that usage has been developed. Such an effort is made in the present chapter. POPULAR

CONCEPTIONS

T h e "average man" is disposed to use the term inflation with a moral or ethical connotation which is not uniform but which varies from time to time. Inflation is prevailingly used as indicating a means of enlarging or raising values in the interest of debtors and is, consequently, regarded as a popular, or generally beneficial, policy. Inflation when spoken of by banking interests, on the other hand, usually appears as an epithet of dislike or condemnation, practically identifiable with repudiation, and sometimes vaguely identified with "unsoundi By H. Parker Willis.

4

T H E IDEA OF

INFLATION

ness" in monetary or currency thought generally. A recent use of the term by politicians and social reformers extends it to include practically any effort to give a larger share of the "national dividend" to some presumably depressed group in the community. "Deflation," on the other hand, is contemporaneously a conception representing the desires or views of the "conservative" members of the community—those, namely, who wish to adhere to the older and more established methods of organizing industry and dividing wealth. During the political struggles of 1933-34, deflation and inflation, respectively, have thus come to denote the general policies or interests currently assigned to those groups in the community which have some ownership of wealth, and those which have not. T h e distinction in the United States has been peculiarly artificial because of the very widespread character of wealth ownership. T h e crude current discussion of the subject has failed to take account of the circumstances that savings accounts, insurance policies, ownership of an equity in real estate, etc., give to the proprietor of these values an interest in the maintenance of stability in purchasing power and avoidance of artificial changes in the worth of the monetary unit. T h e assumption that the people of the United States are divided into two classes—one very large, consisting of persons without ownership rights and living purely upon current day-to-day incomes; the other, very small, and consisting of persons to whom salaries and wages are practically of no importance, their chief interest consisting of the product of wealth—is erroneous. As the discussion has gone on, a rather more refined form of this grouping has supervened, and we may perhaps say that the distinction between the two groups drawn by politicians is now representative of relative differences existing between one element which is comparatively dependent upon salaries and wages, while the other and opposing element is far less dependent, if at all, upon such wages and salaries for its income, and relies upon rents, interests, and dividends for income. Viewed in this light, the inflation-deflation controversy is presumed to be a struggle be-

T H E I D E A OF I N F L A T I O N

5

tween groups relatively more or less interested, as the case may be, in increasing or decreasing the purchasing power of fixed or contractual elements in the yield of capital and land. T h e terms inflation and deflation have thus come to be roughly identified in popular speech with this background conception, although usually without a definite specification or working out of its implications. A T T E M P T TO D E F I N E

USAGE

The exceedingly broad and uncertain meaning assigned to the term inflation as thus outlined has necessarily led to some effort to define the meaning of the term as employed by the press and by publicists generally, if only for the sake of a slightly greater consistency in writing and speaking on the subject. Several fairly distinct uses or types of use may thus be recognized, in prevailing practice, where the word inflation is employed. T h e outstanding use thus assigned to the term identifies it with movements of prices. Those who make this identification take it for granted that high prices of commodities are the hall mark of inflation, and they consequently speak of an inflationary policy as one which tends to raise prices or to fix them at high levels. Deflation, on the other hand, is in this connection identified with falling prices, or with prices that have reached a very "low" level. Implicit in these uses of the terms inflation and deflation is usually the idea that an advance or decline of commodity prices is the direct result of enlargement or contraction of the supply of money or credit—an assumption to be later dealt with at some length. The use of the terms "high" or "low," "rising" or "falling," as applied to the prices of commodities, presupposes an idea of equilibrium or normality as incidental to the concept of inflation. Those who speak of inflated prices usually regard them as prices that are high as compared with some level which is regarded as a base, or as compared with some year or period thought of as "normal." The term "reflation" is currently employed to refer to processes of raising commodity prices from their present levels back

6

T H E IDEA OF I N F L A T I O N

to a former point, w h i c h is spoken of as "inflated," or higher than a previous level originally taken as normal. T h u s inflationists in the U n i t e d States d u r i n g 1933-34 eventually came to conceive of the price level of 1926 as an inflated level—perhaps 60 per cent above the level of 1913, but accepted subsequently as a normal period; while the price level of the end of 1932, figured as about 60 per cent of that of 1926 by the United States Bureau of L a b o r statistics, was thought of as "deflated," and hence, to be "reflated" back to the 1926 level. T h e question, what is meant by the term normal in this connection, is, of course, never very carefully specified. It is frequently thought of as merely a former level representing a period of prosperity, or a time at which industrial and financial conditions are conceived (now, though perhaps not formerly) as having been satisfactory. It will be noted that this use of the term, although perhaps more widely employed than any other in current controversial discussion, practically treats the entire subject from a financial standpoint, rather than from an economic point of departure. Nevertheless, a certain proportion of those who engage in the inflation controversy, employ an interpretation which is to be carefully differentiated from that which has just been outlined. T h e y recognize that the higher or lower level of commodity prices prevailing at any given moment as compared with a previous time, is not necessarily, or at least not solely, the product of monetary causes. W h a t e v e r may be the influence of monetary policy in raising prices or putting them back to a former level, this group of writers fully concedes that there may be industrial factors which tend to alter the price level; the latter at most were not offset by the monetary changes tending to contract or cancel any industrial influences which if left to themselves might have affected prices. T h i s industrial or economic point of view with respect to inflation and deflation obviously assumes the existence of a normal period from which all changes 01 departures are to be measured; and it likewise assumes the existence of a definite opposition of interests among different groups in the com-

T H E

IDEA

OF

I N F L A T I O N

7

munity—sometimes designated as "debtor" or "creditor" classes. Its characteristic is mainly the admission that there may be nonmonetary factors at work to bring about the change. T h e r e is a third main type of current usage which needs also to be recognized, although this is found much less frequently than either of the others. Inflation, to this group of persons, appears to signify an economic condition in which overdevelopment of some function or relationship has taken place, while deflation is an opposite condition of underdevelopment. T h u s it is not unusual to hear of an "inflated condition of agriculture" or a "deflated level of wages," or labor may be spoken of as having been "deflated." T h e apparent meaning of this latter expression would seem to be that through shrewd bargaining or through the application of monopolistic or organized power some element in production, or some class in the community, has been assigned more or less than that share of the product of industry which would otherwise normally have been given to it. Here, again, is the conception of a normal, or right, distribution of wealth or income; while deflation or inflation is thought of as simply a departure from that normal or right level, regardless of the means by which such departure has been attained. Usually, as already intimated, the means for forcing such a departure which are conceived of as most effective, are those of monopoly, or of capitalistic, control. This may be defined as the political use of the term. These three usages—financial, economic, and political—practically sum up the main shades of meaning assigned to the terms inflation and deflation, and, as already noted, differ in their implied theories of causes while they agree in regard to the processes themselves (inflation or deflation) merely as variations from a more desirable level or normal figure. THE

E C O N O M I S T AND

INFLATION

American economists and, in fact, economists generally, although, as might be expected, far more cautious and discriminating in the use of the term than is true of the rank and file of the public, have nevertheless permitted themselves to make

8

T H E IDEA OF I N F L A T I O N

use, to a considerable extent, of popular locutions, and to fall into frequent confusion of language and meaning. Their discussions of the terms, however, at least recognize the principal elements involved in the controversy as a matter of definition, and they seem to agree substantially upon the following points: 1. Inflation and deflation are comparative terms which should be used without necessary implication of merit or demerit. So used, they refer to a basic parity which is taken merely as a point of departure and which is not necessarily normal in any sense other than that it is used in the construction of an index of measurement. 2. They agree, abstractly at least, that the price level of commodities is an abstract conception representing an average of many different individual prices or units; and that an inflation of prices may be due to the preponderating effect of a few elements so that it does not necessarily signify a complete restoration of the conditions taken as basic. 3. They consequently recognize further that the relationship among groups of prices or price units may be much more important to the producer or recipient of income of certain classes than the question whether prices in the aggregate are high or low; and that the recipient of money income may be far more beneficially situated in a period when commodity prices on the average are falling but when total real income (and employment) are rising or steady, than he can be in a period when prices are rising and when income is uncertain or falling in the aggregate. 4. With reference to the base or norm from which inflation and deflation are to be measured, economists generally admit that this selection should not be based upon vague conceptions of prosperity or large turnover in business, but that a desirable basis or norm is that which exists at times when economic forces are in equilibrium, i.e., when each element in production is receiving that return for its services which is most nearly consistent with the economic strength of the community as a whole.

T H E I D E A OF I N F L A T I O N

9

These bases of agreement are substantial and have gone far toward clarifying the discussion of inflation and deflation, especially during recent months. It should be noted, however, that the economic community is far from a unit regarding other essential elements in the debate. T h e following points of difference must be conspicuously reckoned with: 1. There is no agreement as to whether inflation is or is not primarily a monetary or financial phenomenon, or whether it is fundamentally a general economic phenomenon. 2. This difference of opinion grows out of a fundamental lack of agreement with respect to the factors which tend to establish commodity prices. Inasmuch as a large group of economists still insist upon holding that the prices of commodities in general, as measured in money or money representatives, are directly and primarily influenced by the volume of this money or money representatives, they must evidently regard changes in the volume or ease of attainment of money or credit as being most fundamental factors in inflation. On the other hand, they must regard individual changes affecting the industrial status of given commodities as merely localized alterations, whose effect upon the general price level will be felt merely as they tend to alter the average index number representing the prices of a great group of selected commodities. 3. With these differences in mind, economists obviously must differ greatly with respect to the influences to be produced through voluntary alteration in the supply of money or credit, or in the conditions under which that supply is provided. 4. Still broader differences of view necessarily exist as between those who believe in a "planned" society and those who do not. Believers in a planned society are of the opinion that by shifting the ownership of purchasing power and so altering its application in use, they may not only alter price levels but also the distribution of money incomes. Heavy taxation, for example, resulting in great expenditures by a government in behalf of public buildings, loans to citizens who wish to improve their living conditions, construction of new roads, slum clearance and the like, permits a planning of society which

10

T H E

IDEA

OF

INFLATION

alters the uses to which wealth is put and which incidentally causes changes in commodity prices, by giving to masses of consumers control over goods which they otherwise would not be able to exert. Opponents point out that such changes in wealth ownership and application do not imply corresponding changes in wealth saving and creation and that hence, while the consumption industries may be affected more or less frequently by such planning of industry, the "capital goods industries" are remotely affected, if at all, so that the immediate influence of such efforts upon prices is uncertain or incalculable. With these fundamental differences of theory greatly modifying the fundamental bases of agreement already indicated, it is evidently difficult to obtain and secure any general definition of the term inflation which may be used as a guide in current economic discussion and which may be taken as fitting all cases. Perhaps the nearest approach to such usage would be found in the statement that an inflated or deflated condition is one in which voluntary action on the part of the state, or of the community in general, has established a set of economic relationships which is different from what would ordinarily have been established had it not been for such "planning." T h e fact that, in times past, much inflation and deflation has occurred without any voluntary planning whatever, and has merely been the result of accidental or interventional effort, or of effort designed by persons who had their own axes to grind, need not alter the current use of the term. T h e fact that inflation and deflation may have been involuntary or unconscious processes in the past, whereas it is now intended to make them voluntary or conscious, does not alter their character or the methods by which they have worked. It merely calls for a closer understanding of the underlying elements by which they have been controlled. ECONOMIC PLANNING

T h e connection of economic planning with inflation and deflation is thus clear. Inflation and deflation are conceived by many economists as the unconscious processes of the past whereby changes in wealth distribution have taken place, or whereby

T H E I D E A OF I N F L A T I O N

11

great differences in the relationship of the so-called debtor and creditor classes have been developed. Economic planning is thought of as the self-conscious method by which changes in the relationship of economic classes are being, or are to be, brought about in the present and in the future as against the presumed laissez-faire or automatic methods of other years. T h e great difficulty of economic planners in adapting themselves to actual conditions, like the great difficulty of not a few economists chiefly concerned in the study of money and prices, is found in the assumptions which they have allowed themselves to make: (1) that economic planning necessarily implies changes in commodity price levels; and (2) that such changes in price levels may be most easily brought about by changes in the supply of money or the conditions under which credit is established. Due to the uncritical acceptance of these assumptions, a great many conclusions with reference to economic planning which might otherwise be accepted in some cases have proved impossible of such acceptation. On the whole, it would seem clear that the idea of economic planning, whatever may be thought of it, should in its own interest be kept entirely distinct from the theory of money, banking, and prices. Only in that way can a reasonable consensus of opinion be developed with respect to the major subjects in which inflation figures as an important, but not a necessary, factor. It may, for example, be desirable to alter the debtor and creditor relationships of the community, and to do this through some act of legislation; as, for example, the indebtedness of the landowning classes in various countries has been occasionally modified or practically wiped out. Such a decision does not necessarily imply either that the desired result can be reached by debasing the currency, or that it is best that this should be done. Some other and far preferable mode of procedure may be worked out. USE

OF E X C H A N G E

MEDIA

This whole current discussion of economic planning has thus too largely centered in its contemporary aspect around the question whether a nation's system of money and banking

12

T H E IDEA O F I N F L A T I O N

should or should not be used for some purpose other than that for which it was devised. Economists have for long years agreed that the purpose of a system of money and banking is to facilitate exchange—to bring about the purchase and sale of as large a quantity of goods as may be economically desirable. T h e requisites of good money have been frequently described as including stability of value, but this was for the sake of confirming the confidence of the community in the money itself, not for that of attaining some ultimate purpose. In the same way the existence of "sound banking" and the ability to be certain of the redemption of a bank note have been frequently insisted upon by economists, but always with the idea in mind that convertible bank notes of known standing would be more useful to the community and more serviceable in performing the functions of currency than any other, not because their soundness or unsoundness tended to alter the distribution of wealth in certain ways. In a good deal of the contemporary discussion of planning, the opposite of this past usage has been taken for granted, and it has been assumed that there is no reason why the exchange media of a country may not be contracted or expanded, undermined or strengthened, for the purpose of attaining some nonmonetary object—an object associated with the redistribution of wealth, or the encouragement of business, or some other even less obvious purpose. Economic science is distinct in its teachings that economic institutions, in order to be successful, must be applied to the purposes for which they were designed, and that their use as intermediaries for the attainment of some other purpose is invariably likely to diminish their effectiveness and success in their own field. Money and credit cannot, in other words, be expected to serve as media for the redistribution of wealth and at the same time be considered likely to operate as satisfactory media of exchange and measures of value. Inasmuch, therefore, as the idea of inflation is an idea of change in economic position, it would seem to be associated with the idea of monetary and banking manipulation only fortuitously, and in no sense as a necessity. T h e fact that the use of the

T H E I D E A OF I N F L A T I O N

13

monetary and banking system for this ulterior object has so often served to bring on disorders of an unexpected but dangerous sort, in itself tends to emphasize the sharp line of distinction to be logically drawn as thus indicated. WORLD-WIDE

POLITICAL

IMPORTANCE

What has been said illustrates the world-wide political importance of the inflation concept. It is, of course, not accidental that political controversies the world over are centering about the distribution of wealth, and that either through taxation, readjustment of monetary systems, repudiation of foreign or domestic debt, or other means, a definite attempt is being made in many countries to rearrange the burdens of economic life and to shift loads so that they may more easily be borne, or that they may be so represented. T h e number of countries in which the redistribution of wealth is assuming a primarily monetary form is a long one; and this accounts for the fact that the identification of inflation with changes in the price level has been so widely prevalent. T h e fact that there are other countries where no such identification has taken place and where the monetary question occupies a secondary, sometimes a wholly unimportant, place, and where the fundamental issue is still as sharply drawn as ever, calls attention, nevertheless, to the necessity of dealing with the question broadly as an economic issue and of refusing to accept the hasty identification of it with monetary change. Artificial monetary restoration, intended to bring about a change in the price level, is, however, so widespread at the present time that it may be accepted as the characteristic form in which the philosophy of inflation has been applied. It is this that accounts for the world-wide character of the issue at the present moment—the universality of interest, often falsely ascribed to a general dissatisfaction with the gold standard, or to some other incidental and nonessential element. W e must, in fact, in our own study of inflation, deal constantly with the subject as exemplified, but never exclusively characterized, by monetary changes. T h e constant effort to bring about an agreement among

14

T H E IDEA OF I N F L A T I O N

nations for what is called a "stabilization" of the currency, in order that international exchanges may rest upon a more sure footing and may permit greater freedom of intercourse among nations, is frequently regarded by public men as being "deflationary." It is thus a device intended to end inflationary practice in some or all of the countries that so enter into an agreement or, perhaps, to bring about a "freezing" or stereotyping of price levels on a fixed basis which would prevent some participants from shifting their internal economic relationships fast enough to enable them to compete with other countries in foreign markets. Critics of this view forcefully point out that international stabilization agreements have not necessarily any bearing whatever upon the question of inflation or deflation, in the true sense of the term; but that such agreements are merely the embodiment of an understanding that whatever may be done in an inflationary or deflationary direction in the future shall not be effected by the use of the currency or banking system as a medium for attaining that result. Indeed, one of the major issues in connection with inflation is unquestionably whether it is or is not sound and right ever consciously to use the banking and currency system of a nation at any time as a means of bringing about a redistribution of wealth. It is entirely conceivable that a general wealthredistribution policy could be accepted, coordinate with a definite understanding that no attempt whatever would be made to bring about what is called a "stabilized dollar," because of a belief that such interference with the working of the currency system would produce more injury than good and hence would stand in the way of a sound outworking of the inflation policy itself. T h e converse of this proposition is, likewise, equally defensible on the same grounds. T h u s viewed, inflation must be thought of as embodying the economic controversy which is now raging throughout the world, but as being in many cases a distorted medium through which to study the issues involved.

T H E IDEA OF

INFLATION

IMPLICATIONS OF

15

INFLATION

T h e implications of the inflation movement in the United States, often plainly expressed by members of the national administration and others, have been that, as a result of rising commodity prices certain to follow the devaluation of money and the enlargement of paper currency in amount, there would be a far greater ease in the payment of indebtedness and, consequently, in all probability a very large payment or settlement of such indebtedness; while, at the same time, as the result of rising prices, the community as a whole would find its turnover greatly enlarged and hence would witness a broadened activity and employment. It should be noted, parenthetically, that these conditions have never developed in any clear-cut way, in foreign countries in past monetary and banking history, as the result of inflation. Since 1931, however, very striking alterations tending further to operate against the assumptions just detailed, have also made their appearance. Great Britain, by abandoning gold redemption in September, 1931, took a step which was regarded, by many groups in the English financial and economic world, as certain to bring a higher level of prices in local currency (sterling). As a matter of fact, no such conclusions have been realized during the three years since the action was taken, for at the end of this time prices were lower in sterling than at the time the action was resolved upon. In the United States, the direct and specific promise that abandonment of the gold standard would permit, and probably accomplish, a very large liquidation of debt has not been warranted. Although no conclusive statistics on the subject are available, there is nothing to indicate that the years 1933 and 1934 have been periods of considerable debt payment, either on the part of individuals or of corporations. On the other hand, the inflation policy of 1933, so-called, involving as it did reduction in the weight of the gold dollar and the adoption of lax credit policies, did not result in raising prices of commodities, such prices being at about the middle of September, 1933, practically at the same

16

T H E

IDEA

OF

I N F L A T I O N

level that they occupied a year later. The experience of the United States, in other words, has been substantially similar to that of Great Britain; and in both cases the expected results of an inflationary policy have not been accomplished so far as the level of prices for the rank and file of commodities is concerned. Price changes have taken place owing to changes in conditions of producing, selling, and distributing goods, and in these processes changes in money and banking have been only an incidental factor. T h e discussion of inflation must unquestionably be given a different basis in the future as compared with that on which it has rested in the past. Recognition of this fact is, however, slow, the older idea of prices as dependent upon changes in the supply of currency being almost impossible to shake. In February, 1934, the Secretary of the Treasury informed a committee of Congress in so many words that, if prices should fall further, additional power to devalue the dollar would be asked; while the body of business men known as the "Committee for the Nation," as late as the spring of 1934, were asserting that changes in the weight of the dollar had "worked" by bringing about a corresponding change in the wholesale prices of certain commodities—a claim without any support whatever in fact. CONTEMPORARY

POSITION

OF

INFLATION

T h e review which has thus been made of the prevailing use of the term inflation, and of its general application in the political and economic life of the world within recent years, brings into sharp relief the contemporary position of opinion in the United States relating to the whole question. It would appear feasible to define the following general propositions regarding the contemporary aspect of the inflation discussion: 1. What is called inflation in the United States is essentially a debate about the redistribution of the national income and wealth. 2. This debate has been made artificially to center about the currency question, partly as a result of precedent; partly because manipulation of the currency has always been thought

T H E I D E A OF I N F L A T I O N

17

of as an easy way to dispose of controversies about ownership. 3. T h e American public does not realize the real nature of the inflation controversy as thus defined, for it only subconsciously and unwillingly recognizes itself as influenced essentially by the psychology of debt delinquency. 4. American public opinion takes refuge in vague reflections about the oppressiveness of the gold standard and of other currency standards as a reason for its advocacy of inflation. These complaints of currency standards and their inadequacy may be well founded—but they are not the cause or even an important contributory element in the reappearance of inflation in this country. 5. Every analysis of inflation must, therefore, seek to orient itself from the standpoint of debt and ownership, and must recognize that currency discussion means really, in its essence, a discussion whether currency measures should be employed at all in regulating redistribution of ownership. 6. T h e answer to the last question cannot be supplied on the basis merely of good faith. A moral problem emerges in connection with the discussion of repudiation. T h e currency problem is far more technical and, as has just been said, it is whether or not currency should be used for wealth redistribution at all, and, if so used, whether it would not be far more expensive in its introduction than beneficial in its results. 7. Because of a conjunction of circumstances, most of which have little or nothing to do with currency and banking questions, the problem of "relief," or of restoration of prosperity has thus been allowed to become entangled with that of currency depreciation or devaluation, notwithstanding that there is no necessary association between them. 8. Politically speaking, the controversy about inflation, centering as it does on the question of redistribution of wealth, is usually a controversy between the so-called debtor and socalled creditor classes. But since in the United States distribution of wealth is very wide, while many of the creditor classes (savings-bank depositors, insurance-policy holders, and others) are simultaneously debtors (makers of mortgages, etc.), the

18

T H E I D E A OF I N F L A T I O N

sharp cleavage which exists in some other countries does not exist, with the result that issues involved are less clear-cut and less definite than they are elsewhere. 9. This confusion of interests and of functions suggests, as the proper method of approaching the general analysis of the question, the discussion of inflation in its effects upon different elements in the community. One purpose thus is to secure a clear-cut summary of inflation results, which may then be synthesized for the purpose of obtaining a general view of the situation as a whole. 10. Such a fundamental analysis naturally starts with an inquiry into the banking aspects of inflation, with a view to ascertaining the meaning of the term as applied in connection with banking operations and banking theory. In this view of the case 2 the following chapters (II-VII) seek to furnish a sketch of the meaning of inflation in connection with banking and credit, and a survey of the history of banking controversy in the United States in so far as it relates to inflation and to that phase of inflation which has to do with currency values and prices. T o this we now address ourselves. 2 In Part II of the present volume, Essay 1 "Inflation in Current Economic Literature," by Anatol Murad, furnishes a more detailed sketch of the status of inflation in monetary literature. T h e reader should read that discussion, in conjunction with the present chapter.

II INFLATION AND ITS R E L A T I O N T O

BANKING1

THE discussion offered in Chapter I has presented several views of the idea of inflation and has furnished a preliminary analysis of the thoughts underlying them. Such a review inevitably raises the question whether inflation is, after all, really a banking concept, or whether it may not be more truly a field of inquiry in general economics, particularly in the economics of distribution. T h e fact that contemporary discussion makes it predominantly a monetary and financial issue, and deals with it fundamentally as a problem in the management and administration of banking, seems at first sight to afford a negative answer to the question which is thus put forward. Further reflection, however, shows that, as intimated in the preceding chapter, inflation often, if not usually, assumes a monetary form; and that, when it does so, the monetary aspects of the situation tend to take precedence over its general economic phases, even though the latter may be more fundamental when theoretically viewed. Inflation is certainly not an exclusively monetary, financial, or banking concept, but is a concept which currently finds expression in the monetary and banking field, and which, in any event, must profoundly influence any system of money and banking that may be employed. T h e problem in dealing with inflation from the monetary and banking standpoint is not to exclude it from that field, but rather to show the methods by which money and banking find themselves affected or intimately associated with the phenomena of inflation. I N F L A T I O N AND L O A N S

T h e process by which the banker makes actual loans and advances to borrowers needs only brief restatement. As is well known, the business of the ordinary banker is that of "discount, deposit and issue." By discounting paper, or "lending i By H. Parker Willis. Statistical analysis (pp. 28-31) by V. D. Kazakivich.

20

RELATION TO

BANKING

money," he satisñes the demands of his customers, and the proceeds of the loans he thus makes are either placed upon his books as deposits to the credit of the customer, or handed to the latter in the form of bank notes—the banker's own obligation—or may be converted into the latter by the customer who "draws" upon the bank after he has been credited with a "deposit." All these values are expressed in terms of money of account of the country—in the United States, in dollars. Let us now note what the effect of actual changes of prices will be so far as the banker is concerned. T h e loans made by the banker may be "secured," in which case the banker is given a prior claim as a preferred creditor on the property of the borrower; or "unsecured," in which case the banker is a creditor like others and is likely to be settled with as any others are settled with. What are the considerations which influence the banker in making such loans? Fundamental among them, is the actual possession by the borrower of values stated in dollars likely to enable him to pay back the loan when due. Equally fundamental is the probability that the borrower's income will be likely to amount on a specified date to a sum sufficient to enable him to meet the claims maturing on that date. These requirements of "solvency" and "liquidity" may be said to be most fundamental in the banking field, and hence absolutely essential to any safety in management. Higher prices for commodities usually tend to bring about an increase in the market value of the security underlying the loans of the banker and thus have a tendency to make his portfolio safer and, perhaps, more liquid, during the period when prices are rising. In the same way, an advance in commodity prices usually tends to raise the prices of securities or, at least may do so, under certain very well-marked conditions. Commodity price advances, therefore, tend to strengthen that part of the banker's portfolio which consists of loans protected by commodity values or by security values. On the other hand, decline of commodity values exerts the opposite effect. Advance or decline of security values frequently occurs without any change in commodity values, and affects the protection behind

RELATION T O BANKING

21

that part of the banker's portfolio which consists either of the securities themselves or of loans thereon. If it were true that advances of prices, therefore, could be regarded as definitely held or fixed, they would be beneficial to the banker, while declines would have the opposite result. T h e question in all such cases, accordingly, is how far such advances or declines are to be regarded as semipermanent, and how far as merely transitory. If they are fundamentally transitory, banking, which is a continuous process, cannot be regarded as being helped by them. T h e banker's interest is better served by stability. T h e other side of the situation now calls for analysis. How far do advances made by bankers on the strength of commodities or securities tend to raise the price of those values? If bankers by making larger loans upon, say, United States Steel, tend to raise the quoted value of Steel, it might be inferred that similar loans, all around, if made by bankers, would tend to enable borrowers to maintain their ownership of the values used as collateral, and hence to sustain the value of the collateral itself at specified levels. Hence arises the frequent assumption that an enlargement or "release" of bank credit will necessarily bring with it an advance of values—a special phase of the theory of inflation which we have considered in the first chapter. Experience evidently warrants such a broad assumption only upon certain very well-marked conditions. Of these, the first is that the funds thus furnished by the banker will be used for the purpose for which they are nominally borrowed. If "A," for example, borrows on his Steel and uses the proceeds for the purpose of paying off such other loans as he may have outstanding, or if "B" borrows on his cotton in the warehouse nominally that he may be assisted to "carry" it, but uses the proceeds of his loan to enlarge his personal expenditure, there is nothing to show that any permanent result in the way of advance of either kind of collateral has been attained. T h e effect of the banker's advance is found not only in its influence upon the particular commodity used as a basis of borrowing, but is also experienced in other directions, according as the loan which is supplied by him may be applied in purchasing

22

R E L A T I O N

T O

BANKING

or controlling commodities. It is quite true that at times such a loan may prevent the particular owner of cotton or of United States Steel from having to throw his ownership upon the market in order to realize immediate proceeds, and that the effect of it may thus be to avoid a sudden depreciation in price. This, however, is a very different matter from the long-range effect of the action so taken. T h e ultimate effect of the banker's decision is dependent entirely upon the direction that is given to the purchasing power which he furnishes. CHANGES

OF

INVESTMENT

VALUES

T h e point at which inflationary tendencies or methods touch banking is indicated by the fact that banking deals with capitalized values. T h e current prices of commodities represent, in a certain sense, a capitalization of the supply-and-demand factors which are acting upon them at the time. One dollar a bushel for wheat, for instance, represents the current estimate of the value per unit to be assigned to the cost of production, and the current demand and supply elements, which have entered into the production of the grain. On the other hand, the loans made by bankers, when based upon collateral, are controlled by the capitalized value of stocks and bonds; that is to say, the estimated or current worth of the capital investment is expressed in terms of money, after all due allowance has been made for changes in earning power and the like. T h e banker is thus engaged in a business which is immediately affected by the combined variations of capital value, registered in prices of commodities and securities. When the prices decline, his collateral protection is less strong, or the amount that he may safely lend upon the products of industry declines. When they advance, he is in a position to grant their owners the power to control or assume a larger share of the current output of labor and capital. T h e commercial banker thus, as a business man, may profit or lose as a result of changes in purchasing power of money, or in the income-producing power of wealth. T h e relationship between him and the rest of the community is more largely

RELATION TO

BANKING

23

dependent for its safety and soundness upon the maintenance of a satisfactory relationship between the capital values in which he has been dealing than is the protection of the outstanding liabilities which he has created under the head of deposits, or otherwise, and which he has undertaken to maintain convertible into current cash. T h e banker's portfolio consists of two major parts: (1) the notes, demands and claims, which he has taken from his customers and which represent their agreement to pay him wealth to an extent indicated by the stated money values of the paper which he has taken over; and (2) a group of papers which represent titles to capital assets and which represent his capital, and the funds of his long-term customers, which he has embarked in enterprises where they are represented by nominal or face values stated in terms of money. As the banker's ownership or assets tend to assume a form under the first of these heads which cannot be collected, owing to deficient income or earning power by the debtor, or, under the second head, which tend to become "frozen" because not salable either at face value or at that value at which they were taken over by the banker, the latter tends to lose and hence to be obliged to write off a portion of the wealth presumably represented by his portfolio. In the event that his capital thus becomes exhausted or written off, the banker similarly tends to bring into jeopardy the titles of his creditors (depositors) to payment out of the body of wealth which he has been holding on their behalf and which is currently said to have been "invested" by him, either in commercial paper or in securities. We may state this matter in another way, and say that the outworking of inflation is to change the ownership of wealth for reasons which we have already set forth; and that since the banker himself is of the opinion that a very large change in capitalized value has taken place, the opinion tends to make him more and more willing to establish obligations on his books (deposits) against wealth placed in his hands by the borrowers (his portfolio). Thus, it often happens that advances in prices are said to produce inflation in banking, or by some are

24

RELATION T O BANKING

said to have been produced by inflation in banking—the truth of the matter usually being that they have been produced by entirely different causes and are neither the origin nor the result of inflation, but are merely the reflection thereof. Inflation, however, in the sense in which we have defined it, is evidently an important element of danger in connection with banking, and unless promptly and sincerely realized by the banker may result in giving to his portfolio a fictitious quality, likely to operate strongly against safe relationships between him and his customers. EFFECT ON PORTFOLIOS

T h e direct effect upon the banker's portfolio of an inflation policy is thus indicated, but it has further effects which are not so obvious. In typical inflation the tendency of the banker is to make advances of current funds as represented by demand liabilities to customers who, for a variety of reasons, find it increasingly difficult to meet such liabilities. This is not because the customers in question are insolvent or dishonest. Inflation, however, is usually accompanied by the expansion of business enterprise in the effort to obtain a profit. This expansion of business enterprise comes about through the continuously increasing investment of capital; and, as the ordinary sources of capital dry up, there is an increasing tendency to apply to the bank for loans of "money" which tend to become less and less easily repayable. Repayment of bank advances is a matter which is determined ordinarily by the activity and profitableness of industry. Businesses which have a high rate of turnover are businesses that are furnishing goods immediately wanted by the community. Their borrowings are constantly put into the form of consumption goods, absorbed by the community and then repaid out of the proceeds of current labor. T h e result is a steady interchange and reconversion of banking funds into goods and back again. In periods preceding so-called panics or crises, banking advances usually tend to rise sharply, for the reason that this process of reconversion has been slowed down, often because of the fact that so-called overproduction has taken

R E L A T I O N TO BANKING

25

place and that demand has been satiated and is falling off. T h e net result of this situation is to bring about a conversion of bank loans into investment forms. T h e banker, for example, who finds that a given enterprise is deeply in his books, and cannot pay him off, may recommend to it the flotation of some capital obligations, of which he himself takes a part as "investments." T h e country banker who has loaned heavily over a series of years to a farmer and finds that the latter has no possible chance of paying his indebtedness out of the proceeds of crops, accepts a mortgage on the farmer's land, and thereby becomes in effect a partner of the farmer in the ownership and operation of his farm. In one way or another, the progress of inflation in banking is thus witnessed through the enlargement of the investment side of the portfolio, and the relative, sometimes the absolute, decline of the paper or current-loan side of the portfolio. This means, in effect, that the banker's assets are passing into a frozen form, or, in other words, are assuming more largely the status of capital assets. They may eventually be salable, quite likely at a rate which will ultimately return to the banker the amount which he has originally put into them. T h e inflation of which complaint is made is found not in the fact that the banker has "lost money," but in the fact that he has placed his immediate funds outside his control, and has accepted in their stead a claim to ultimate wealth whose eventual conversion into current funds carries with it some element of risk beyond that which is always involved in the lending or advancement of a bank's "money." Thus a change in the form of portfolio is a usual accompaniment of so-called inflation in banking, and quite normally characterizes the movement of bank portfolios antecedent to panics or crises. This does not mean that the period prior to crisis is the only one at which such changes take place in the composition of bank portfolios, but suggests merely that at such times this change tends to be characteristic.

26

R E L A T I O N

T O

B A N K I N G

BANKING I N F L A T I O N AND PRICES

A t this point it is worth while to inquire rather more particularly, at the risk of repetition, how far banking inflation of the type just described, or inflation as reflected in banking assets, is also a price phenomenon. T h e assumption is usually made in discussions on the subject that extensions of "credit" on the part of banks, steadily increasing in amount prior to a panic, are a fruitful cause of "high" prices, so that a steady climb of prices up to a peak is to be expected; such a climb, for example, was witnessed prior to the panic or depression of 1920, commodity prices having then reached a level of 270 (or 250 according to revised figures) in May, 1920, followed soon thereafter by a decisive shrinkage of values both in the stock market and elsewhere. T h e facts in the case do not bear out the assumption that such advance in commodity prices is an inevitable concomitant of banking inflation. As has been frequently remarked, the years 1926-29 were a time of shrinking commodity prices, although during the same period tremendous advances occurred in the prices of stocks and in bank "deposits." T h i s has suggested to some the thought that "surplus credit," which has been "released" by banks during a period just before a crisis, or breakdown, must find an "outlet" somewhere, and does occasionally find it in the extensive purchase of commodities at rising prices or occasionally in the equally extensive purchase of securities at similarly rising prices. From such reasoning, the corollary would seem to be that banking inflation is invariably accompanied by an advance in the prices either of stocks or of commodities, leading up to a panic or crisis situation. It would, however, be difficult to bear out even this more moderate statement. As has just been seen, the development of inflation during a prepanic period does not necessarily take the price form, but may take form primarily as a change in the character of portfolios of banks. What would seem to be a fair statement is that bank balance sheets tend before a panic or crisis to show an inordinate expansion in the

RELATION

TO

BANKING

27

amount of credit granted on deposit account, and that, since such credit is granted only upon the payment of interest, there must have been a definite reason on the part of customers for soliciting it. This reason may be found in a desire to buy and hold commodities, or in a similar desire to buy and hold securities, or in a desire to expand capital assets, or in a disposition to carry a volume of trade which is out of proportion to the capital of the business man engaged in the enterprise. Such distortions have their inevitable repercussions, but it should not be supposed that any particular phase of price or capital distortion is necessarily a resultant of such inflation on the part of the banks, although it may often be a concomitant of the banking changes referred to. SOME REPRESENTATIVE

CASES

T h e facts of inflation as affecting representative banking portfolios may best be illustrated by selecting periods in which undoubted inflation—so admitted by competent observers—was occurring, and noting what the trends of banking portfolios in those periods were. For purposes of such study we have selected the years immediately prior to the panic of 1893, those covering the period of the World War and ending with the panic of 1920, and those immediately prior to the panic of 1929. In addition, figures covering the depression years 1929-32 will likewise be presented. In comparing these different series of years, the questions to be considered are briefly these: 1. What changes in banking portfolios occurred during the few years immediately prior to a distinct collapse or breakdown of banking structure? 2. When the collapse or breakdown had taken place what changes in banking portfolios resulted therefrom? 3. What alterations of commodity and security prices occurred simultaneously with these changes of portfolio? T h e results obtained from such study must necessarily be interpreted in such a way as to avoid the post hoc-propter hoc criticism, and at the same time to be as nearly free as practicable of the intervention of extraneous factors. With this

28

RELATION TO

BANKING

qualification, the following pages undertake a brief statistical analysis along the lines already indicated. A great deal has been written on the subject of credit expansion, but surprisingly enough, very little factual material is available as to exactly what takes place in the composition of bank assets during periods of expansion. 2 In order to survey the existing data from this point of view it is essential first of all to establish the dates that can be considered as typical of a period of expansion. A convenient way of doing this is to take the standard reference dates for business cycles in the United States used by the National Bureau of Economic Research and attempt to obtain the composition of the portfolio of a definite group of banks as closely as possible to the date designated as the peak of expansion. T h e standard reference dates indicate that the following months may be regarded as representing the high, in each particular cycle: 8 Jan., 1893 Dec., 1895 June, 1899 Sept., 1902 May, 1907 Jan., 1910

Jan., Aug., Jan., May, Oct., June,

1913 1918 1920 1923 1926 1929

In this particular instance, we are going to compare the portfolio situation on six dates: prior to the decline of 1893 and 1899, just before the panic of 1907, preceding the prewar slump of 1913, on the eve of the postwar collapse of 1920, and at the start of the latest depression, that of 1929.4 On September 2, 1892 (the high was in January, 1893), the loans of all national banks amounted to 2,171 million dollars, 2 T h e League of Nations has published a manual of Commercial Banks—19131931, containing portfolio statistics for various countries. Chapter X X I V in The Banking Situation, by Willis and Chapman, gives an analysis of national-bank data. In Part II of this volume the postwar portfolio trends are presented as Essay 7. » See Clark, John Maurice, Strategic Factors in Business Cycles, National Bureau of Economic Research (New York, 1934), p. 1 1 . * T h e figures quoted show the changes that took place from one prosperity period to another. In order to trace the course of expansion and contraction in banking over several cycles, one must have uniform data that could be subjected

RELATION

TO

BANKING

29

and investments to only 338 millions, or around 15 per cent of the loans. 5 T h e s e investments were composed of 183 million dollars of United States bonds and 155 million dollars of miscellaneous stocks and bonds. D u r i n g the expansion that preceded the depression of 1893, the holdings of "governments" exceeded those of other securities and the entire investment portfolio equaled only about one-sixth of the loans. O n J u n e 30, 1899 (the high point is given as June, 1899), the loans of all national banks amounted to 2,508 million dollars and investments to 651 million dollars, or about 22 per cent of the loans, 6 as against approximately 15 per cent prior to the decline of 1893. J n ^ 9 9 we find that United States bonds held, amounted to 346 million dollars and other securities to 305 millions, or that a larger share of the investment portfolio was placed in miscellaneous securities than in 1892. Prior to the panic of 1907, or in May, 1907 (the reference dates designate as the high period May, 1907), the loans of all national banks amounted to 4,664 million dollars and investments to 1,446 millions or about 31 per cent of loans, 7 as against 15 per cent in 1893 and 22 per cent in 1899. In this expansion we find that the holdings of miscellaneous stocks and bonds exceed by 12 million dollars United States bonds held. D u r i n g the expansion that preceded the prewar slump, we find that on November 26, 1912 (the high is in January, 1913), all loans of national banks equaled 6,085 million dollars, with investment comprising, just as in 1907, about 31 per cent of the loans. 8 B u t this time investments in U n i t e d States bonds amounted to 822 million dollars, while all other securities equaled 1,037 millions, so that the investment portfolio now to a standard analysis. T h e figures given by the Comptroller do not enable one to build up an adequate banking series over several decades. In these pages a rough comparison of portfolio statistics has been made and in Table VI, p. 124, are presented portfolio changes of all national banks since the war. Unless one were to have access to the files of the Comptroller and construct entirely new sets of data, one can do little more than this with the existing figures. 5 Annua! Report of the Comptroller of the Currency, 189», p. 46. »Ibid., 1899, I, ix. i Ibid., 1907, p. 9. «Ibid., 1913, p. 1.

30

RELATION TO

BANKING

consisted of 44 per cent government obligations and 56 per cent of other long-term assets. On December 3 1 , 1 9 1 9 (the high is in January, 1920), or prior to the postwar depression, investments of all national banks comprised 38 per cent of the loans, with 59 per cent of the investment holdings consisting of government bonds (loans 12,204 million, government bonds 2,733 million, and other investments 1,924 million dollars). 9 In the case of this expansion, investment rose higher relative to loans than in the four previous instances, and government securities returned to the position of dominating the investment portfolio as they did prior to 1900. On J u n e 29, 1929 (the high is in J u n e , 1929), investments equaled 45 per cent of loans, with United States government bonds comprising only 42 per cent of the total investment while 58 per cent is made up of other bonds (loans 1 4 , 8 1 1 millions, United States bonds 2,804 millions, and other bonds 3,853 million dollars). 10 T h e increase of investments relative to loans continued after the "break" of 1929, all through the depression that followed, with the portion of investments placed in government securities increasing at the expense of holdings of other bonds. 1 1 On the basis of this brief survey, we may conclude that the holdings of investments by commercial banks in periods of expansion increase with every period of prosperity, but that the composition of these holdings (whether government bonds or other securities) changes, depending on the financial policies of the government. T h i s review would be grossly incomplete if we were not to point out that in appraising the relationship of commercial and investment assets of banks one must classify a certain portion of the loans as investment assets. During the postwar expansion, loans on real estate and loans secured by stocks and bonds increased to a very marked degree, so that in the case of all »Ibid., 1920, I, p. 114. 10 Ibid., 1929, p. 31. 11 For a detailed presentation of this trend, see below, Pait II, Essay 7, by John F. Van Deventer.

R E L A T I O N

T O

B A N K I N G

31

national banks 62 per cent of the entire portfolio (loans plus investments) consisted, in June, 1929, of investment assets, whereas only 38 per cent of all assets was based on commercial transactions. It must also be remembered that, although we based this survey on the standard "reference dates" of the National Bureau of Economic Research, these "reference dates" are mere turning points, used only as a cyclical pattern for the United States, and have never been represented as indicative of banking cycles. T h i s general pattern was used here in the absence of other reference dates that would be more applicable to bank portfolios. Such a set of dates could be constructed only from banking series themselves if and when analyzed with the object of business-cycle study. 12 I N T E R P R E T A T I O N OF I N F L A T I O N F R O M T H E B A N K I N G

STANDPOINT

It is now possible to attempt an interpretation of inflation from the banking standpoint. Experience, as we have seen, does not seem to warrant the belief that advance in the prices of stocks and commodities, which often or usually occur prior to a crisis or collapse, has been caused by an expansion of bank credit. It seems rather to be true that expansion of bank credit occurs simultaneously with the advance in price of stocks or commodities and is a vehicle by which what may be called the forces of inflation make themselves felt. Thus, for example, an advance in the price of land, or a "land boom," is usually brought about by reason of a belief on the part of a group of local landowners or land speculators that a movement of population or some other strong demand for the use of land is likely 12 Considerable further light could be thrown on the subject of inflation and deflation in banks if one were to subject portfolio statistics to a standard set of business cycle measurements. These are the bases of a study by Carl Schmidt, German Business Cycles, 1924-19-)} (National Bureau of Economic Research, 1934), and are used by the Bureau in its work on business cycles. However, the statistical data published in the Annual Reports of the Comptroller of the Currency do not lend themselves easily to the construction of homogeneous series covering several cycles. Without full access to the files of the office of the Comptroller and constructing entirely new sets of figures, it is doubtful whether more refined statistical methods could be of much avail.

32

R E L A T I O N T O BANKING

to set in; as a result, effort is made to purchase or control the land. This may be brought about either through the actual purchase of and payment for the land, or it may be brought about through the taking of options upon specified pieces, or in any one of a number of other ways. It does not appear from an analysis of actual conditions that an establishment of bank credit prior to the making of an effective demand for landownership is necessary, nor that the establishment of such credit as a preliminary to increase of the price of such land is requisite. On the contrary, there seems to be good reason for the belief that the action of the bank in granting credit upon the imaginary or fictitious values that are established in the course of a boom, is primarily effective in stereotyping or recognizing or registering the fact that such values are being paid or named, so that the bank credit is a subsequent and not a preliminary development in connection with a price movement such as has been spoken of. Another factor of equal importance deserves mention. When the bank has once advanced funds upon goods or securities upon what it supposes to be tenable valuation, the fact that it has done so has an appreciable influence in "pegging" or confirming the values themselves. This influence is exerted by reason of the fact that bank credit enables owners to take the values off the market and to hold them awaiting further development. For example, if cotton speculators have succeeded in forcing the price of the staple up to 15 cents a pound, and if they are then able to obtain from the banks loans secured by cotton amounting to a given number of bales, the effect of the bank advances is not to produce a further advance in the price of cotton, but is to keep the cotton which has been used as security from coming back into the market and thus causing a fresh depreciation of prices. T h e influence of the inflation then is to conserve advances in valuation by altering the current balances of demand and supply and adjusting them temporarily to one another, under conditions that permit a further increase in current prices. When banks have to liquidate, either through failure or pressure upon them resulting from demand on the

RELATION TO

BANKING

33

part of depositors, the result is to compel them to withdraw the support which they have afforded by holding the commodities or securities off the market. Thus, after 1929, the banks throughout the country generally were inclined to continue their advances upon securities and to let matters alone in the hope that the market would soon right itself again. When it did not do so and when the banks were compelled to realize funds in order to meet demands of depositors, the consequence was that they sold the securities which they were carrying and thus put back into the market an additional supply which had to be disposed of in some way. T h e effort to put this additional supply in the hands of permanent holders thus led to a fresh depreciation of prices and there resulted a current theory that the banks had reduced prices by "withdrawing credit," whereas the credit itself had been withdrawn by the depositors who insisted upon liquidation by the banks, the effect of such liquidation being then to add to the quantity of that particular kind of collateral that was present in the market, and to call for purchase funds from those who were interested in preventing further reductions. Here again the relationship between bank credit and condition of the market is seen to have been a practical reversal of that which is often assumed as having been the case. In another aspect, also, the relation of the bank to the price level is significant. Those processes which have just been described, in which an effort is made to rectify the banking situation, almost inevitably result in loss by the bank itself, owing to the fact that in order to sell or dispose of the goods or securities it is holding, it finds necessary a sacrifice of their value. Such sacrifice may at times be covered by the "margin" which the banker has left between the amount he has advanced and the theoretical market value of the goods or stocks. At other times this margin is not sufficient, and as a result the sums actually obtained by the bank may be much smaller than the amount that was due it from its customers. In such cases the bank itself finds it necessary to absorb a corresponding amount of the shrinkage of values and this obviously constitutes a

34

RELATION

TO

BANKING

"write-off" from its capital, or, in more extreme cases, a reduction of the amount available in the hands of the bank for use in meeting the claims of its depositors as these are presented. Here the relation of the bank to inflation appears to be indicated by the fact that its capital practically becomes a buffer which is used for the purpose of absorbing values that have been erroneously assigned to given objects in the course of an upward movement or a boom. T h e bank in such circumstances is the technical loser, but from the community's standpoint the change is not loss, but is rather a revaluation of goods and securities. RELATION TO CURRENCY

Such a revaluation if carried beyond the point at which the capital of the bank is absorbed or destroyed in endeavoring to reestablish the balance between its assets and liabilities, leaves the bank insolvent, or at all events without capital assets. Under such circumstances, the bank finds it necessary to ask for new capital, which stockholders may deny it, thus driving it into liquidation. Where a good many banks are in this position, a general condition of insolvency will inevitably ensue, unless the community as a whole may determine that it will itself absorb a part of this write-off by changing the unit in which values are expressed—the money of a country. Thus, for example, if the bank should find itself in possession of specie in the amount, say, of one million dollars, while it has a deficit of assets of one million, the community may, by establishing a 50-cent dollar, practically turn over to the bank a fund of one million dollars (doubling its original specie value). This sum or profit may be used to make up the difference between the assets and liabilities, and thereby to leave them on the same relative basis as before. Such a process of devaluation is, of course, equivalent, to the distribution of loss or write-off, in paper values and the spreading of it over the entire community. In cases of devaluation it does not necessarily follow, of course, that the proceeds of the devaluation are given to the bank. For example, in most of the recent instances in which various countries have altered the value of their currency unit, the state has

R E L A T I O N

T O

B A N K I N G

35

intervened to take to itself the profits of the operation. 13 If it be assumed that these profits are then used in lieu of taxation, or in some way for the purpose of strengthening the reserve behind outstanding public notes, there is an indirect accomplishment of the result already spoken of—the strengthening of the technical position of the bank or banking system by putting it into a better position to convert its outstanding claims into specie (of the new tenor) when and as requested to do so. It may be that the effect of such inflation or devaluation, whichever term may be employed, is in practice the strengthening of the currency position so far as the balance sheet of the bank is concerned. T h e action taken may or may not weaken the regard or confidence of the community for the banking system. Should it, however, so weaken confidence, the net result may be to impair the entire situation. Should it, on the other hand, be regarded by the public as the fair and proper way of overcoming current difficulties it may, for the time being, operate as a means of relief from what had threatened to be an embarrassing situation. In such a case inflation of any kind, resulting in the establishment of a bank portfolio consisting of frozen assets, obviously nonconvertible into purchasing power, has resulted in necessitating inflation of another kind—the reduction of the actual specie weight or value of the currency itself. TESTS

OF

INFLATION

T h i s analysis of banking policy enables us to recognize the major conditions of bank inflation and to point out tests for them. T h e first of these tests is furnished by the degree of fluidity of the bank's portfolio. A bank which finds itself steadily increasing, as shown by its balance sheet, the amount of long-term, slow-moving assets which it carries in proportion to deposits, is a bank which is gradually becoming frozen and is therefore inflated in the sense in which we have defined that term. It is also true that a bank whose deposits are rapidly in13 A n interesting summary of such instances has been compiled by the National Bank of New Zealand. T o its compilations may now be added the case of the United States as exemplified in the Act of Jan. 30, 1934.

36

RELATION TO

BANKING

creasing, as is often the case, and which has a high turnover of business, may nevertheless find its cash reserve falling off and its capacity to meet obligations depending more and more 011 the ability to realize upon current maturities. Such a bank, if its past operations have been wisely conducted so that it does not need to grant extensions in any more than a moderate proportion, finds itself entirely able to supply what is required of it, and may not immediately come to any grief. Yet, its ability to convert is evidently being weakened and it is therefore a victim of inflation in a true sense of the term. Again, a bank which finds an increase in the amounts steadily drawn out of it by other banks, through the presentation of checks upon it at the clearing house, is evidently a bank whose depositors have begun to lose confidence in it, and which therefore must necessarily view itself as having too large an outstanding of demand obligations as compared with quick assets. It is inflated in a very real sense of the term. Such a bank may be properly described as inflated, even when its total transfers and aggregate balance-sheet showing are falling off as compared with former periods taken as a basis of comparison. This answers the question often raised, whether, in the definition of inflation herein set down, it might not be true that the more a bank liquidates and the nearer it gets to disposing of its entire body of assets, the more inflated it is, inasmuch as the proportion of nonliquid paper among the remaining assets will steadily increase. As to this the answer is very clear. Such a bank is in fact increasingly inflated. T h e idea that it could be otherwise grows out of the practice of analyzing its position absolutely instead of relatively. T h e mere fact that it has succeeded in disposing of large quantities of its assets, and hence has paid off large quantities of its liabilities, does not alter the character of its resulting position, any more than the fact that a great quantity of water has been pumped from a cistern indicates that the cistern is therefore far from empty because it was originally so capacious.

RELATION

TO

BANKING

37

A BANKING PHENOMENON?

W e are now in position to consider the question raised at the beginning of this chapter: Is inflation a banking phenomenon? T h e answer necessarily to be given, as our analysis has clearly shown, is both positive and negative. W e may answer the question best by summarizing a few important points as to which definite answers have been given in the course of the chapter: 1. Inflation is not caused by the enlargement of bank liabilities, but such enlargement often comes in response to inflationary forces. 2. Such inflation results primarily in distortion of values or in shifting of capital from one group to another without economic justification. 3. T h e changes in prices which usually take place upon such occasions and are often regarded as the outgrowth of bank inflation, are only an accompaniment of the latter and are usually wiped out or canceled by subsequent reaction which results in cutting the price level back again, frequently below the level from which it started. 4. Inflation is thus a banking phenomenon in the sense that it is a phenomenon very often closely associated with banking operations and likely to result from erroneous management of them. It is not a banking phenomenon in the sense that it is exclusively produced by banks or by bank operations, or in the sense that such operations are the only medium through which it could be effected. Banking and bank credit are merely a medium which may be conveniently used for giving effect to inflationary forces. 5. T h e reflex effect of inflation is unavoidably felt by banks and eventually takes form, either as a write-off of capital or a conversion of fluid assets into fixed forms which must be carried at paper values and cannot be reconverted into immediate purchasing power. 6. T h e thought that banking inflation automatically raises price levels, without regard to the actual use or application of

38

RELATION TO

BANKING

the purchasing power advanced, is erroneous. Credit that is "released" in such ways and passed out to the community, but is not wanted by the latter, returns promptly to the bank that established it just as unnecessary notes come in for retirement. In such cases credit accumulations may create so-called "excess reserves."

ILL

I N F L A T I O N AND M O N E Y 1 within recent years, particularly in American political discussion, more consideration very often has been given inflation as a credit phenomenon, the quite general application of the term (certainly in former times) has been found in its relation to money and monetary standards. As time has gone on, there has been reversion to the other use of the term. At present the habit of speaking of inflation as a monetary policy has again become general. In this chapter, it is desired to examine the meaning and application of the word in this monetary connection, and to classify some of the principal uses that have thus been made of it. ALTHOUGH

I D E A OF STANDARD OF V A L U E

In order to get a satisfactory basis for analysis of the inflation concept in connection with money, it is necessary first of all to define the term standard of value. By standard of value is meant the base selected for measurements of the exchange power of commodities. This standard may thus be practically an abstraction, or it may be a selected commodity such as gold, divided into units of specified weight and fineness which then may (or may not) be used as an actual currency or money. The standard of value, however, is not these units, but is the gold itself, which in that case is taken as the embodiment of value. Another type of standard which may be used as illustration is the so-called "commodity standard." In this the power of a group of commodities to command others, or the changing power of any commodity to command a specified group of others, is taken as the standard or base of measurement. This kind of standard may take any one of several actual forms, but in every case these go back to the base which has been chosen for reference. The idea of the standard, in any case, is that of a fixed i By H. Parker Willis.

40

I N F L A T I O N AND MONEY

base or measuring rod which is to be used in computing or stating the exchange values of the varying commodities entering into the exchange process. With this as a definition, the use of the term inflation to denote a monetary phenomenon must evidently follow certain rather narrow lines, as follows: 1. Inflation as applied to the standard of value may mean the substitution of another base for that which has prevailed up to the time of the adoption of an inflationary policy. If, for example, obligations had been contracted in terms of formal units, each of which is thought of as consisting of a given aggregate of commodities, it is conceivable that, say, this base may be doubled or halved by the arbitrary action of a legislative body. In the same way, gold, if chosen as the standard of value, with a designated weight representing the measurement unit, may be subject to a similar process of halving or doubling. In this sense, then, inflation as applied to money merely signifies a change in the amount of purchasing power which is to be transferred into the settlement of debts, or which is to be allowed to assume a specified name, e.g., "dollar." Stated briefly in this view, inflation is the substitution of a smaller amount of value as standard for a standard previously existing. 2. In the monetary sense, inflation may also be used to indicate a change in the conditions under which the actual possession of the commodity chosen as the standard of value may be obtained. For instance, if in a country on the gold standard it has been customary to pay gold to those who present a certain paper claim for it, an act of legislation to the effect that such conversion shall no longer be made for an indefinite period may be defined as inflation. It is a limitation of the degree of ease with which actual possession of the standard of value may be had. A somewhat parallel situation might develop if, in a country on the commodity standard, it were to be provided that in place of a composite unit of value consisting of designated amounts of different items of goods, there should be substituted a unit of value consisting of future claims to such items of goods. Thus, in place of so many bushels of wheat there might be substituted an item of "wheat futures," etc.

INFLATION

AND

MONEY

41

In the monetary sense then, inflation may be defined as either a change in the basic unit of value with a corresponding change in all obligations that were expressed in terms of such units, or as a change in the attainability of the possession of the unit. Substantially all recent policies of monetary inflation may be reduced to one or the other of these types; and, assuming that this statement is correct, it is accordingly possible to classify all reasoning on the subject of monetary inflation according as it affects standards of value in one or the other of these ways. T h i s point becomes important when consideration is given to the multifarious specific forms in which inflation is exhibited as a phase of practical economic life. "GOING O F F THE STANDARD"

Perhaps the most conspicuous among the popular conceptions of monetary inflation is that of abandoning the standard of value, or "going off the standard"—a step which has been taken by many countries within recent years. By this is meant that, instead of continuing to carry out agreements expressed in terms of the standard of value, debtors are authorized to disregard their contracts. Thus, in the most familiar form of inflation—that in which a general bank suspension occurs— what happens is that the bank in question is no longer called upon to supply actual money in settlement of its notes and deposits. Where the gold standard exists, this change is called "going off gold." T h u s England, in September, 1931, went off gold—giving up the gold standard. T h e Bank of England was merely authorized to refrain from further obligation to supply gold in specified amounts to creditors who presented to it its own notes for redemption. T h e United States went off gold in the same way in the spring of 1933, by suspending payments in gold domestically, and by imposing an embargo on gold internationally. Here there was, at first, no official change in the standard of value, but there was an alteration in the conditions under which possession of it could be obtained. Such possession being deferred until an indefinite time in the future, the dollar (theoretically consisting still of the same number of grains of

42

INFLATION

AND

MONEY

gold as formerly) continued to be the standard of value; and claims to dollars ("notes") were manufactured and paid out by the Reserve banks under specified conditions. Later the definition of the dollar was changed, and an altered number of grains of gold was made the unit of value, i.e., was likewise called a dollar. This, however, was a secondary development. As already stated, the original and most common change in monetary systems is that of refusing to pay, for the time being, in terms of the actual standard of value, i.e., the act of substituting a future (date usually not specified) claim for an immediate or "sight" claim. T o this process the term inflation is ordinarily applied, although it evidently is not etymologically correct. What has happened has been a change in the standard of value, either as to attainability or amount contained in a unit of the standard, or both. REPUDIATION

T h e term repudiation is frequently employed in current monetary discussion, as well as in analysis of public and private debt situations. It is desirable to attempt to relate it to the definitions of monetary inflation just furnished. T h e term repudiation has been believed to maintain a much simpler and more clearly defined meaning than has inflation. It is ordinarily used as meaning refusal to pay obligations. If country "A," for example, reaches the conclusion that a debt which it has owed is unjust, it may simply give notice to its supposed creditors that it will no longer recognize the debt—as was, for example, done by the Soviet government when it declined to acknowledge the indebtedness of its predecessor, the Czarist government of Russia. In the case of money, repudiation takes place either by authorizing debtors who have made contracts in terms of money to liquidate them in full and to be legally absolved from further obligation by the payment of a smaller amount of metal or of claims to it than they had undertaken; or it may mean, in some circumstances, the complete release of creditors from their obligations, as has been attempted in some central European countries where the peasant population had been absolved from further payments on a portion, or in

I N F L A T I O N AND

MONEY

43

a few cases, on the whole, of their land-mortgage indebtedness. As applied strictly to money or circulating medium, repudiation usually means the withdrawal of the legal-tender power from it, and perhaps the outlawing of the particular form of money in question. T h u s , Germany at the close of her inflation period in 1924, repudiated her entire outstanding " m a r k " currency, simply declaring it of no further exchangeable value. Such cases of repudiation are unusual, the more common form being partial repudiation, like that enacted by the United States, for example, on January 30, 1934. It then adopted a Congressional enactment providing for a change in the weight of the dollar, reducing the latter by about 40 per cent and specifying that dollars of the new tenor should be payable for all obligations incurred in old-definition dollars. T h i s was a repudiation of approximately 40 per cent of indebtedness; the phenomenon being the same of which we have already spoken, following popular usage, as inflation. Inflation and repudiation in this aspect are identical, with the proviso that in such a use the term inflation ordinarily applies to partial repudiation only. DEVALUATION

Another term which is widely used, but without very careful definition, is devaluation. In theory, devaluation is identical with partial repudiation, but in actual practice it may assume some special forms. A f t e r the World War, for example, most European countries being then off the gold standard, i.e., refusing to redeem their outstanding bank and other obligations in terms of gold or of the currencies in which such obligations were originally contracted, recognized the necessity of deciding upon some stable, and more or less uniform, monetary policy for the future. T h e y , accordingly, in a good many cases, attempted to ascertain the amount of their obligations which they could practically undertake to keep convertible into a gold unit, and they then accordingly altered the theoretical weight of their gold unit. Italy thus substituted a lira worth about 5.5 gold cents (American) for a lira formerly worth 19.3 cents; while France substituted a franc equal to approximately

44

INFLATION AND

MONEY

3.92 gold cents for one formerly worth 19.3 cents. England, on the other hand, undertook the restoration of her pound sterling at a rate which recognized its old value, $4.86%, as still valid. Devaluation in these cases was the decision upon a policy of partial repudiation, and the act of changing the weight of the monetary unit in such a way as to correspond to or to define the extent of the repudiation. T h e effect of it was to clarify the conditions established for the future by the fact of repudiation; and, instead of leaving them to be determined later or subjecting the community to continuous uncertainty regarding the scope and character of the repudiation program, it fixed once and for all the limits to which the new policy of repudiation should go. Repudiation, devaluation, and inflation, are thus seen in their monetary aspects as different aspects of the same policy or measure—a change in the accessibility or weight of the monetary unit or, where the monetary unit is a group of commodities, a change in the accessibility or the amount or total of such commodities going to make up a specified unit. In this view of the situation, it may well be asked whether there is any actual need for the term inflation at all, and whether the field is not adequately covered by the two ideas—repudiation and devaluation —as they have already been defined. Strictly speaking, the reply must be in the affirmative, and it must be concluded that there is no legitimate need for the use of the term inflation in this connection. However, as we shall shortly see, actual practice is not so clear-cut nor sharply recognizable as is suggested by the definitions that have just been given, so that the term inflation survives, rather as an indication of tendency than of actual fact. T o illustrate the meaning of this statement further, we may take the case of Great Britain during the World War. Great Britain, at the outset of the World War, had suspended the convertibility of the pound sterling and had taken many measures which must have raised in the minds of all observers serious question as to whether the possessor of claims upon the British government or the Bank of England would ever be able

I N F L A T I O N

A N D

45

M O N E Y

to possess himself of pounds sterling of the old weight and fineness. Such pessimistic expectations were put to flight by the act of 1925, which reestablished the convertibility of the paper notes into gold of the old weight and fineness. Great Britain is customarily and correctly spoken of as having passed through a period of inflation during the war and the immediate postwar years, that is to say, from 1914 to 1925. It was a period in which the actual value of the paper pound sterling was much less than that of the old gold unit which it was presumed to represent. Great Britain, in other words, passed through a period in which it was believed by many that the nation either could not, or would not, fully redeem its old obligations in gold of the weight and fineness originally used in defining the pound sterling. In this case, then, inflation was a temporary departure from convertibility; or, as we have defined it, an action temporarily abrogating the power to obtain and hold gold in the amounts indicated by the nominal face of the circulating claims to such gold units. Looking at the matter from this point of view, then, the use of the term inflation as indicating a policy tending toward or likely to culminate in repudiation or devaluation, represents the prevailing conception of the policy in question. BEARING

OF INFLATION

UPON

OTHER

IDEAS

In the current monetary sense, monetary inflation may thus be thought of as a policy looking toward a certain definite end, or objective, which may or may not be finally attained. Since, in most cases, the public, and particularly those who are interested in monetary matters, have their own opinions definitely formed as to the desirability of a given outcome, a discussion of inflation as a policy is thus given a specified trend. Many persons, for example, would oppose repudiation or devaluation if it were proposed to them as a fixed object to be aimed at. Probably far fewer would, in recent years, have shown an equal degree of opposition to inflation in the monetary sense. T h e y would have been inclined to say that an inflationary monetary policy did not necessarily imply eventual repudia-

46

INFLATION AND

MONEY

tion; and that there was, therefore, an argument for it on grounds other than those growing out of the principles of commercial morality or agreement which militate in many minds against the admissibility of repudiation as a fixed policy. In fact, it has usually appeared that the discussion of inflation was chiefly concerned with its unascertainable effects, and that those who advocated it declined to consider the evident ultimate result—repudiation—as a necessary outcome of it. Indeed mental recognition of the fact that inflation was merely a way of slowly bringing the public mind to a repudiation policy would frequently have alienated some of its advocates. MONETARY

INFLATION

AND

DEBT

T h e actual meaning of inflation in the monetary sense as thus outlined has been greatly obscured by the gradual elimination of coin from actual circulation and by the substitution of paper currency in place of it. So long as such paper currency was directly and frequently redeemable into the standard of value, so that a change, let us say, in the gold content of a pound sterling by 50 per cent of its amount would be immediately perceived as a change in the size and value of the coin, the identity between inflation and partial repudiation was clear. W h e n the time came that most handlers and users of money received it in the form of "representative money," or paper currency, which they seldom or never converted into gold, the case radically changed. When a further step was taken by which the actual holder of notes was forbidden to convert his money units (sovereigns or dollars) into gold, and at most was able to obtain bullion or bar gold, the connection was still further obscured. T h e popular mind became habituated to a conception of money which identified the paper unit with the ultimate standard, and the actual definition of inflation as repudiation or devaluation, or at least a partial step toward such a result, became blurred, or disappeared. Monetary inflation now came to be thought of as largely a change in the relationship between the paper units of exchange and the power to purchase goods on the market or in the shop.

I N F L A T I O N AND

MONEY

47

If, as often happened, general economic factors had resulted in advancing prices—as excessive consumption and scarcity of food products during the war resulted at the close of the struggle in enormously high costs of living—it was a comparatively easy conclusion on the part of many that the number of paper units available ought to be increased in such a way as to enable the rank and file of the community to command the same amount of commodities as they had formerly had for a given outlay of labor, or in exchange for other sacrifices on their own part. T h e average man here conceived of himself as the creditor, the circulating medium, or money, being the means to the attainment of certain commodities of which he stood in need. T h e policy of inflation, or the enlargement of the number of units available, was thought of as a way of placing him in a more favorable position, approaching the one from which he had departed as a result of factors over which he had no control. Inflation from this standpoint thus became to many persons not a way of repudiating obligations, but rather a method of meeting them—a method by which persons who had been guilty of no fraud or wrongdoing, but who had nevertheless found their purchasing power shrunken, might be restored to the same control over goods that was formerly theirs. T h e fact that, in most instances, this amelioration of conditions involved a corresponding reduction of the capital claims of those who had saved funds, or who were themselves holders, at the time, of a fund stated in terms of the monetary unit, was not a matter of fundamental significance, their interest being concentrated upon their own economic position and not upon that of others. Viewed in this way, inflation really became a form of controversy, or warfare, between conflicting groups in the community, some of which regarded themselves as quite as much entitled to the maintenance of stability in their consuming power as the so-called creditor class was entitled to stability in the purchasing power of its funds. T h e difficulty in the controversy lay in the fact that a previous misapplication of funds had taken place, with corresponding maladjustment of incomes and capital, inflation being then an incidental means of attempting to

48

INFLATION

AND

MONEY

restore the b a l a n c e of o w n e r s h i p u p o n a m o r e e n d u r a b l e basis. T h u s , at the time of the entry of the U n i t e d States i n t o the W o r l d W a r , for e x a m p l e , d e t e r m i n a t i o n was reached to finance the w a r as far as possible by means of inflation. T h i s m e r e l y m e a n t that instead of i m p o s i n g a direct tax u p o n o w n e r s of capital and i n c o m e sufficient to carry the costs of the w a r o r at least a large part of t h e m , it was d e t e r m i n e d to finance the struggle by p u t t i n g o u t claims u p o n the f u t u r e , either in the f o r m of b a n k notes or b a n k deposits, w h i c h to the

popular

m i n d took the f o r m of " m o n e y " a n d w e r e stated in terms of " d o l l a r s . " E v i d e n t l y , in so far as these claims c a m e to e x c e e d the wealth available for their conversion, they c o u l d b e settled o n l y t h r o u g h r e p u d i a t i o n w h i c h , in effect, m e a n t an expropriation of property or of i n c o m e . F i n a n c i n g the w a r by inflation thus meant the o b t a i n i n g of f u n d s w i t h w h i c h to carry it o n t h r o u g h the e v e n t u a l e x p r o p r i a t i o n of a certain f o r m of w e a l t h (i.e., m o n e y , or securities a n d claims expressed in terms of money), w h i l e

financing

the w a r by taxation m e a n t the g e t t i n g

of f u n d s for c a r r y i n g it o n b y t a k i n g t h e m directly f r o m all those w h o possessed specified f o r m s of wealth, securities, real estate, business o p p o r t u n i t i e s , a n d the like. BANKING

PHASES

OF

MONETARY

INFLATION

T h i s discussion makes clear the character of the c o n n e c t i o n w h i c h o r d i n a r i l y exists b e t w e e n inflation in the monetary sense and b a n k i n g policy. A s things stand today, there are few c o u n tries in w h i c h m o n e y is actually used in its o r i g i n a l form r a t h e r than as a reserve for b a n k credit, or in w h i c h the g o v e r n m e n t insists u p o n b e i n g paid, and in p a y i n g others in settlement of its debts, in actual m o n e y instead of in bank notes, checks, or drafts. B a n k i n g has, in short, b e c o m e closely i n t e r w o v e n w i t h the process of e x c h a n g e , and a substantial part of b a n k i n g consists in s u p p l y i n g , n o t loans or capital, b u t actual m e d i a o f exchange. Usually, therefore, an inflationary m o n e t a r y p o l i c y is o n e w h i c h brings a b o u t or is facilitated b y a certain k i n d of c o r r e s p o n d i n g b a n k i n g policy. A s we have seen, o n e i m p o r t a n t phase of inflation is afforded b y the a d o p t i o n of measures calcu-

I N F L A T I O N AND M O N E Y

49

lated to make it more difficult to obtain possession of the ultimate standard of value. T h i s phase of the matter is seen in its most striking form when a given country suspends specie payments and definitely releases the banks from the necessity of converting their obligations into cash. A step in the same direction, however, is noted when a government reduces the amount of reserve which was required behind notes, or exempts its noteissuing agencies from the necessity of redeeming save under very exceptional conditions. While we may thus note that in simpler civilizations repudiation is the policy directly to be expected, in the more highly organized societies the policy actually adopted is that of releasing the banks from the necessity of supplying the medium of exchange. Whereas it is true, therefore, that inflation in the banking sense may occur without any necessary interference with the standard of value, monetary inflation usually is given its effect by alteration in banking method or policy. Thus, at times, it is difficult to distinguish between monetary and banking inflation until all the effects are known, and it frequently seems as if the two procedures were nearly identical, both in purpose and effect. T h e essential difference between them lies in the fact that in banking inflation there has been clearly erroneous appraisal of values. In monetary inflation what has happened is a direct alteration in the basis upon which values are measured. T h e fact that modern economic life makes it ordinarily easier, sometimes inevitable, to apply monetary inflation through banking technique, does not alter the facts already stated. Least of all does it eliminate the essential difference between the two methods of reaching what seem to be substantially similar results. Abstractly speaking, it is certainly not true that monetary inflation, as we have defined it, necessitates banking inflation. Conceivably a nation might, if it chose, determine to cut its standard of value in two, and do so without producing any disturbance in its banking structure. Actually nothing of the kind is likely to take place. T h e r e is usually a reason for monetary inflation which finds its roots in conditions directly affecting banking. In order to take practical

INFLATION AND

50

MONEY

effect, monetary inflation often has to go through the media of banking, and it is frequently the case that those who have initiated such monetary inflation can get the full results of it only by having it operate upon the banking structure. T h e y are therefore desirous that banking inflation accompany monetary inflation, and thus it usually appears that the two phenomena are, if not simultaneous, at least very closely intertwined one with another. MONEY

AND BANKING

INFLATION

IN T H E

U N I T E D STATES

T h e working out of this condition may be readily observed in the working of the credit system of the United States. From the close of the World War onward, it is generally admitted, there was widespread price and credit inflation—actual inflation, due to faulty judgment of credit values by banks. There was not, however, any suggestion of alteration in the underlying gold basis of the currency. T h e total of gold held by the United States increased from about $2,250,000,000 at the close of the war to very nearly double that sum at the outbreak of the panic of 1929. Indeed, at times it was a fixed Treasury policy to endeavor to force gold out into actual circulation, in order to restore the popular holding of gold (so-called "concealed reserves") which had been found in most of the industrial countries prior to 1913. There was thus afforded an example of violent inflation which took the form of misjudgment of credit, at the same time that there was no change, actual or proposed, in the monetary base of the country. Contrast with this situation the state of affairs which developed after 1930. Gold had begun to leave the country, and some feared an extraordinary and dangerous loss of the metal. Business profits had largely disappeared and many were prone to assert that it would not be possible for debtors to meet their obligations. On the other hand, declining prices led to the growth of a belief that business could never again become profitable save through the cessation of the downward price movement and, if possible, the substitution of price advances. These considerations eventually culminated in monetary in-

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A N D

M O N E Y

51

flation, which took definite effect in the act of 1934. During the year preceding the adoption of this measure, the inflation process leading up to actual devaluation had been going on, the act in question being the final embodiment of that policy, as carried out during the preceding months. However, the years 1933 and 1934 were actually years of reduction in the amount of bank obligations outstanding. Notes in circulation fell off in a remarkable degree and bank deposits followed the same general course. T h e r e was a pronounced decline in the volume of loans made to business establishments. Altogether, the years in question, if statistically viewed, would probably be described by ordinary standards as a period of unmistakable deflation, notwithstanding the efforts of the government to bring about an opposite trend of affairs and notwithstanding, also, the devaluation process already referred to. Commodity prices, moreover, as measured in gold, declined sharply during this period, although from the beginning of 1933 to the middle of 1934 a technical increase from a commodity index of approximately 61 to an index of 74—an advance of 13 points, or something over 20 per cent—was achieved. It, of course, much more than disappears when allowance is made for the transference of the standard of value of a dollar of 25.8 grains of gold to one of 1 5 % ! grains of gold. It may well be, therefore, as thus illustrated, that monetary inflation may at times exist contemporaneously with banking deflation, and that it may take form primarily as a repudiation of indebtedness, without any of the secondary influences supposedly growing out of or due to it which are ordinarily classified as its characteristics. TIME

LAG

OF STATISTICAL

SERIES

T h e question should properly be raised, whether this occasional coincidence of policies that appear to be in opposition to one another may not be due merely to time lag. In the years 1933 and 1934, for example, it may well be contended that the failure of monetary inflation to show distinct economic results of the kind that were sought and desired from it is merely the

52

INFLATION AND

MONEY

result of postponement; and due to the fact that large forces can seldom be so arranged as to show their results simultaneously or contemporaneously. Put in another way, this might mean that our statistics bearing upon inflation are usually defective, in that they are not taken over a period that is of sufficient length to permit of a complete registration of the economic results to be anticipated from such factors. Put in still another way, it then amounts to a question whether, granting that sufficient time is allowed, monetary inflation must not invariably bring about parallel phenomena in banking, or, in other words, whether the results of monetary inflation will not always be registered in changed banking conditions, granting that sufficient time has been allowed to permit them to take full effect. In answering any such question, of course, familiar limitations must be imposed. Evidently the longer the time allowed for a study of figures upon a comparative basis, the greater will be the chance that extraneous factors of various kinds will intervene, with the result that forces that otherwise would register themselves may be neutralized. During the years of American development here under consideration, for example, great changes have been occurring in industrial technique and method and in the introduction of labor-saving machinery. T h e r e may be serious question whether the lengthening of the period of time studied, in order to obtain a period long enough to permit the reflex effects of monetary inflation to show themselves in the banking field, may not defeat itself. Leaving this question aside for the moment, however, and assuming that a number of years of practically undisturbed industrial conditions succeed one another, we are warranted in asking whether monetary inflation of the kind that has been described must not be conceived of as always registering in large banking returns. T h i s is partly a factual question and partly a matter of theory. W e may analyze it from the latter standpoint first. It is evident that a bank operating upon a specified reserve basis representing, let us say, 50 per cent of the outstanding liabilities, such reserve being carried (we may assume) in gold, if relieved of the necessity of keeping the reserve intact or,

INFLATION AND

MONEY

53

what is the same thing, if permitted to multiply its reserve by two owing to a devaluation of 50 per cent, will then have a correspondingly larger power of credit expansion, backed by a 50-per-cent reserve, than it had in the first place. From this it is usual to argue that such a bank will invariably enlarge its extension of credit correspondingly, so that devaluation or repudiation in the form assumed will eventually be reflected as an enlargement in the unit value or dollar value of outstanding bank credits. In these circumstances the average borrower " A , " who was formerly able to obtain bank accommodation upon specified security in the amount of " x " dollars, will now, it is supposed, be a suitable candidate for double that amount of credit. Inflation then in the sense of increase of the volume of bank credit upon a specified property basis may, according to this reasoning, be expected. T h e weak point in the discussion, however, is found in the assumption that prices of property and goods, that is to say of the "collateral," automatically and evenly move up, in accordance with the change in the value of money. T h i s is obviously out of the question, even from the standpoint of those who accept an extreme form of what is called the "quantity theory of money." Prices seldom move up evenly in any such fashion, nor do they increase practically in proportion to the volume of bank credit outstanding. It would be difficult indeed to find any period of time either in the United States or in any other country in which a movement of prices exactly paralleling the volume of bank credit available could be recognized. Now, if in any community which has greatly enlarged the power of banks to expand credit on a given money base by halving the monetary unit, there be certain classes of property which remain stable in price, refusing to advance, it is clear that the expectation of a corresponding increase in the amount of bank credit extended to such classes of business is without foundation. Examples of such types of collateral are furnished, for instance, by patented goods, articles for which an inelastic demand exists, and the like. These articles do not respond to competition in the same way as do others, and there is no necessary reason,

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I N F L A T I O N AND

MONEY

accordingly, why an enlargement of bank credit should be paralleled by a corresponding enlargement of prices, or vice versa, or why a steady upward movement of prices should bring with it or be accompanied by a corresponding advance of banking accommodation. T h e conclusion, therefore, to be drawn from such a survey of the situation would seem to be that while unquestionably an inflow of gold into a country or, as in our illustration, a halving of the gold requirements of reserves in any country, might by rendering gold more available in proportion to outstanding obligations, provide a possibility for increase in the amount of loans and in the price level of the country, there is no essential reason why such a parallelism must be observed or why gains of the kind referred to must necessarily take place in practically equal proportions. THE

THEORY

OF

PRICES

T h u s far this discussion has related entirely to the definition and qualification of the idea of inflation as applied to money. Incidentally reference has been made to the connection, so far as it exists, between monetary inflation and banking. In much that has been said, however, a theory of prices has been implied and it has been assumed that the reader had practically accepted a definite theory of prices upon which his reasoning about monetary inflation might rest. Logically speaking, this is a sound assumption. No satisfactory conclusions about inflation can be reached except on the basis of definite price theory, and the absence of such a theory on the part of not a few economists must be regarded as the fundamental reason why their discussion of the subject has lacked in clarity and positiveness. It seems desirable at this point, therefore, to indicate briefly the relationship of monetary inflation to price theory. T h e older theory of prices was a static doctrine which endeavored to analyze the influence of changes in the volume of money in existence upon the price of commodities (assuming that no changes occurred during the period under discussion, in any other factors likely to influence the price equation). With this as a base and on the assumption that by money was

I N F L A T I O N AND MONEY

55

meant only the total number of units of metallic money actually employed or in existence, it is not difficult to reach the conclusion that the greater the number of units of such money actually in use, the higher, with a given volume of business, would be the prices. This view of the situation necessarily had to be immensely modified, when it was admitted that credit intervened to perform the same work of exchange as did money or that, as J . S. Mill expressed it, credit acted upon prices exactly in the same way as money. When once this step had been taken, the analysis of the quantity of credit available, as well as the examination of its velocity or power of effecting exchange, became quite as necessary as the examination of the similar factors regarding money itself. Hence the general disposition to devote more and more attention to questions affecting bank technique, the enlargement of credit, the ratio of reserves, and other problems of a similar sort. The later discussion of the theory of prices, however, has necessarily taken a new turn. Instead of a static point of view, it has come to embody a dynamic attitude; in other words, it has begun to concern itself, more and more largely, with the factors which tend to bring about changes in "other things" which were originally assumed as being "equal." Most writers since 1900, and especially since the opening of the World War, who have devoted themselves to the discussion of credit, have been inclined to concern themselves largely with such questions as the attitude of the producer, saver and spender of capital, his habits of buying, his practices of using cash or bank balances, and, of course, the speed with which currency and checks circulated and the rate at which they eventually made their way back to the bank. A greater part of recent price theory has thus not only failed to concern itself with changes in the amount of money, but has been inclined to direct its attention less and less to changes in the volume of credit. It has tended to study more and more the conditions under which money passes from one group of buyers to another as well as the exchange habits of buyers. It is probably not too dogmatic a statement to say that in

56

INFLATION AND

MONEY

consequence of the movements thus described, the older socalled quantity theory of money has pretty definitely come to assume the position of a truism—when expressed in the form in which it was stated by the classical economists—and a truism whose value is in very considerable doubt. While doing homage to the quantity theory of money in a technical sense, most recent British writers have gone on to devote themselves to questions which lie far outside this scope when interpreted upon any reasonable basis. Ultimately the theory of prices has come to be regarded as a complex subject in which the question of demand and supply of goods, the shifting of consuming power among classes and the influence of bank credit upon business— especially in the shifting of investment capital in one or the other direction—all have a very large part to play. While certainly not denying to changes in the amount of gold or the amount of bank credit the very definite influence to which they are entitled as factors in a large group of elements tending to fix prices, the drift of opinion has been strongly away from the older and mechanistic concept of price making. So well established, however, had become the old quantity theory of money in its simplest form and so natural and easy to understand, that continued adherence to it has been characteristic of most politicians and public men as well as of not a few economists, who have in some cases taken pains to limit their expressions of allegiance by the older phrase, "other things being equal." During the monetary and banking discussion in the United States in 1933-34, the uncritical acceptance of the view that changes in the money unit would be immediately reflected in similar changes of commodity prices was very general on the part of public men and their economic advisors, so that a great deal of contemporary monetary policy has unquestionably been founded upon, certainly has implied the acceptance of, what is now generally admitted to be and regarded as, a wholly obsolete form of reasoning. In such circumstance it was hardly to be expected that the conclusions arrived at could find themselves sustained by facts. So, explanation has frequently been given that this noncorrespondence was

INFLATION AND

57

MONEY

to be interpreted by the circumstance that an insufficient period had been afforded for satisfactory comparisons, or for the actual exertion of influences arising out of changes in the money supply, either upon the price level or upon the condition of bank portfolios. As a result of widespread popular propaganda, it would seem probable that today, more than at any time in the past, there is a general acceptation of the thought that a mere enlargement of the number of money units in a country must result in an advance of commodity prices. It is worth while to place on record, by way of commentary on this claim, comparative indices showing the trend of commodity prices in Great Britain and the United States during the period in which these two countries have found it necessary or desirable to surrender the gold standard—Great Britain having resorted to this plan in September, 1931, and the United States in the spring of 1933. TABLE 1 * M O V E M E N T S OF PRICE INDEXES IN THE UNITED STATES AND ENGLAND WHOLESALE PRICES IN THE UNITED STATES (1926 = 100)

Jan Feb March April May June July Aug Sept Oct Nov Dec

'93'

'93'

'933

1934

78 77 76 75 73 7a 72 72 71 70 70 69

67 66 66 66 64 64 65 65 65 64 64 63

61 60 60 60 63 65 69 70 71 71 71 71

72 74 74 73 74 75 75 76 78 77 77 77

• Source: Abstracted from Federal Reserve Bulletin, Jan. and Dec., 1933, July, 1934, and March, 1935; United States index : compiled by the Bureau of Labor Statistics; English wholesale price index, in the Board of Trade Journal, Jan. 24, '935In connection with the use of this table one should note the following: (1) One index is on a 1926 and the other on a 1930 base; (2) the composition of the two indexes is different in respect to the weights allotted to various commodities and the proportion of rigid and volatile prices included; (3) certain statisticians

58

INFLATION AND

MONEY

TABLE I ( C o n t i n u e d ) M O V E M E N T S O F P R I C E I N D E X E S IN T H E U N I T E D S T A T E S AND ENGLAND WHOLESALE PRICES IN ENGLAND (1930 = 100)

Feb March April May June July Aug Sept Oct Nov Dec

'93'

'93*

'933

'934

9' 90 89 89 88 87 86 84 84 88 89 89

89 88 88 86 85 83 83 84 86 85 85 85

85 84 83 83 84 86 87 87 88 88 88 88

89 89 88 88 87 88 87 89 88 88 88 88

claim that price indexes for various countries should not be compared to one another, unless they are constructed with that end in view. So far no up-to-date set of price indexes for various countries is available that would be strictly comparable.

IV I N F L A T I O N AND I N D U S T R Y 1 IN the foregoing chapters, emphasis has been placed upon the thought that inflation is essentially a process of wealth transference or of the regrouping of economic classes. In pursuance of this thought, it has been insisted that there is no necessary connection between the mechanism of money and banking and the forces of inflation, although it is usually true that the mechanism of money and banking is employed in effecting or making operative, an inflation movement. It has further been sought to make plain the view that, in the inflation process, there usually occurs a distortion of wealth forms which may result in the overincrease of certain classes of goods (overproduction) or in the undue expansion and enlargement of capital forms (overequipment or overcapitalization). It is now worth while to see exactly what is meant by inflation in this nonmonetary or nonfinancial form. In other words, could inflation in the sense in which we have been discussing it, occur without the agency of a system of money and banking? If the answer to this question should be negative, we must at least modify our past conclusions to the extent of admitting that, whether or not inflation be strictly and exclusively a monetary and banking phenomenon, it is at any rate a phenomenon which could not have occurred without the existence of a system of money and banking. On the other hand, if the question receive an affirmative answer, it will be incumbent upon us to explain why it is that inflation rarely occurs without a disturbance of the monetary and banking system, so intimately associated with the movement itself as to give rise to the all but universal opinion that inflation and monetary and banking changes are identical or simultaneous, and certainly interdependent, i By H. Parker Willis.

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INFLATION AND B O O M S AND

INDUSTRY

DEPRESSIONS

In current economic literature, it has become customary to place a great deal of emphasis upon so-called booms and depressions, and not a few authors are inclined to identify them with price irregularity. Without an unstable monetary system, say these writers, we should have no fluctuations of prices, and without great fluctuations of prices we should have no booms or depressions. " T h e business cycle is instability of the price level," as one economist expresses it. In giving these questions at least a preliminary answer, let us note, first of all, certain characteristic elements of the boom. Outstanding among these are obviously activity or large turnover in some particular line or lines, and usually advance of prices. T h e latter, although often spoken of as if it were an inevitable concomitant of the former, is not necessarily so, as experience shows. For example, it has often happened, within recent years, that a government needing a large supply of a given kind of war material has parceled it out to manufacturers at a fixed price, or at actual cost plus 10 per cent. T h e result has been to bring about a very large production of this particular item, which has usually thereafter been consumed, but, in not a few cases (as at the close of the World War), has not been used by those for whom it was intended, and hence has found its way back into the market again. In other cases, the rise of prices has stimulated buying on the part of persons who believed that conditions would shortly become such that they could not otherwise supply their own wants. While no hard and fast rule can thus be laid down, it may freely be admitted that in the majority of so-called booms, heavy turnover and rising prices are characteristic, and it should be added that these may occur without any intermediation of the machinery of lending, and without any alteration or devaluation in money, or inflation of credit. In depression or deflation, it usually appears that demand is weak and that supply is in excess of current needs. This condition frequently gives rise to a reduction of prices, but does

INFLATION

AND

INDUSTRY

61

not necessarily do so. In some notable cases, prices of commodities have risen during depressions instead of falling, usually owing to the higher unit costs of producing a small quantity of a given commodity ordinarily subject to the law of increasing returns. So far as the mechanism of the boom and depression goes, therefore, it may be accepted as correct that the intervention of money and banking is not necessary to bring about those changes in the volume and direction of production which are currently designated as "boom" or as "depression." FORMS OF BOOM

T h e simplest form of boom thus described is obviously the development of a condition of overactivity in a given branch of industry, resulting in overproduction. What is overactivity? It is clearly that stage or degree of activity in industry which results in a disproportionate demand for labor or raw materials to be used in the making of a particular article. For example, the automobile industry, if confident of a sale of four million units in a given year, may establish a manufacturing schedule based upon that forecast, and may accordingly place orders for tires and accessories sufficient to complete production of the four-million-unit output. Incidentally, it may be noted that the highest prices for automobiles have by no means coincided with the periods of largest purchase and consumption, while, conversely, the times of smallest production have not necessarily been those of lowest prices. Such a miscalculation of consuming power may result in overpurchase of materials, which results in an excessive speeding up of auxiliary industries and in a drawing off of materials that would be used elsewhere. T h e boom may then continue as long as those in charge are willing to direct their means toward its support by continuing their purchases of materials and labor. Another form of boom is noted in those cases where the industrial entrepreneur, instead of buying very largely of materials, buys very largely of highly specialized machines for manufacturing, either because he already has a great supply of raw materials, or is confident that he can get such materials

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A N D

I N D U S T R Y

when and as needed. He does not devote himself to the accumulation of materials, but to the stimulation of the capital-goods industries which are capable of turning out the mechanisms he desires. A boom in the automobile industry very often does not result in a great accumulation of unsold automobiles, but in a large accumulation of machine tools capable of manufacturing the revised patterns or "models" that have been determined upon as characteristic for the industry in question. T o put this in another way, the characteristic features of a boom may be large production and higher prices, as already indicated, but they may be great output of indirect means of p r o d u c t i o n capital goods, or what we ordinarily call machinery. Conversely, depression may be evidenced by the suspension of manufacturing, by a reduction of orders for materials, or by the curtailment of capital-goods requirements. One or all of these features may be witnessed, and probably will be encountered at the opening or in the progress of a depression. CAPITALISM

AND

OVERPRODUCTION

It is the facts just enumerated that have led many persons to assert that overproduction is the result of modern capitalism, 2 or, in other words, that the capital system inevitably tends to self-destruction by employing more and more indirect mechanisms of production, and by making these more and more capable of turning out larger volumes of goods than can be used. Because capitalism fails to distribute as wages a consuming power which will enable the recipient of wages to buy the product of machines, capitalism is said to contain "the seeds of its own destruction." 3 Based on this familiar old syllogism, the so-called "technocratic" philosophy sought to terrify the community by assertions of limitless productive capacity on the part of the machine equipment of modern industry. Hence the widespread fear of continuing unemployment, due to the fact that the community was able to produce more than human a Of the multitude of works in which this thesis is presented, the earliest and still the best is that of J. A. Hobson, entitled Evolution of Modern Capitalism. a Marx, Kapital (Everyman's Library No. 848, 1928), I, 460, states this thesis.

I N F L A T I O N

A N D

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63

beings could want, while, on the other hand, unwilling to distribute to the community the power to buy such products of industry. Evidently these extraordinary fears were the outgrowth of a belief that it would be possible to peg the prices of commodities in such a way as to prevent consumers from buying them; and the assumption was that manufacturers would follow that course until, as Hobson says, "compelled to clear the g r o u n d by sacrifice sales effected at less than cost in order to open the way for renewed production and sales." From one point of view this assumption of the Marx-Hobsonian doctrine seems to presuppose an independence of boom psychology and mechanisms, from techniques of contemporary banking, money and price machinery—which, it is assumed, cannot be made to work in such a way as to take off the market the burden of capitalistic production. T h e assumption here evidently is that wages and other money remunerations cannot or will not competitively be adjusted, sufficiently steadily, to carry off excess supplies, or to relate the returns to capital for machine production to a lower scale so as to prevent u n d u e multiplication of production activity. It is not, however, necessary to assume any such failure on the part of the financial mechanism to function, in order to see h o w inflated conditions may make their way into given branches of industry. A beginning is made by the existence of high profits in given branches of trade, and an u n d u l y positive acceptance of the thought by industrial entrepreneurs that there is a practically unlimited field for further sales and for a proportionate realization of earnings. RELATION

OF

BANKING TO

PRODUCTION

A fundamental assumption underlying this whole school of thought must now be considered. T h i s is that the manufacturing enterprise is practically possessed of, or controls, all of the capital necessary for its own purposes, which include: (1) the installation of the necessary machinery for operation; (2) the supplying of w o r k i n g capital for the conduct of processes of production; and (3) the actual carrying of the product so l o n g

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I N F L A T I O N AND I N D U S T R Y

as may be necessary to put it on the market; or, in case of a surplus, the carrying of the product until such time as it can be disposed of at the original price, or must be disposed of at a cut price in order to secure its sale to actual consumers. As capitalistic society has developed, and the absence of these sums in given hands has become more and more evident, the evolution of banking and of the process of collecting both actual capital and working funds in small amounts from savers to be dispensed in large amounts to industrialists, has made it unnecessary and generally uneconomic for the industrial enterprise to provide itself at the outset, with capital in such quantity. Generally speaking, it has been preferable to organize the enterprise with a minimum of capital requirements and to borrow working funds and carrying charges when and as necessary from the banks, repaying the latter in times of slack business and requesting the latter to expand in times of active business. As a result, the theory of an "elastic" currency and credit system has taken deep root. T h e function of banking, in this case, has been in part that of accumulating from many sources the current funds that were necessary in the conduct of industry. It has then been the function of the wise banker to determine whether these funds should be supplied to given industrialists, or not; and the banker's decision has normally been dependent upon the question whether in his opinion the business enterprise was likely to be able to dispose of its output—whether it was, or was not, well adjusted to the needs of the community. It is, of course, quite true that, particularly in recent years, industrial enterprises, desirous of emancipating themselves from the control of the banking community, have at times succeeded in getting from the savers of the country a large supply of cheap resources which they have then used to pay off their liabilities at banks, and thereafter have devoted themselves to the building up of reserve funds, sometimes carried in the form of government bonds which could easily be liquidated at times when absolutely necessary; and could, on the other hand, be readily restored at times when surplus funds were sufficient to permit

I N F L A T I O N AND I N D U S T R Y

65

such re-creation of reserves. This has, in numerous cases, made the industrialist practically independent of the bank, and has thus freed him from banking control of the kind described in the preceding paragraph. It may parenthetically be said that the result of this process has been bad, and that, in most cases, such elimination of the banker's judgment has resulted in what is normally called overproduction or overinvestment, as the case might be. Let it be carefully noted that this statement by no means implies that the banker's judgment has in every case been sound. In fact, a survey of the recent industrial history of the United States will furnish multitudinous cases in which the bank has been induced to provide the funds for overproduction, and great numbers of others in which it has provided funds for overinvestment. Because of the fact that, not infrequently, this action by banks has been the result of the existence of a bank directorate whose interests were identical with those of the borrower, emphasis has been increasingly placed by thoughtful students of banking upon the separation of bank management from business management, the purpose being, of course, to obtain that degree of independence of judgment and freedom of action which have long and correctly been considered the principal merit of banking as developed in the Anglo-Saxon countries. T h e reader will naturally recall many instances in which the situation just described does not exist, the most notable, perhaps, being found in the German banking system, where industrial banking was, before the World War, seen in its most successful aspect. As to this, it is sufficient to observe in the present connection that the German system was part of a general structure of industry in Germany which was designed to permit rapid industrial development, aiming at very large exportation, under subsidized conditions intended to force excess production into use in other countries, no matter what might be the competitive conditions in the latter. This method of banking, in Germany, was in fact regarded by able German writers as unsound, and largely for the reasons already men-

66

I N F L A T I O N AND

INDUSTRY

tioned. T h a t was the view of Knies, as well as of Wagner; and the admirers of the German method who later developed numerously in England took a shortsighted view of the whole situation, which has since been shown by events to have been without much foundation. All this is a matter apart from the present discussion, which primarily bears upon conditions established in the English-speaking countries under a system that still retains essentially the original spirit of English banking, however far distorted and diverted from its original channel. W e may, therefore, with substantial accuracy, say that the function of the bank is still that of directing new applications of capital into desirable channels, and of withholding such new applications from undesirable channels. And thus the essential connection between English (and American) banking and the investment market has been found in this negative role of the bank—the direction of new increments of capital. It is thus not true, as many writers have asserted, that English banking merely "leaves the capital market to take care of itself." It never accepted any such view; but it did work upon the theory that a more satisfactory control of the capital market could be obtained by the "marginal" method—that of applying or withholding small increments of capital funds—than by directly interfering with and directing the placing of capital in this, that, or the other, enterprise. Where, therefore, banking satisfactorily exercises the role mapped out for it in the capitalistic society of the nineteenth century, the presence of overproduction is guarded against; and where it does not do so, the presence of such overproduction or its corollary, overinvestment, is certain to make itself felt. From this standpoint, then, we may think of inflation as a distortion of the productive or investment processes which is not corrected by banking methods, or in which the appropriate banking corrective has not been applied. T h e idea that the capitalistic system results in accumulation of vast quantities of unsold goods—which are far in excess of the power of the community to consume, and which cannot be disposed of be-

I N F L A T I O N

A N D

I N D U S T R Y

67

cause of low rates of wages, preventing, as the latter are said to do, the ready distribution of consumable commodities—is based upon the assumption that the banking processes, with the correctives which we have already described, will always or, at least periodically, fail to work. INFLATION

AS A D I S T O R T I O N

OF

PRODUCTION

Let us follow somewhat further this analysis of the idea of inflation as a phase of production. If it were possible always to have a properly adjusted system of capital distribution, we should have industries so organized that the products of one would furnish a demand for the products of others. T h i s demand would not consist in the wages of employees, but would be largely made up of the demands of industries for their raw material and other supplies. N o error of the technocratic theorists, or of the Hobsonian school, is more serious than the assumption that demand is always reducible to a demand for consumable goods. Every individual, except those upon the barest of subsistence minima, makes some demand for capital goods—even if such demand be only in the form of a demand for housing. T h e wealthier individuals of a community ordinarily find it impossible to dispose of their income in mere consumption, and incline more and more toward the bestowal of it in the acquisition of titles to capital objects of various kinds. It may well be that these objects are not themselves those which are calculated to produce immediate supplies of consumable goods for others, although in some cases they may be. T h e point is that they are not items that would ordinarily be included in the group of "consumption" goods in the strict sense of the term. In the imaginary society of which we have been speaking, the application of capital takes place in such a way that the output of every industry is immediately demanded for the support of every other, as well as for the support of the community through the supplying of consumption goods. Perfect application of capital then results in the utilization of each item of capital in such a way as to obtain maximum usefulness, so that the plant

68

I N F L A T I O N AND I N D U S T R Y

is continuously operated, while labor itself is distributed in the same way, in such fashion as to furnish the necessary number of men for the operation of machines. Those who assert that, in such circumstances, we still would have the phenomenon of overproduction or, as some express it, "underconsumption," commit themselves in effect to the view that it is possible to have a general overproduction—that is to say, the creation of consumable products in excess of the power or desire in the community to use them. As to this, of course, no argument is needed. T h e real question at issue is whether by any means it is ever possible to obtain the ideal distribution of the capital and labor of the community to which reference has just been made. T h e answer to such a question is undoubtedly in the negative; and a prosperous or successful community is accordingly one in which the nearest approximation has been made to such ideal distribution. Such a community is one in which the numbers for productive activity are evenly distributed upon a plan which will result in making the movement of both capital and labor continuous, and one giving to the different shares of production that return which the condition of the arts and their relation to natural forces permits. Obviously, a country large in resources, fertile in soil, with an industrious and skillful population, will be more prosperous, in the sense that it will be able to create a larger output or to create the output it desires with shorter hours of work, than will be the case in a country whose soil is unfertile and whose people are low in industrial capacity. T h e concept of prosperity, however, is not one which depends upon or connotes high return. Conceivably, the country of poor soil and unskillful labor may be quite as prosperous in a technical sense as the country of greater resources—a fact illustrated by the circumstance that in recent years many of the poorer countries have appeared to have a more normal, steady life with far greater regularity of employment and far greater safety of capital than has been true in the countries of much larger means. Looking at the situation from this point of view, then, the factors which immediately lead to dislocation

I N F L A T I O N AND I N D U S T R Y

69

of industry and overproduction are those which bring about an excessive development of certain kinds of capitalistic undertaking, and which, of course, correspondingly shorten activity in other directions. Such dislocations may be brought about as the direct outcome of the development of some new industry, the intervention of some new process of production which supersedes older processes and mechanisms, and makes it feasible to displace the latter, and hence temporarily grants a prospect of greater profit in the making of the machinery which is to effect this displacement; in social disturbances (e.g., war), which suddenly call for an overemphasis upon certain kinds of production, and as suddenly terminate this exceptional demand. In consequence of the working of any or all of these factors, the dislocation of production already referred to may occur, with corresponding shifts of demand and supply. In such cases, overdevelopment of a given class of productive mechanism, or, in the case of world changes, overdevelopment of the entire productive mechanism of the nation, may operate to give temporarily high returns to the capital and labor so employed. We then have a characteristic inflation condition—one which might very often have been avoided had the banking community resolutely refused to supply the capital for the process. In the absence of such refusal, the fact that the banking community itself immediately becomes deeply involved in the process and is obliged to accept as security for advances the capital forms which are themselves the outgrowth of the inflation process, may often make it seem that the banks have been the real cause of the dislocation, through the fact that they have furnished the capital by which it has been carried on. In most such cases, it will, however, appear upon closer analysis that the motivating force is something very much deeper, and that the banks themselves have been only indirectly responsible. They have, in such instances, frequently lent themselves to the inflationary movement; but it is usually true, especially in time of war, that they probably could not act otherwise, and that the force of public opinion has compelled them to make the

70

I N F L A T I O N AND

INDUSTRY

advances that were demanded in the supposed interest of the entire community. So, also, in the case of depression, when a cycle of production based upon the prospect of immediate large profits, and motivated as just explained, by some one of the exceptional factors referred to, has run its course, the consequence usually is to leave the community with an oversupply of goods or of capital forms, or, in some cases of both. Such oversupply cannot be corrected immediately, because of the fact that demand has been fully satiated, or at best can be stimulated only by reducing current prices in a proportion or degree which will inflict upon the producers losses greater than those believed likely to result from an attempt to carry the goods until consumption catches up with the productive process. T h i s latter is necessarily a slow way of bringing about readjustment. It normally implies idleness on the part of various units of capital, pending the time when demand can, as explained, be redeveloped, or when existing supplies can be so reduced as once more to normalize demand. A special danger is involved in such a process. T h i s is, that technical improvements in methods of production may intervene, with the result that both the capital forms and the supply on hand have to be greatly written down. T h e business enterpriser is always afraid of such a possibility and is correspondingly anxious to keep his plant at least partially employed. Hence the constant call for inflation in the popular sense—that is to say, the adoption of a policy which will "create purchasing power" on the part of the rank and file, and so presumably lead them to buy more freely, and thus to take off the market the overproduced goods. Hence, also, the demand for another popular form of inflation—the adoption of changes in the money and banking system calculated to bring about a different pricing of the goods themselves, in order that the manufacturer may be able to make a balance-sheet showing that will free him from the danger of losses as far as possible. Inasmuch as all business affairs are conducted in terms of money, the assumption in such a case is that, by correcting the money position of the manufacturer, the evils which have been

I N F L A T I O N

A N D

I N D U S T R Y

71

brought about by misapplication of capital may likewise be corrected. In such a situation b a n k i n g is ordinarily called upon to extend credit freely—that is to say, to give the manufacturer renewed access to the capital of the community, regardless of mistakes that he may have committed in the past; or to finance manufacturers notwithstanding that their balance sheets are still out of adjustment with the requirements of safety; to convert capital goods into means of immediate payment, in defiance of the fact that the conditions of demand and supply do not warrant such action. It is obvious that the banks can comply with such mandates only by passing over to persons w h o have already made mistakes in the conduct of the productive mechanism, control over the new supplies of capital which are coming forward and whose destination the banker is called upon to determine. T h e fact that in such circumstances bankers always manifest a strong desire to be " l i q u i d , " is the way in which the b a n k i n g c o m m u n i t y manifests its recognition of the fact that blunders have occurred—usually blunders on its own part as well as on that of the manufacturers, and a further recognition of the fact that new applications of capital are hazardous until the equation of demand and supply can be readjusted through a settling d o w n and rearrangement of the purchasing power of the c o m m u n i t y . Such a desire for liquidity may be, and often is, exaggerated and allowed to continue m u c h beyond the limits that a more larsighted policy w o u l d impose. In this case, as in the original situation where overproduction occurs as a result of banking error, all that need be said is that economic processes are not exact, and are the outcome of h u m a n judgment, with all the fallibility that implies. T h e r e is likely to be a certain percentage of mistakes and faults of j u d g m e n t with regard to restarting the activity of industry as there was in overdeveloping it. INFLATION

AND

BUSINESS

FLUCTUATION

T h e connection between inflation as we have defined it and business fluctuation is thus indicated. T h e excessive develop-

72

I N F L A T I O N AND

INDUSTRY

ment of a given industry or group of industries which we ordinarily describe as a boom, is the industrial phase of inflation. It consists in the misapplication of capital, due to the impression that unexpected or large opportunities for profit may be realized through a given type of investment. T h i s type of inflation is well reflected in the popular crazes for real-estate speculation or overbuilding of suburban "additions," sometimes the overconstruction of office buildings in cities, and the like. I t is sometimes true that the boom thus developed results in a permanently profitable placement of capital, but at the expense of other capital which is thrown out of employment and has to be written off. This is conspicuously the case in all industries that are undergoing very rapid development owing to the progress of invention. Inflation thus takes the form of the overapplication of capital to a given purpose. T h e fact that such a misdirection of resources may at times be merely the shifting of capital into different forms or, in other words, the supporting of a different type of capital investment, thereby throwing out of employment the old equipment, and hence necessitating its loss or writing off, is merely another phase of the same situation. T h e question may be asked whether, when industries appear to be undergoing a boom, the condition is truly what is ordinarily termed "prosperity." A review of the economic history of the nineteenth century seems to reveal a few cases of this kind, but none that cannot be satisfactorily explained upon other terms. As has already been stated, it often happens that a given nation appears to be undergoing a general boom of industrial processes, sharing in abnormal profits and striving to develop its plant capacity at an abnormal rate. T h i s was the case, for example, in the United States during the earlier part of the World War. Such instances of prosperity are obtained at the expense of the capital accumulations of other nations, at whose instance the expansion of productive capacity has taken place. In other cases, where the expansion has originated for internal reasons, the prosperity is usually only partial. Thus, for example, after the close of the

I N F L A T I O N AND

INDUSTRY

73

World War and during the so-called prosperous years of 1922 onward, there were many industries that were constantly complaining of existing conditions, and were apparently suffering. Conspicuous among them were some phases of agriculture. The fact that such industries are usually not able to make themselves heard, their complaints being drowned in the chorus of satisfaction originating with others which are in the process of overdevelopment, does not in the least diminish the validity of what has just been said. Inflation thus appears as a process of shifting the distribution of capital, and incidentally of changing the relative quantities of the output of capital industries. It at times implies a redistribution of losses, displaced capital having to be written off and the losses "taken" oftentimes by large groups of people who had not expected any such outcome. Such displacements and readjustments inevitably bring about great changes in consuming power on the part of other classes in the community. When these are carried far enough, "depression" may set in, and the profits which induced the redistribution of capital in the first place may disappear. The restoration of normal conditions is then a problem of bringing about a redistribution of labor and capital in such proportions as will permit the regular functioning of the industrial mechanism of the country. This seems to make inflation, at certain stages of its life at least, primarily a phenomenon of production, secondarily a phenomenon of consumption. As we have already seen, the disorders and sufferings caused by these readjustments frequently, if not usually, lead to a demand for alleviation through some change in the monetary statement of the position of different classes in the community. Displaced industries, or industries whose equipment has been rendered obsolete by the substitution of new capital forms, find it difficult or impossible to get the current receipts which will enable them to maintain payment of the interest on their debt in those cases in which they are borrowers. Farmers who have borrowed heavily in order to acquire land of secondary fertility, may find great improvements in farming not applicable to their fields

74

I N F L A T I O N

A N D

I N D U S T R Y

(e.g., the application of large-scale agriculture makes it difficult for them to obtain for their output the amount of money that will enable them to meet the interest on their mortgages). Labor, which had been employed by enterprises that theretofore had been able to "carry o n " through the results of sales, may now be out of work because of the lack of profits due to falling prices, which in turn are the result of changed conditions of world production or of new invention. In all such cases there is an insistent demand, if the suffering be broadly enough distributed, for a change in the monetary expression of values, adequate in amount to restore the balancesheet position of the suffering classes. T h e copper mine which is unable to keep open because of inability to sell its product at more than 7 cents a pound when its costs are 8 cents, naturally wishes to see the price of copper raised to 10 cents, and argues that such an advance will enable it to reemploy labor. T h e farmer who has done well enough in the cultivation of beets when granulated sugar brought 8 cents a pound, cannot meet his mortgages with sugar at 6 cents. He calls for a higher price for sugar and is usually inclined to complain either that the banks are harsh creditors, refusing to give him an extension of time for payment, or that there is an insufficient amount of money in the country to enable him to meet the needs of his trade in the way that he desires. Hence, a call for " f r e e r " banking and credit, and "cheaper" money. T h e connection between money and banking then, on the one hand, and industrial boom or depression on the other, is found in the fact that, since values are expressed in terms of money, changes in the productivity of capital and in the consumptive adjustment of demand and supply are reflected in monetary language; and hardships which originate in faulty distribution seek a correction in symptom-treatment, rather than in terms of underlying causes of trouble. INFLATION

AS A N I N D U S T R I A L

CORRECTIVE

What is the industrial effect, it may next be asked, of applying devaluation of the monetary unit, or inflation of credit, as a

I N F L A T I O N AND

INDUSTRY

75

business corrective? T h e essential influence of the remedy proposed is, of course, that of eliminating liabilities that have already been incurred through economic mistakes. T h e business concern which is unable to get rid of its outstanding debt through an artificial "mark-up" of the price of its products resulting from some form of state activity or, perhaps, through debasement of the currency (in certain circumstances), has not altered its relative situation. If this business house be handicapped by the fact that its competitors have cheaper processes, or by the fact that the nation in which it is situated has been excluded from the world market either through its own or another nation's policy, the mark-up of prices, like any other form of repudiation of obligation, merely relieves it of the consequences of what has already happened. It does not change the industrial position of the enterprise, either nationally or internationally, as compared with others. T h e American farmer, for example, who was able to enjoy an advance in his products during the years 1933 and 1934, in some cases by 100 per cent, did not find himself helped in the slightest, because of the fact that he promptly found that the commodities he had to buy had risen in practically the same degree as had his own products (in some cases in a greater). He would undoubtedly have derived benefit from the change in prices in so far as related to his already outstanding indebtedness, had it been true that he was in a position to retire, and that the question at issue was merely that of writing off his obligations and getting out of his agricultural operations with as much money in his hands as possible. Evidently, for example, if his indebtedness was $10,000 and his annual crop of wheat was 10,000 bushels, he could, in such a case, clear off his debt with the current year's crop of wheat when that commodity was worth $ 1 a bushel; whereas at 50 cents a bushel he would have been left with an indebtedness of $5,000. T h e difficulty in this case, overlooked by all inflationists, is the fact that the farmer not only does not wish to retire, but cannot do so. He, or his successor (and from the social standpoint it matters not which), must continue the productive

76

I N F L A T I O N AND

INDUSTRY

process and must, of course, have the use of the capital necessary to carry it on. He does not, therefore, wish to pay off his mortgage, but is more likely to have to increase it; and the effect of the artificial mark-up in the prices of his product, although theoretically enabling him to withdraw, practically does not do so. In spite of all the political promises that have been made to the effect that the "inflation" of 1933-34 would enable the community to "relieve itself of debt," the facts in the case plainly show that no such relief occurred; or that, where it sporadically occurred, it was the result of cessation of production or of going out of business. T h e debts of the United States in fact, and of the different industrial groups in it, contrary to general impression, have not increased especially rapidly of recent years, nor have they increased more rapidly in the aggregate than bank credit or industrial output. These are axiomatic facts in the situation and they lead inevitably to the conclusion that if, by what is called inflation, it should prove possible to scale down this indebtedness, the community would still be left with the same necessity for the use of borrowed capital and with the same necessity of paying for it, although its borrowing power or "credit" must necessarily have been impaired by the methods employed in relieving it of the legitimate burden of debt which it had incurred. Finally, the question may fairly be asked, whether inflation, in this sense of the term, may be regarded as an inducement to greater business activity. If, for example, the use of methods for scaling down obligations either by exemption of the debtor or by artificial increase of prices, actually had the effect of making the business man more active and more inclined to engage freely in production, the argument for inflation might be found in the fact that it thus shortened the period of readjustment, consequent upon the ending of a boom—which as we have just seen may often be a long one. It is, perhaps, just here that the strongest argument for such inflationary policies may be developed. T h e question at issue then is whether the shock to credit, and consequently to the supply of capital, produced by repudiation or cancellation of obliga-

I N F L A T I O N AND I N D U S T R Y

77

tions which, as we have seen, is essentially characteristic of all inflation, does not more than offset any increase in activity of investment that might be conceived of as resulting from inflationary methods. SOME

CONCLUSIONS

The present chapter has shown that the process of inflation, described earlier, is a process which exerts its chief effect upon productive conditions. By altering these productive conditions in their relation to one another, it necessarily alters the position of goods and the relationship between different groups of goods. Inflation thus appears as a process of unduly raising the volume of given classes of goods, or of the machinery for producing such goods, to a point where it is out of harmony with the capital or goods situation in other branches of industry. It is, in short, a dislocation of demand and supply. Such relationships of demand and supply are not constant in any society, nor are they identical in different societies. They gradually alter and the "equilibrium" which exists at any moment is necessarily unstable. Relative stability is brought about through the application, or the withholding, of new supplies of capital as they relate to given industries. Such application may be made by a paternal state operating a "planned" system of society and artificially furnishing new increments of capital to old industries, or at times installing new industries at the expense of old ones. Whether such planning will be successful or not depends upon whether it is accomplished or carried out under the influence of superior ability. If such planning merely aggravates existing discrepancies, this, of course, is worse than useless and likely to intensify the very conditions it is attempting to mitigate. In a capitalistic society, the new capital which comes forward is directed to its ultimate position through the mechanism of banking, whose function it is essentially to determine whether given enterprises are entitled to the use of the new resources or not. Their "title," as thus indicated, is dependent upon their capacity to use the new capital up to its full marginal value—

78

I N F L A T I O N AND

INDUSTRY

to get more satisfaction for the community out of it than would be obtained through any other use. T h e determination of this title is ordinarily made by the banks through an inspection of the profit-making power of the concern. Because of the fact that profits are necessarily short-term in character and are affected by many fortuitous circumstances, banks often make serious blunders in their apportionment of capital. They frequently allow its use to enterprises that cannot expect to get a return from it for more than a very short period, and they occasionally deny its use to those concerns who, while earning upon a basis of narrow profit, are stable and permanent in their earning power and should be sustained by the community because of the support that they give to other elements of the economic structure. These blunders, when made by banks, permit the process of overinvestment or exaggeration of industry and thus conduce to overproduction. T h e mistakes are not necessarily confined to banks, and in many instances are committed by industries which have been in the habit of going direct to the public for their new capital instead of working through bankers. W e must not, therefore, fall into the error of considering industrial inflation exclusively the product of banking error; it is in practice largely the result of the latter, but the effects of the banking process thus indicated are usually not so great as those of the planned process conducted by the state, or of the process of decision by industrialists as to their own needs for capital. After the mistakes have been made, they necessarily result in a dislocation of industrial effort, and are often accompanied by collapse of prices. T h e result of such collapse is to compel banks to assume the duty of reversing their former decision, thus bringing about a distribution for consumption of the new savings of society, just as formerly they had to bring about a distribution of these savings to industrialists. T h e attempt to apply the popular method of inflation by devaluing the unit of currency, or by issuing new credit in the form of greenbacks, or unsoundly based bank credit, may result in relieving debtors of a part of their obligations, but in

I N F L A T I O N AND I N D U S T R Y

79

so doing ordinarily alters, unfavorably to new borrowers, the conditions under which credit is extended. Since the latter are not going out of business and expect to remain as borrowers, they are seldom helped by it, and while the greater activity may at times shorten the period of dislocation of industry, the question whether it will do so or not is largely problematical. T h e marking up of prices through devaluation is likely to relieve the inefficient or unwise producer of his obligations in quite as effective a way as it relieves the efficient producer; and the process thus affords no safeguard against recurrence of the old offense in exactly the same form. T h e banks are subject to the same limitations of judgment as are other institutions, and often undoubtedly prolong the period of depression through overcaution in withholding the use of new savings which might otherwise be put to good service in industry. This overcaution must be overcome by such methods of reassurance as are available, but the plan of substituting for banking judgment large applications of capital guaranteed by the government or by some outside factor, is subject to exactly the same criticism as hasty action by the banks, and can be beneficial only if those who make such grants of capital are more wisely informed with reference to the needs of the economy. T o attempt to stimulate the economy, by overdevelopment, at points which have already been found to be deficient, in order to create what is called purchasing power, evidently does not touch the real root of the evil, and may simply aggravate existing conditions by encouraging further development of industry at the hands of the unskillful, further production of goods for which there is no service, or the creation of so-called capital goods which are not wanted and not likely to be. In such cases this "relief" merely reduces the total of wealdi currently at hand for use.

V INFLATION

AS A

CONTEMPORARY

PROBLEM

1

THE situation depicted in our earlier chapters with reference to the doctrinal attitude and beliefs prevalent in the United States can be better understood if we review in more detail the history of inflation and the discussion of the subject since the close of the World War. In so doing, brief reference is necessary to the war experience and to the general character of the credit ideas developed during that struggle. We may divide the war period, for the present purpose, into two main subdivisions—the first representing the years from August, 1914, to April, 1917, in which the United States stood by as an observer of the world conflict, claiming the right to dispose of goods as it chose, and to receive payment therefor from the various combatants, assuming that it maintained general observance of the doctrines of international law; the second, covering the years after the entry of the United States into the war in April, 1917, to its exit from the struggle in November, 1918, followed by some subsequent months of readjustment. T h e two periods will be found to reflect rather different conditions of inflationary development, as well as interesting changes in the popular, as well as the "scientific," attitude on the subject. PREWAR INFLATION

During the period just spoken of as preceding the entry of the United States into active participation in warfare, the general characteristics of our trade were found in the creation of a growing export balance paid for in gold and securities. The figures of this period have been often reviewed, but for convenience' sake have been recapitulated in Table II, showing the trade and financial position of the United States. Commodity prices during the early war years in question tended upward all over the world. They increased sharply in 1 By H. Parker Willis.

A C O N T E M P O R A R Y PROBLEM TABLE

81

II

FOREIGN TRADE AND CHANGES IN MONETARY FACTORS PRIOR T O THE ENTRY OF THE UNITED STATES INTO THE WORLD WAR * (In Millions of Dollars)

PERIOD COVERED

'914 Aug. Sept. Oct. Nov.

Dec. *9'5 Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec, mf/% Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec. '9*7 Jan. Feb. March

EXPORTS

IMPORTS

N E T IMPORTS O R EXPORTS ( - ) OF GOLD

n o 156

I30 I4O

206

'95

138 127

246

" 5

268 300 897 295 a 2* 369 269 361

122

301 336 338 359 330

402 4:1 399 475 465 445

510 515

493

516

533

613 468 554

«35 158 l6l 142 158 «43 «43 «5« «49

156 «73 184 «94

214 218 229 346 183

— « 5 — « 9 —44 — 7 — 4

50 «5

61 40 77 57 34 5 — 8 — i

—5 «5

114

164

53 39 86

«79 «77

31

342 200 270

38

83 133

'.853

I,8o8

3.54« 3.732 3.744

1,813

3H«° 3.3 « 9

1,822

5» « 5 °

1,838 1,869

5.535

«.893 1,929 1,986 3,007 2,076 3,134

6,193

3,36o

5»4'3 5.326

8,198

6,369 • .

•

6,336 6,696 6,620

3,313 3,335 3.325 2.323 2,318 3,336 2,445

3,506

3.253 3.242

3.264 3.284 3.3« 7 3.320 3.323 3.4°2 3,455 3.5 «9 3.544 3.589 3.592

3.603 3.613 3.621 3,585 3.649 3,658

...

3,549

3.737 3,832

2,7«4 2,736

3,876

7.556 7.375

2,843

3.877 3.966

...

2,933 3,996

3.989 4,130

7.537

3,«°5

4, «73

6,926

9°

'3«

MONEY IN CIRCULATION

1,807 5.«96

«5

30

MONETARY GOLD STOCK

1,844

6

12 35

«99

205

DEMAND DEPOSITS

2,630

* Source: Exports, grand total in millions of dollars. See Standard Statistical Bulletin, base book Jan. »5, 195*, p. »38. Original source. United States Department of Commerce, Bureau of Foreign and Domestic Commerce. Imports, gTand total in millions of dollars. Source and origin of figures the same as for exports. Net imports or exports (—) of gold into and from the United States, in millions of dollars. See Report of Federal Reserve Board, 19*7, Table to, p. 79. Demand deposits of all member banks, including United States government

82

A CONTEMPORARY TABLE

PROBLEM

III

P R I C E CHANGES IN T H E U N I T E D S T A T E S P R I O R T O T H E DECLARATION O F WAR • W H O L E S A L E P R I C E I N D E X E S F O R G R O U P S OF COMMODITIES 1 9 2 6 = IOO

ANNUAL

FARM

AVER-

PROD-

AGES

UCTS

1914

«915 1916 '9'7 '9'4 March June Sept. Dec. '9'5 March June Sept. Dec. 1916 March June Sept. Dec. '9'7 March June Sept. Dec.

FUEL

HIDES FOODS

AND

TEX-

AND

LEATH-

TILES

LIGHTING

ERS

METAL AND METAL PRODUCTS

BUILD-

CHEM-

ING

ICALS

FUR-

MA-

AND

NISHING

TERIAL

DRUGS

GOODS

71.2 7'-5 84.4

64.7 65-4 75-7 104.5

70-9 75-5 93-4 123.8

54.6 54-1 70.4 98.7

74-3 105.4

I5O.6

52.7 53-5 67.6 88.2

72.1

71.6 71.2

69.O

62.0 62.2 70.2 66.7

69.8 71.1 715 74-3

55-7 55-7 54-6 5°-9

60.4 56-7 54-7 52-1

82.2 79-7 80.4 78.3

53-9 53-o 53-0 50-5

7i-3 70-3 69.2 73-i

65.6 64.0 62.7 68.5

75-6 74-3 75-7 78.0

52.0 53-2 54-7 60.0

49-2 48.2 52.1 62.2

81.8 88.9 86.7 95-5

76.9 78.2 89-5 99-o

70.0 73-0 79-0 85-3

83.1

91-8 93-a '24-5

66.4 72.4 82.5

68.6 68.8 68.8 100.6

113-4 118.0 "5-5 135-2

92.1

127.8

84.7 96.5 106.9 "7-3

108.3 114-5 97-9 101.4

'44-5 166.6 165.6

I29.O

"3-3 134.0 «35-9 141.0

106.6 111.0

114.4

123.1 118.1

122.2

67.1

56.6 5t-8

80.2

86.3

I16.5

130.1

81.4 I 12.0

HOUSE

56.8 56.O

160.7 165.O

61.4 74-2

78.7

56.6

87.2 86.6

56.7

5i-3 53-0 53-3 58.9

93-6 101.7 122.7 149.0

55-4 56.0 56.2 56.7

66.3 67.4

175.8 166.8 143-3 1522

59-« 60.7 62.2 65.0

154-7 160.8 "75-5 179.6

693 72.6 78.4 80.8

68.1

73-9 80.4 94-8 94.6 90.1

78.O

56.6

56.I

• Source: Abstracted from Standard Trade and Securities, base book published by the Standard Statistics Company (Jan., 1932), pp. 220 28. T h e indexes are compiled by the United States Bureau of Labor Statistics. See table, p. 24, for European price changes.

the United States, although the country was at that time technically at peace. These increases may be briefly depicted in Table III, which presents index numbers of prices of the prindeposits and exclusive of due-to-banks, in millions of dollars; as of call dates falling within the specified months. See Report of the Federal Reserve Board, «926, Table 76, pp. 142, 143. Monetary gold stock of the United States; end-of-month figures; in millions of dollars. See Report of the Federal Reserve Board, 1928, Table 26, p. 85. Money in Circulation; end-of-month figures; in millions of dollars. See Report of the Federal Reserve Board, 1928, Table 31, p. 90.

A CONTEMPORARY PROBLEM

83

T A B L E IV

CHANGES IN BANK C R E D I T AND G O L D M O V E M E N T S A F T E R U N I T E D STATES HAD E N T E R E D T H E WORLD WAR •

THE

(In Millions of Dollars)

PERIOD COVERED

'9*7 April May June July

Aug. Sept. Oct. Nov. Dec. ¡918 Jan. Feb. March April May June July

Aug. Sept. Oct. Nov. Dec. •9'9 Jan. Feb. March April May June July

Aug. Sept. Oct. Nov. Dec.

RESERVE BALANCES

743 744 804 1,101 1,141 1.13° >»243 '»439 1,467 1,468 1,466

I.504

1,482 «»512 1,448 '»459 '»507 '»539 '.520 1,586 I»635

1,61a

1.652 1,656 1,686 1,696 1.719 1,740 '.769 '.793 '.837 1,820

BORROWINGS AT FEDERAL RESERVE

25 43 '55 '51 134 181 320 563 683 612 529 537 75« 897 939 1,162 '.333 1,604 1,683 1,760 1,765 «,73« 1,765 1,863 1,920 '.976 1,840 1,864 1,798 1.776 2,068 2,140 2,115

MONEY IN CIRCULATION

MONETARY GOLD STOCK

NET IMPORTS OR EXPORTS ( - ) OF GOLD

7,95° 7,997

4,194 4.256 4,066

I 1,829

3.973 3.980 4.051 4,107 4.252 4.373

3.137 3,133 3,220 3,190 3,165 3,151 3.153 3,154 3.155

15 5 24 —42 —27 —27 — 7 — 4 13

4.136 4.315 4.396 4.434 4,416 4,482 4,564 4,776 5,027 5,'45 5,'95 5,238

3.160 3,162 3.'65 3,l66 3,172 3>l63 3,162 3,l6l 3,153 3,156 3,159 3,l60

4,9'9

3,162 3,165 3,165 3,177 3,177 3,H3 3,064 3,125 3,147 3,103 3.O44 2.994

DEMAND DEPOSITS

12,510 12,275

12,724 '3,781

4,922 •3,593 14,802

16,024 16,7"

4.948 4.943 4.918 4.877 4,870 4,948 5,036 5,127 5,269 5,378

—

i —

3

— 1 — 1 3 29 —5 —2 t

—1 —1

T

—i i 7 5

—i

—57 —53 —43 —28 —39 —49 —33

* Source: Reserve balances of all member banks, in millions of dollars; monthly averages of daily figures. See Report of the Federal Reserve Board, 1928, T a b l e 50, p. 117. Borrowings at the Federal Reserve banks by all member banks; in millions of dollars, monthly averages of daily figures. See Report of the Federal Reserve Board, 1928, T a b l e 51, p. 117. Demand deposits of all member banks, in millions of dollars; including United States government deposits and excluding due-to-banks. As of call dates falling

84

A CONTEMPORARY

PROBLEM

cipal groups of commodities during the earlier of the war years. While the growth of prices in the United States was decisive, it was not of a nature which need have left any doubt as to its cause in the mind of the observer. T h e United States was practically the only large industrial and agricultural area from which supplies could be readily drawn for the warring armies. Both grain and farm products of every kind were shipped, to the full extent of the tonnage then available to carry them; while as the war advanced, it became more and more necessary to place with American factories orders for clothing, munitions, and equipment, in short, for a vast variety of manufactured articles designed for use both by the armies in the field and by the civilian population of the several countries. T h e market was essentially what is ordinarily called a "sellers' market," and, in not a few kinds of commodities, practically any price might be named and find buyers. In these circumstances it is not at all necessary to fall back upon the statistics of gold production or Importation or upon those of bank credit for the years in question, in order to explain the advance of commodity valuations. For convenience of reference the figures showing gold movements and bank-credit changes after the opening of the World War are, however, here recapitulated in T a b l e IV. W A R E X P E R I E N C E OF T H E U N I T E D STATES

T h e entry of the United States into the war occurred at a time when the price level had thus been very materially raised as the result of industrial changes. Contemporaneously, too, demand and consumption were steadily exceeding supply of most inside the months indicated. See Report of the Federal Reserve Board, 1926. T a b l e 76, pp. 142-43. Money in circulation outside of the Treasury and Federal Reserve banks, in millions of dollars; end-of-the-month figures. See Report of the Federal Reserve Board, 1929, T a b l e 30, p. 84. Monetary gold stock of the United States, in millions of dollars; end-of-themonth figures. See Report of the Federal Reserve Board, 1929, T a b l e 26, p. 81. Net imports or exports of gold into and from the United States, by months, in millions of dollars. See Report of the Federal Reserve Board, 1928, T a b l e 30, p. 89. f Less than $500,000.

A CONTEMPORARY PROBLEM

85

of the ordinary products of the farm and of the factory. Bank reserves were high, the Federal Reserve system in particular having on hand gold and lawful money amounting to more than its outstanding liabilities. Soon after the United States entered the war, measures were taken to limit the further advance of prices in certain essential commodities, and these were, from time to time, followed by price-fixing measures applied to large groups of industrial products. In spite of these measures, the price level at the close of 1918 showed an index of about 200, or double that of the year 1913. As a result of this situation, securities in many directions had been forced into a severe reaction. Fixed-rate bonds necessarily suffered. Thus, for example, a $ loo-bond yielding interest of $4 per annum, which had sold before the war at close to par, could not be expected to do other than depreciate at the end of 1918 when its $4 of interest would command only one-half of the commodities or products that it would have bought four years earlier. Such bonds did in fact fall to levels between 70 and 80, while other securities of the same sort suffered likewise. The element in the community which depended for its existence upon its investments and fixed incomes thus had to bear the burden of the advance in prices which had occurred during the war. Labor, especially organized labor, might have suffered in the same way had it not been able with the aid of public men to raise its rates of wages far more than corresponded to the advance in prices. Salaried workers were not so fortunate. They closed the war with a purchasing power but little more than half that with which they entered it, although probably with a considerably larger number of actual incomes, owing to the fact that more members of the average family were employed because of the absence at the front of a large number of men. T h e old question, what the effect of the inflation developments of the war was upon the rank and file of the community, is thus complex. So far as the United States is concerned, because of its peculiar position as a recipient of large orders from foreign countries and of its effort to maintain large working forces operating mills at full speed in producing munitions, at

86

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PROBLEM

the close of the war (with the cost of living still moving steadily upward), a very large element of savings as well as of security ownership had been expropriated. T h e upward movement of prices continued for more than a year after the close of the war, the turning point being reached only in the spring of 1920. T h i s long continuance of inflation was in part due to the desire of industrialists to maintain the profit-making era which had been opened to them by the immense purchases of goods abroad; and it was at their desire that the Treasury Department continued to make advances to foreign countries aggregating $2,500,000,000 subsequent to November 12, 1918, the date of the Armistice. T h e price level continued upward, reaching a level of 250, and with corresponding hardship reflected upon the rank and file of the community. Perhaps these changes were not at the time as much noted as they otherwise would have been, had it not been for the rapid rate at which the inflationary movement had been carried forward during the war. SPEED OF INFLATION DURING THE W A R

It is worth while to note exactly in what particulars and approximately at what rate the inflationary movement had proceeded during the war period. W h e n the United States declared war upon Germany, the Treasury was practically empty, o w i n g to the fact that the then national government had, since its accession to power, been extremely hesitant to do anything that could subject it to the charge of reliance upon b o r r o w i n g in time of peace. W h e n actual hostilities were declared, there was practically no balance of revenue available, and an immediate loan was then obtained from the Federal Reserve banks. T h e unavoidable slowness in imposing new taxation and getting it into working order made practically necessary very large borrowing, and this borrowing was generally placed in the banks of the country, with direct aid from the Reserve banks in carrying the securities. T h u s , during the course of the war, the public debt was increased from less than one billion to approximately 27 billion

A CONTEMPORARY PROBLEM

87

dollars. T h e Reserve banks alone held a total of close to 2 billion dollars of government securities in their own ownership. T h i s was probably an unprecedented record for speed in inflation. Inflation had taken the immediate form of placing in the banks 7 billions of dollars of obligations, constituting a part of the protection of notes and deposits and sight claims, acting as purchasing power, although bonds so placed were nothing more than representatives of a deficit which might be cleared off in the future, but which, pending the new provision for amortizing it, represented merely a theoretical claim upon future earning capacity. At the same time, the demand deposits of the banks had increased from $11,104,027,000 on J u n e 4, 1 9 1 3 , to $21,223,715,000 2 at the end of J u n e , 1918; while the Federal Reserve notes which did not exist prior to the war, amounted at the end of 1 9 1 8 to about 3 billions of dollars. Purchasing power, technically so called, had thus been established, both by way of notes and deposits that had been placed in the banks to represent or protect the latter items at a time when real incomes were not growing but were being greatly curtailed by reason of the destruction of wealth which had taken place throughout the world as a result of the war. T h e immense advances which the United States made during the war in favor of the various Allies, which aggregated more than 1 1 billion dollars net, were represented largely by goods that were shipped from the United States: but these goods, as the future proceeded to show, were largely gifts, and it was in that proportion then true that the inflation of the war period consisted in creating future obligations, many of them used as actual purchase media, while the assets which nominally protected them were worthless. 2 T h e two figures for total demand deposits were computed from the combined balance sheets for all banks in the United States and possessions published by the Comptroller of the Currency. T h e item due-to-banks is included in both cases. T h e 1913 figure covers 25,993 banks as of J u n e 4; the one for igi8 is for 28,880 banks as of J u n e 29. In 1918, over 31/^ billion dollars of unclassified deposits have been included as demand deposits, but at the same time the United States government deposits for that year are given only for national banks. See Annual Report of the Comptroller of the Currency, 1913, p. 38; Ibid., 1918, I, 110, 1 1 1 .

88

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PROBLEM

Current computations seem to indicate that the war period resulted in enlarging the banking and other obligations of the country by a total of not less than $37,169,000,000; 8 while against this vast sum there were held as assets the claims upon the Allies amounting with interest to some 1 billion dollars, later to turn out practically worthless, and the marked-up values which had been established in some phases of wealth, notably in real estate, where failure to continue regular housing construction left the supply of housing at the close of the war entirely inadequate to meet requirements. T h a t these changes could have taken place within the comparatively short period of about eighteen months during which America's participation in the war extended, is a remarkable event in financial history. T h e rapid growth of inflation during the war has often been ascribed to the great quantities of bonds issued by the government and to its almost exclusive dependence upon the banks for current aid. As a matter of fact, the various financial expedients resorted to probably could never have had such results as they had, had it not been for the steady growth of demand for goods and for the fact that our advances to foreign countries took the form largely of goods which were at once shipped to the Allied buyers who needed them for the use of the various armies in the field. Higher prices were directly due to this continuance of a sellers' market and to the ability of American sellers, referred to above, to exact practically any price they saw fit, for goods which it was considered absolutely essential that foreign armies should receive. T h e inflation movement hesitated at the close of the war, and probably would have come to a sharp end, had it not been for the policy of the government, already referred to, which supplied foreign countries with the means to go on buying largely from American producers. Even as it was, an early collapse was foreseen by all careful thinkers on the subject, and it was apparent, from the beginning of ' T h i s figure represents the difference between the estimated total long-term debt for the years ig.3-14 and 1920-21. Clark, Evans, Ed., The Internal Debt of the United States, Macmillan Company, 1933, p. 10.

A C O N T E M P O R A R Y

PROBLEM

89

1919, that steps must be taken, as speedily as possible, to stabilize conditions, and to bring about a rectification in those branches which were being overdone to the great danger of the entire economic organization of the country. CORRECTING INFLATED CONDITIONS

Contemporary conditions in the United States are illustrated and interpreted by the efforts, made immediately after the close of the war, to bring about a correction and curtailment of the situation which had then been produced. It was perceived, at the outset, that a stop must be put to the unreasonable advance of commodity prices, and that effort must be made to restore the banks to a condition in which they could maintain convertibility of their obligations, and could at the same time be expected to eliminate from their portfolios a fair proportion of the long-term assets, particularly government bonds, which they had absorbed during the inflation period. The effort of the Federal Reserve system in bringing this conclusion about was, accordingly, to discourage further rediscounting by member banks with Federal Reserve banks upon paper made with government collateral, establishing a rate of discount which gave the members no inducement to ask for advances or accommodations. T h e attempt was made to induce the banks to sell or dispose of the holdings of government bonds which they directly owned, by endeavoring to transfer them into the hands of the rank and file of investors. Moreover, the policy of the Treasury and of the Reserve system, during the years 1919-20, was directly toward the stimulation of the commercial-paper market, bankers being urged to prefer commercial-paper discounts in place of advances upon government bonds, while the government itself sought, so far as possible, to bring about a funding of its short-term obligations, and hence a transfer of them into the hands of actual individuals who were thought likely to keep them in their safe deposit boxes as a permanent repository of saved funds. T h e struggle against inflation had thus included a change in

90

A CONTEMPORARY

PROBLEM

the fiscal policy of the government, designed to substitute taxation for borrowing, and the placement of these obligations in the hands of individuals rather than with the banks. A change in the credit policy of business, whereby it ceased to buy government bonds to be used as collateral at banks, was recognized as essential. By such a change, business once more sought to create its own commercial paper and to bring it into good standing at the banks to which the business houses looked for support. Moreover a recession in the prices of commodities was one phase of policy which the government had favored and to which it had turned, abandoning the practice of pegging or fixing prices of certain articles for common use. T h e success of these measures appeared from the fact that, by the end of 1920, prices had fallen 50 or 60 points, and banks had simultaneously eliminated a considerable part of the long-term paper of the government from their portfolios, its place being taken by actual commercial borrowing or by government short-term obligations instead of long-term bonds or business notes to which such bonds had served as collateral. It is often asserted that the panic of 1920-21 was a result of these efforts, but it would probably be fairer to say that the panic of 1920-21 had been in the making for a good while, and the efforts at conservatism which we have just described, helped to modify it and to bring about the restoration of a fairly normal condition of affairs sooner than would have been the case, had matters been left to take their course. In fact, the panic of 1920-21 may be regarded as having been nipped in the bud through well-considered action on the part of the banking authorities. T h e y had perceived the character of the danger by which they were faced, in time to take some positive steps designed to head it off, and to interpose and restore a condition of reasonable soundness before the financial structure of the community had become entirely disorganized. BREAKDOWN OF

1929

A n ultimate breakdown of the economic order, as it existed in 1926 and the following years, was inevitable. T h e real ques-

A CONTEMPORARY PROBLEM

91

tion at issue was not how to collect foreign debts and to get more than was at the time actually flowing into the hands of American investors, but it was rather how to prevent additional collapse from occurring and to restrain the tendency of prices to shrink, with corresponding infliction of loss and suffering upon the community at large. It had been evident, for some time before 1929, that at some comparatively early period a reckoning must be expected, owing to the abnormal conditions then existing. Such a period was reached, as it became apparent that further lending to foreign buyers would be merely throwing good money after bad, and as the inability of the foreigners to keep up the payments which they had promised to make came to be a generally more established fact. T h e collapse which occurred in the autumn of 1929 had thus been anticipated by the better-instructed observers, although naturally no one could have foreseen the time when it would be likely to make its appearance. T h e survey which has thus been made enables us, however, to indicate the main particulars in which a change was necessarily to be expected. These may be briefly summarized as follows: 1. Prices which, as we have seen, had been relatively stable from 1926 to 1929, had no natural basis of support which could be expected to keep them materially higher than the level they occupied in 1913. A recession toward the 1 9 1 3 level was thus almost inevitable. 2. Security values, which had been advanced far more than was warranted by changes in earnings or in economic conditions, were likewise seen to be calling for rectification, and a restoration of these levels, eventually, to something like those of the prewar period was accordingly to be expected. 3. In view of the purely artificial basis of borrowing which had been developed in Europe, it was to be expected that European loans would in most, if not all, cases become uncollectible and call for a scaling down or perhaps in some cases a complete cancellation. 4. At the same time and as a result of these fundamental changes, it was apparent that exceptionally high wages of labor,

92

A CONTEMPORARY

PROBLEM

which had been reaching unheard-of amounts during 1928 and 1929 and had therefore tended strongly to cripple and retard the growth of business in specified trades, should be reduced to a plane corresponding to the probability of industry to maintain them. In default of the attainment of these conditions, or most of them, it was the opinion of observers at the time that very serious economic changes must be expected to occur; and these, as is well known, did actually make their appearance from the end of 1929 onward, in recessions of values, in unemployment, business and bank failures, and in generally bad conditions. It is this process of rectification which has been styled the current "depression" and which had by about the close of 1932 given rise to a general readjustment of values and wages. T h i s readjustment has often been termed "deflation,"—an expression which does not coincide with the use of that term which we have, in previous chapters, determined upon. T h e deflation which is often spoken of as having taken place from 1929 onward, was deflation only in the sense that it was a process of restoring some portion of the balance of economic relationship that had existed prior to the inflationary expansion preceding the year 1929. T h e conditions of 1929 are certainly not to be regarded as "normal," nor were those of 1926. As we have seen, a new group in the community had profited and had come to the front as a result of the war, tending, when the struggle was over, to displace those who had previously been in control of business and finance. It was now a question whether this short-lived "ruling" class (in the economic sense) should be allowed to continue indefinitely or should, on the other hand, be expected to submit to the same kind of readjustment to which it had compelled others to assent. As to this latter question, there could be no doubt—there was nothing in the economic basis established after the close of the war and eventually prolonged by artificial means up to 1929, that could be regarded as especially entitled to maintenance. T h e effort to restore the conditions of 1926, which was undertaken in the beginning of 1933 by the Federal administra-

A

CONTEMPORARY

PROBLEM

93

tion, could not, therefore, by any stretch of the imagination, be regarded as a policy which had for its object the replacement of "legitimate" owners, or persons who had an indefeasible claim upon their places in the economic community. GROWTH OF DEBT

T h e r e is one phase of the inflation struggle during the years 1929 to 1934 that deserves some special attention. It has been frequently asserted that one reason for new arrangements all around is to be found in the fact that under the old régime, producers and business men had naturally or intentionally fallen so deeply into debt that it was out of the question for them to meet their obligations. Such obligations, according to some hasty interpretations of the situation, had become so large in 1929 that a national aggregate of them would have shown that the total of such debts was equal to, if not greater than, the net aggregate wealth of the United States. T h i s statement has been repeatedly made, and apparently has the sanction of very highly conspicuous political authorities. It should be noted carefully that no evidence in support of it has been anywhere furnished. T h e survey of debt made by the " T w e n tieth Century F u n d " and published in 1933, states that the total of indebtedness in the United States increased to 134 billion dollars by the end of 1932, as against 75 billions in the depression year 1920-21. 4 All estimates of national wealth or national income are fundamentally defective. T h e y cannot lay claim to any substantial accuracy and must be taken for what they are—that is, little more than mere guesses or approximations as to probable fact, oftentimes doubtless very wide of the mark. Viewed in this way, the figures thus cited are, however, worthy of study; and taken at their face value do not indicate a situation which in any other country would cause serious alarm. T h e inquiry into corporate debt has already shown that, in many cases, leading plants in an industry are hardly, if at all, indebted, the debt figures shown relating largely to small or obsolete institutions * See below, Table V, p. 117.

94

A

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PROBLEM

which have been unable to sustain themselves by reason of the efforts of their managers to meet others on a competitive basis, and which are now largely dependent upon government subsidies, tariff duties, and the like for continuance. In other cases, it would seem that the working of the antitrust laws had been such as to preserve inefficient concerns and to give them a lease of life to which they were not entitled. A l l these facts seem to support the view that the economic position in the United States, in so far as represented by indebtedness, was similar to that which was exhibited in previous times of recession and recovery, and that there was no occasion why it should be regarded as anything more than the ordinary attempt of industrial society to restore itself to equilibrium by eliminating unproductive or inefficient members. T h e violence of the struggle which has been waged during the past three years with reference to this subject, however, seems to show that very strong elements in the community are unwilling to submit to the periodical readjustment which for many years has followed the undertaking of overdeveloped and profitless schemes, and that the attempt to maintain the 1929 (or 1926) level of prices, business, banking, and the like, is an effort for which no good warrant can be afforded—an effort inevitably certain to be defeated because it has no adequate weapons with which to conquer the forces which it must meet. COMBATING THE DEPRESSION

It is thus clear that the efforts to "combat the depression," of which a great deal has been said in the United States during the past two years, are primarily efforts to alter or reverse a course of events which has been a characteristic means of recovery of equilibrium throughout the world. T h e means which have been employed in bringing about such a restoration of equilibrium have been largely those included under the head of "inflation"; or, as already seen, they have been efforts to maintain an unwarranted distribution of property and income which had been brought into existence temporarily as the result of fortuitous circumstances; or else they have been efforts

A

C O N T E M P O R A R Y

P R O B L E M

95

to bring about a redistribution of such property and income in a way to meet the claims and flatter the prejudices, of favored classes w h o have considered themselves entitled to a larger share of the social product than they had been receiving. T h e struggle of 1929 to 1934 in the United States is thus a recrudescence of the controversy about property and ownership which has been threatening from time to time, for many years past, and which presents itself today in an especially pronounced form in the U n i t e d States. T h e United States, however, is by no means the only locale where this controversy is b e i n g gradually f o u g h t out. INFLATION

IN E U R O P E A N

COUNTRIES

T h e W o r l d W a r left practically all European countries with heavy burdens of debt. In the majority of cases this debt was primarily uncollectible, the change not having resulted in enlarging the existing prewar debt d u e from certain groups of citizens to certain other groups. In some cases, however, the prewar debt was itself very considerable so that the situation at the close of the W o r l d W a r was composite in character, the nation being burdened with a heavy external debt at the same time that citizens had serious problems to deal with in adjusting their own domestic indebtedness. In a very few instances, notably in the U n i t e d States, n o foreign debt whatever existed, but the indebtedness was purely domestic—owed by the government to its own citizens or by citizens themselves. Practically at the beginning of the war, most participants, compelled in some cases by necessity and in other cases by an undue fear of loss of gold, had suspended the redemption of bank obligations in that metal and had forbidden the exportation of gold. T h e y thus took a very definite step toward what has already been defined as inflation (see above, Chapter I) by rendering the process of acquisition of the metal in which the standard of value was stated, more remote. T h i s type of inflation was not necessarily accompanied by an enlargement of bank obligations in a degree which w o u l d render their conversion into gold at a future time more difficult,

96

A CONTEMPORARY

PROBLEM

while placing behind such obligations mere government indebtedness which might, or might not, be paid. As, however, the war advanced and the problem of providing for current expenditures grew more and more difficult to solve, the temptation to resort to this phase of inflation—the substitution of government indebtedness for current values—became more and more prevalent. Thus, in practically all of the European countries, the close of the war found a very large body of so-called currency outstanding, such currency being nothing more than irredeemable government obligations. This currency usually assumed one of three forms: (1) in some cases it was the direct obligation of the government itself, usually designated in economic writings as "fiat money"; (2) in other cases the currency outstanding was the obligation of the central bank of the country itself, the notes not even professing to be government obligations, except in so far as the bank itself might be organized as a governmentally owned and operated institution. Occasionally the "backing" behind such notes was the obligation of the government itself which had been sold to, or discounted with, the central bank. These notes differed from those of the first class already described, simply in that they were made by the banks, and not by the government, and thus had a rather different legal status. In economic and financial character they were the same in one case as in the other. (3) In a few countries which were not actually engaged in the war, governments had found themselves with large note issues outstanding which were protected by, or based upon, assets that had become frozen or unliquid as a result of the war, but that had fair prospects of being reconverted into the standard of value upon demand, as soon as the abnormal conditions which were prevalent as a consequence of the war should be relieved. This situation was fairly representative of conditions in Holland and Switzerland. T h e monetary question thus presented itself in varying degrees of severity or insistence as the war drew to a close, and practically presented to all countries the problem of what was to be done in order to bring about a restoration of existing circulating media to a point that would permit business to go

A CONTEMPORARY PROBLEM

97

forward satisfactorily. I t was soon seen that the problem of thus restoring E u r o p e a n currency to a satisfactory basis was practically the problem of finding some international footing for the circulation, a n d reorganizing domestic b a n k i n g and note issues in such a way as to establish a stable relationship for them. It was gradually recognized t h a t two essential elements were involved in this process: (1) T h e creation of a balanced international trade u p o n which t h e nation could count without the danger of being constantly obliged either to ship gold or to obtain accommodation a b r o a d in lieu of it; (2) the establishment of a balanced budget domestically, to the end that the governm e n t need not be constantly obliged to supply its requirements t h r o u g h additional b o r r o w i n g at banks. T h e result of such provisions would be that internal supplies of currency would be protected and no unnecessary d o u b t s cast u p o n current ability to m a i n t a i n the currency at a specified relationship to gold or to other currencies. Recognition of these two necessities a n d effort to provide for t h e m characterized t h e years 1919 to 1925. T h e a t t e m p t to b r i n g a b o u t a stabilized currency a n d a stabilized b u d g e t eventually resulted in t h e adoption by Great Britain of a modified gold s t a n d a r d wherein the Bank of England u n d e r t o o k to supply gold for export to those who should present to it either its own notes or the legal-tender notes issued by the Brititsh g o v e r n m e n t d u r i n g t h e war. T h i s effort resulted, in Germany, in the complete a b a n d o n m e n t of the older currency, and the substitution of a new one with a unit called the "reichsmark" in lieu of the older mark. A year later (1928), it led to the adoption of a new franc equal to slightly m o r e than one-fifth of the old gold franc, and in Italy to the adoption of a lira worth r a t h e r less t h a n one-third of the old lira. France undertook to supply gold to those who might present obligations to the Bank of France, while Italy agreed to maintain a stable relationship between t h e \ i r a a n d the gold currencies which had thus been reinstituted. Similar action was taken by such countries as Belgium, Czecho-Slovakia, a n d others. For the present purpose, the interest in the situation does not lie in the technique a n d detail of w h a t was done, b u t in the presenta-

98

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PROBLEM

tion of a general problem of economic and financial theory, affecting the f u t u r e policies of all countries. T h e existence of fresh price levels, varying widely from those which existed before the war, meant that great changes had taken place as between different groups in the community. A man who was in possession of 1,000 francs in 1913 when a franc would purchase a specified amount of standard commodities, was in a very different position in 1918, when his 1,000 francs would purchase perhaps not more than one-fifth or one-sixth of the goods it would have commanded before the war. An attempt to reestablish the value of the franc (its power to purchase goods) at the prewar level, would have been equivalent to an attempt on the part of the government of France to place all those who had claims to francs in a position practically unimpaired by the effects of the war. It would have been, in other words, an effort to hold a certain class in a community harmless, economically speaking, from the results of the war, while the remainder of the community had to carry the load in a correspondingly increased proportion. T h e n , too, since practically all governments had become enormous borrowers, the restoration of the franc, or of any other monetary unit, to its prewar position would have been equivalent to a transfer of large amounts of wealth without compensation to those who had owned or were the holders of government obligations. For example, by 1928 the government of France had borrowed a given number of billions of francs. At the time, the purchasing power of the franc was, say, onefifth of its prewar capacity. A restoration of the franc ten years after the war to its full prewar level would have been equivalent to a repayment of the bonds, issued at varying rates, at a five-fold value. T h e problem, then, of practically all governments was that of finding a valuation of the currency which would result in the fairest possible redistribution of wealth; or to put the matter in another way, the problem of these different governments was to ascertain what change in the monetary unit would least unfairly effect the distribution of wealth and income. As we have already noted, the discussion of this

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99

problem, greatly affected as it necessarily was by the difficulties following upon the war, resulted in some cases, e.g., in Germany, in a decision completely to expropriate the owners of prewar values, through the entire repudiation of the old currency. In other cases, as in Great Britain, it resulted in the attempt to put back the prewar holders to their old position, by giving them units of purchasing power equal in gold value to what these had been before the war. It may well be questioned whether the latter course of action was calculated to realize equity, in any except a technical sense, owing to the fact that it unavoidably resulted in giving to a certain class in the community very much more purchasing power than had been parted with. It was true, as in all such cases, of course, that the so-called creditor class was by no means permanent. Many, perhaps most of those who had held the obligations of others prior to the war, had been obliged to sell them, or had for reasons of their own determined to do so, so that the "creditor class" existing at the close of the war was by no means identical with that which had existed before the struggle. This fact, after all, was merely an element which tended to mask the real question of ethics involved in the redistribution of property which underlay the problem. Although thus concealed by the many complex factors in the case, it cannot be disputed that the monetary and fiscal problem of Europe at the close of the war was that, as already stated, of determining how to redistribute existing wealth and income as fairly and equitably as practicable. It was a question that might have presented itself without any reference to the currency question. Theoretically, at least, every country might have conducted the war on a basis of taxation, taking over from the owners of property the amounts needed to provide for the common defense and general welfare. In that case, the entire burden of the struggle and of the economic changes growing out of it would have rested upon the owner of realized or "funded" property. In such case, the real problem existing at the close of the war would have been present in exactly as truly

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a measure as was actually the case, although it would not have exhibited itself under the same guise. Any government would still have had before itself the question, whether to attempt to maintain an economy under which, as the result of circumstances, the great strains and stresses growing out of the war had been for the time being borne by a small class in the community, and it would necessarily have asked itself whether this particular class was not entitled to some measure of relief. Again, it might, theoretically, have been the case that the expenditures of the war should be borne by longterm borrowing, without resorting to the aid of the banks in any particular, individuals accepting the bonds of the government in payment of supplies, services and the like, so that, at the close of the struggle, they were the actual proprietors in fee simple of government obligations, while the government itself was in the position of having to tax property owners sufficiently to get the funds with which to pay the interest on these debts. In such a case, again theoretically, it might have been true that the price level would have been disturbed only to the extent that changes in supply and demand had affected it, the alterations growing out of the disturbance of the monetary and banking mechanism being entirely absent. Here, again, the same problem as before would have existed, namely, whether the state could wisely or successfully continue on its existing basis of organization under conditions which placed the economic burden growing out of the war so largely upon a comparatively small group in the population. T h e facts in the case, of course, did not obviously indicate any of these as the chief problem; but instead, raised a banking issue. Inasmuch as the funds needed for the war had been obtained by the issue of socalled currency or by borrowing at banks, succeeded usually by the issue of banknotes which were really another form of smallsized government bond, the immediate question at the close of the war was how best to bring about the rectification and strengthening of the banking system. This problem was rendered more complex by the fact that the processes described

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had been of varying intensity in the different countries, so that the varying elements in the community were finding themselves subjected to pressure and loss in varying degrees, and were consequently showing political restlessness. This situation, moreover, implied an unstable condition, technically speaking, of international trade, growing out of the fact that price levels and exchange rates had been disturbed in varying degrees in the several countries. T h e basic question actually at issue—that of obtaining a satisfactory relationship between economic classes and groups—thus took form technically as a problem of restoring the value of currency units, and of putting them into a position which would make possible a definite reliance upon their value at a level calculated both to permit tolerable existence by the different economic groups in the community, as well as continuance of trade between nations. It was unfortunate that this technical question in many cases was permitted to obscure and displace the real and underlying issue—the problem of a satisfactory and equitable readjustment of wealth ownership. Because of the fact that the question was, however, thus obscured and converted into a technical form, instead of being dealt with on its own merits in the different countries, as a fundamental issue of business and social organization, recovery has come more and more to figure as a banking and currency issue, everywhere taking form as what was called "inflation." Inflation thus in nearly all countries came to be identified with the idea of a settlement of this problem of wealth distribution in such a way as not to increase the load borne at the moment by the rank and file of the community, no matter whether it should justly have been increased or not. In some few countries, indeed, the issue took an extreme form as a demand that the state should go even further than it had during the war by making a still greater inroad upon the prewar rights of those who had previously been known as the owners of property or the managers of business. Thus, as we have seen in Germany, such a discussion eventually resulted in completely cancelling the outstanding body of currency and an entire fresh start—a

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C O N T E M P O R A R Y

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policy which implied the definite expropriation of all prewar holdings of currency values. L A C K OF SUCCESS IN DEALING WITH INFLATION

T h e reduction of the inflation question to the basis which has thus been described, necessarily gives to the issue an artificially simple appearance, and must raise in the mind of the student the question, why the subject could not then be dealt with once and for all, even though the solution might at the time have been considered a highly unjust one. Many questions are thus necessarily dealt with from time to time in all nations, their final disposal creating ill feeling and oftentimes leaving behind permanent political ill will, although the issue may, from a practical standpoint, be considered to have been eliminated. Something of this sort, for example, may be thought of as having occurred in the disposition of the slavery question in the United States. Instead of such a disposal, inflation, so called—meaning the use of the currency and banking systems of the several countries as a means of bringing about a redistribution of wealth and of international trade—has not been successful, as an expedient, in any of the countries in which it has been presented. England, as is well known, found herself forced again to resort to inflation by once more refusing to redeem the obligations of the Bank of England in gold, a decision definitely announced in September, 1931. Germany, a little earlier, thought herself obliged to declare an international moratorium on public debt, followed by similar moratorium on private debt, as well as by internal disturbances which show that the basis established in 1924, as a result of an agreement with foreign countries, was far from being settled or stable. The United States, latest of all, repudiated its gold obligations by the act of June 5, 1933, and has since then reduced the weight of its dollar by a little over 40 per cent of the old face amount of that unit. T h e answer to the question, why the subject could not be adjusted once and for all, is complex. It is, of course, partly

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due to the constant agitation of the question as to whether any private ownership of wealth should be permitted. Having made a beginning at the expropriation of those who had put by savings or established titles to property of various kinds, the nonpropertied element in every community naturally resorts to the same apparent way out of difficulties, upon each successive occasion when the same question is presented, and it comes to treat as a permanent remedy what had first been regarded as a transitory way of readjustment of economic life, subsequent to some serious shock and disturbance to the older order. T h e n too, and perhaps more immediately significant in the history of the past decade, is the fact that the readjustment which is actually made in any given case is so erroneously made as to leave the economic difficulties of a community as great as, or greater than they previously were. Since the whole object of the readjustment has been merely that of bringing about a more tolerable condition of economic relationship, the purpose of the readjustment is lost, if it is unwisely conceived and carried through. In those cases in which the readjustment has been partial and faulty, so that even the original basis which was aimed at by those who initiated the program, disappears or is unfavorably realized, the last state is necessarily worse than the first. In such circumstances, the idea of using the currency and banking mechanism as a means of continuously changing the relationship of socio-economic classes in such a way as to keep them, generally speaking, satisfied with existing economic conditions, naturally emerges. T o it is ordinarily given the designation "currency management" or "managed currency,"—a philosophy which regards the constant manipulation of the value of the circulating medium as a means of redressing the faults, errors or injustices that have appeared in connection with the ownership of property, or, more often, the faults and injustices that have made their appearance in consequence of unfair or erroneous management of business. Inflation, conceived of as the alteration of the value of currency to correct economic injustices, is thus a static idea, while currency management or continuous inflation is the dynamic presentation of successive pol-

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icies of inflation adapted from time to time to what are supposed to be the requirements of varying economic classes. Objection may be made to this statement of the case on the ground that currency management is not necessarily a movement in the direction of higher prices or of transference of values or ownership always in one direction (in favor of the debtor). Currency management, according to such reasoners, must be viewed as an alternation of policies. T h u s shifts and changes that are adverse to the creditor class call for correction quite as urgently as those of an opposite variety. This criticism may be freely admitted, noting, however, that in no known case has there ever been an instance of continuous currency management designed to assist the so-called creditor class, while the entire argument for managed currency is an argument based upon the necessity of relieving debtors measurably of the obligations which they had assumed. Indeed, in current discussion, the term deflation is invariably used as a word of reproach by managed-currency advocates. A survey of current literature makes it plain that currency management, although ordinarily and abstractly a way of manipulating or changing currency values that could and should be employed indifferently for raising or lowering such values, has, in fact, been habitually employed as a policy working in a single direction—that of raising prices and assisting those who have made commitments, to relieve themselves of a part of the burdens which they have found it difficult or impossible to sustain. This characteristic of the currency-management idea is today fully recognized in most European countries, where the actual character of the inflation discussion is now more clearly marked than is the case in the United States. T h e discussion of inflation is thus, in effect, a discussion of currency management, but of currency management with a definite aim or o b j e c t that of relieving members of the community who have assumed fixed obligations from the necessity of complying with them except in so far as circumstances have made it feasible for them to do so. In a certain sense, therefore, currency management may be

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identified with inflation; and the two ideas, as already seen, may be considered embodied in the notion of repudiation, a continuous process of measured debt cancellation, designed for the purpose of satisfying debtors and reconciling them to economic conditions which have subjected them to loss. Analysis of European financial history during the past ten years shows that the inflation issue there presented, has assumed form substantially as just indicated, and suggests that the issue so offered has become chronic or semipermanent—an alternative held out by so-called moderates as a substitute for the immediate socialization or communization of all wealth. In lieu of such socialization or communization—a process which necessarily involves organization for the application and management of the wealth so taken over—inflation or managed currency offers an alternative, that of continuance of partial repudiation, profits as earned being expropriated by change in currency values so calculated as to discriminate against the owner of capital or the producer of wealth. In this aspect, inflation at once assumes a position as a fundamental social problem, and the technique of currency and banking by which it has thus been thrust forward tends to be subordinated to the discussion of the desired results of the management process. T h e assumption is made, almost universally, that the process so described is entirely feasible—that inflation can be made to produce the results indicated, and that there is no reason why currency and banking under supervision should not be a satisfactory and acceptable vehicle for social reform. It is, undoubtedly, for this reason that many minds which dissent from existing methods of wealth distribution have tended to accept uncritically the notion of inflation. They, of course, would not do so unless they believed that, by means of inflation, it may be possible to attain the results to which they have fundamentally committed themselves, and when these results are not obtained they are disposed to place the responsibility upon those who have initiated or conducted the inflationary process, charging them with insufficient enthusiasm or thoroughness and alleging that a more convinced handling of the banking and currency

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A CONTEMPORARY

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mechanism would result in greater changes and a quicker attainment of the objects aimed at by those who wish to see continuous changes in ownership and distribution of property. Of course, this view of the situation really makes the problems of banking technique more significant than ever, since if it be true that the mechanism of money and banking could not be successfully used for the objects described without causing disturbances and difficulties greater and more serious than those which it sought to correct, even the most convinced social reformer will doubtless think it wise to seek a nonbanking method for the attainment of the purposes he has in mind. There is, in fact, no necessary connection between banking and the socialization of wealth. It has been by one of those unfortunate coincidences which are often to be noted in economic history that a desire for wealth redistribution and a condition of affairs which probably necessitated some measure of such redistribution at the close of the war, has been united to a wholly unsuited technique—that of banking and currency manipulation. Experience is showing that the employment of this particular technique necessarily involves serious consequences of its own which were not thought of by those who originally resorted to it. In one sense thus, the discussion of inflation in Europe has become a controversy between those who, without any bias or decision whatever as to the ultimate question of wealth redistribution, do not believe the manipulation of the banking and currency system is the best means to that end, and those who are content to achieve such redistribution. It is entirely possible, as current European discussion shows, for a given individual to unite in his own mind a strong desire for socialization or even for communization of ownership, with a firm belief in the older principles of banking and currency, and a fixed desire for what is called "stable currency" as opposed to "managed money." In the United States, the discussion of inflation has not yet assumed a position that is so clear cut or definite as has been attained in European countries. T h e controversy is still based in large measure upon nonessentials or

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107

incidentals, the assertion being frequently heard that "stability of currency value" is to be attained through inflation or money management, since such management is conceived of as merely offsetting the "natural" tendency of the gold standard to discriminate against the debtor. Advocates of what is called "sound money" continue to assume that a stable standard of value is always and everywhere to be desired, and that its stability may be conceived of as absolute rather than relative. They also continue to take it for granted that occasional acts of inflation or deflation will "correct" unsatisfactory economic relationships and will "set things straight," rendering possible a "return to a gold standard" until the time arrives when further devaluation is called for. Many other theories of similar character, inconsistent with themselves and with the general principles of economic life as known and admitted, must likewise be recognized as important elements in the discussion. It is now worth while to examine in some detail the process by which the idea of inflation has made its appearance in its present form in the United States.

VI I N F L A T I O N IN T H E U N I T E D

STATES1

WHILE, as just seen in Chapter V, the appearance of inflation as an issue of major importance is a war and postwar phenomenon in the world, the inflation question in simpler and less settled form has long been a factor in American economic thinking. Indeed, it must be recognized as having been, sporadically at least, an important political issue for fully two generations. It would be entirely feasible to carry the intellectual history of inflation back to the earlier days of American economic thought, and to establish a fairly continuous genealogy of inflation from the early constitutional period down to the present. T h i s early appearance of the idea that distribution of wealth should in some way be controlled, or its inequalities corrected, by manipulation of the mechanism of exchange, is characteristic of most new countries where there is no final or established economic classification. T h e economic history of all new countries is necessarily semispeculative. Neither land nor security values can then, usually, be regarded as in any sense established, and time is required for the working out of different groups of interests which are concerned to maintain existing economic arrangements. T h e conception of inflation as a way of correcting wealth distribution is easily traced in the discussions of the First and Second Banks of the United States, as well as during the interludes of state banking by which the history of these two institutions was preceded. It was least active, although still apparent, during the two decades after the closing of the Second Bank of the United States, and it finds definite exemplification and definition in the writings of many early American economists. 1 By H. Parker Willis.

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CIVIL W A R INFLATION

T h e changes in wealth ownership and distribution which necessarily accompanied the Civil War were more profound than any that had preceded that struggle. T h e abolition of slavery itself brought with it a complete transformation of the industrial economy of the southern states; and the process of opening the western lands, which immediately succeeded the war and was accompanied by the making of large new commitments in the form of mortgages on land, the issue of railroad securities, and the creation of local bonded obligations, led in many cases to the contraction of indebtedness which, later circumstances showed, was not warranted by possible profits— certainly not in any earlier period. Rapid shifts from affluence or comparative comfort, to poverty, and the converse transference from a practically nonpropertied condition to an enjoyment of large ownership, were characteristic elements in American development during the generation which began with the Civil War. T h e war itself, with its resort to fiat money, its depreciation of the dollar to a level at one time a little more than one-third of its old gold value, and its issue of what was for those days an enormous body of government bonds, amounting to about three billions of dollars—many of them sold at a time when the proceeds were only a fraction of their face value measured in gold—would itself have given rise to an inflation problem of no mean importance. It was this question that came promptly to the front in 1868, taking form as a demand for a continuance of the depreciated war currency. It continued to be urgent during the succeeding decade, manifesting itself in the discussion of proposed silver coinage, and of continued suggested measures of repudiation of the government debt. It was aggravated by the sufferings arising from the panic of 1873 and the tremendous losses and depreciation of values which ensued. T h e fact that a complete restoration of the gold value of the currency occurred in 1879; and that, without any other repudiation of indebtedness than that which was necessarily involved in a

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great number of bankruptcies, failures, and receiverships, the nation proceeded to reorganize itself upon its former gold currency basis, must be regarded as due fundamentally to the fact that outstanding obligations, instead of being, as then supposed, a very large fraction of the wealth of the community, were in fact only a very small portion of it. Thus it shortly appeared that the inconvenience and loss involved in unstable currency, depreciation of values or repudiation of public debt, would be far too high a price to pay as a means of attaining the supposed changes of reorganization and readjustment thought likely to follow from the free coinage of silver or the restoration of an irredeemable currency upon a permanent basis. THE

R E A D J U S T M E N T OF L A N D

VALUES

Perhaps the most striking economic change that took place in the United States during the nineteenth century was the settling of the Middle West and the western lands, and the carrying of railway lines completely through from coast to coast, with the economic rearrangements and relocation of industries that necessarily accompanied the process. This process had been well started before the Civil War, throughout what is now called the Middle West. T h e post-Civil War period had seen the settling of the Prairie States, and then the extension of the boundary farther west until it reached the Pacific. In the process of this western exploitation, wealth had been accumulated, and a strong landed interest established. However, as is always true in such cases, many mistakes had been made and much wealth had been sunk or lost in uneconomic projects or in the attempt to establish settlements and industries at points which (as circumstances later showed) were not well adapted to the plans in hand. The results of these mistakes necessarily tended to become more apparent from 1879 onward when, with a settled currency redeemable in gold and affording far less fluctuation of prices and few sudden shifts in land values, the actual economic worth of the landed wealth of western farmers was beginning to be definitely established. Some of the economic changes which had transformed condi-

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111

tions in the United States had likewise operated in their own way, in other parts of the world, to alter the balance of production and to bring about an increasing output of raw materials. T h e tendency of the output of western farms to deteriorate in gold price during the last quarter of the century was part of a general world movement, evidencing the larger productiveness of the soil in all regions of the world, per unit of capital supplied, and, of course, entailing severe hardships on those who had shown bad judgment in locating themselves or had invested their capital upon marginal lands or in the exploitation of natural resources which were on the border of profitableness. The result of this situation was a steady growth during the decade from 1880 to 1890, of hardship and difficulty, especially among the farm population. It represented the realization of mistakes that had been committed in the development process. During the first half of the decade this condition of affairs was far less evident than was the case during the second five years of the period. It was impossible, however, not to recognize from 1885 onward, that a very considerable amount of readjustment must take place and that someone would have to bear the losses thus definitely incurred during the development period. T h e issue naturally showed itself in increasing difficulty on the part of farmers to meet the interest and amortization installment payments upon mortgages which they had made. One result, as during the preceding decade, was an outcry for some means of relief to be attained by changing the worth of the circulating medium, and so relieving the "debtor class" of part of the burden which it had acquired through its speculative investments of funds and its own labor in the opening up of western territory. T h e outcry took form as a call on this occasion for devaluation, rather than for direct inflation of the banking type, such as had been contemplated during the preceding decade. This devaluation itself assumed tangible shape as a call for the free coinage of silver, a demand which sought and found its basis for justification in the alleged wrong done by public officials or by Congress, or both, in the omission of silver from the list of standard coins in 1873.

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This aspect of the inflation or devaluation movement must be regarded as largely a fortuitous American phase of the proposal. Perhaps it would never have assumed such significance if it had not been that the United States as a large producer of silver had at that time a highly organized and highly concentrated "special interest," which sought its own profit, to be attained in providing a larger field of demand for that metal. It is not necessary here to inquire into the occasional methods employed by silver-mine owners in their endeavor to bring about the admission of their product to the mints upon a basis of relationship to gold which corresponded generally to that established twenty years earlier. T h e fact that they were thus highly organized and were able to obtain the expression of a popular movement in terms of their own interest, must be thought of as accidental. T h e phase of the American situation which definitely classified it as a world phenomenon entitling it to be treated as an element in a general movement of international proportions, was the underlying feeling of grievance on the part of a very large group in the community, due to the fact that it had failed in its effort to attain a larger measure of wealth and now ascribed that failure to a fault in the currency, or to an element of injustice in the monetary system which presumably had been so constructed or framed as to discriminate in behalf of those who had put their funds into the form of securities rather than of land ownership. It was to this fortuitous element, brought about through the growing influence and political importance of silver as an industrial product, that we must also ascribe certain of the immediate factors leading to the panic of 1893. T h e silver cause and the recognition it obtained in the silver-purchase act of 1890 had undoubtedly frightened many European investors, with the result that they were disposed to withdraw their capital from the United States in the fear that their obligations might be repaid in "dollars" consisting of a metal of lower value—silver—than that in which they had expected them to be settled. T h i s withdrawal of capital during the years from 1890 to 1900 necessarily aggravated the difficulties which were

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113

already fairly severe, by leading to an exportation of metal from the United States which took the form eventually of gold shipments. T h e movement of capital to other countries thus initiated, had no necessary connection with the unprofitableness of agricultural industry, and in the popular mind the episode speedily assumed shape as a phase of a campaign for "sound money," rather than as an incident in the continuous effort to bring about an equitable business and wealth distribution. Adjustment, or temporary suspension, of the controversy was aided by an improvement in business and in agricultural conditions which had nothing to do with the currency or banking situation, and which gradually broadened into the relatively prosperous early years of the new century. It should be recognized, however, that the so-called silver movement or demand for the devaluation of the currency by about 50 per cent, which had been defeated in the presidential campaign of 1896, had never been actually driven out of the minds of a very large element of the population, as was plain from its reappearance during the presidential campaigns of 1900, 1904, and 1908. In fact, the future historian of political thought in the United States must recognize the existence of a strong inflationary current of thought, this time taking shape as a demand for devaluation of a drastic type, and definitely recognizable during the twenty years following the year 1888. A reading of the political literature of the time shows convincingly the steady development of the inflation conception away from anything connected with the so-called silver movement and into a much broader form, which assumed the duty of the state to rectify the incidence of economic blunders, through an alteration of prices and values which, it was taken for granted, could be accomplished through an alteration of the basis of the circulating medium. The panic of 1907-8 would unquestionably have brought on a decisive revival of this inflation or devaluation demand, had it not been temporarily diverted from its older channel through the general admission of the view that the mechanism of exchange was fundamentally defective, and that

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this defectiveness could and should be cured, by an alteration of the basis of banking. T h e campaign of 1908, in other words, far from witnessing a defeat or destruction of the inflation discussion, simply altered its form and transferred it to new ground by substituting a broader form of it. It now took shape as a discussion of bank currency and bank technique. Underlying this discussion, however, was the constant assumption, later to take tangible form in the so-called "money trust investigation" of 1 9 1 1 - 1 2 , that there was an underlying economic injustice in wealth distribution which could and should be cured by an alteration of the credit and banking system. It is a remarkable fact in American politics that, notwithstanding the definite recognition of this element of political unrest, the party then in control of national affairs was able during the years from 1909 to 1912 inclusive, to prevent the discussion from coming definitely to a head. Plans then formulated for banking reorganization and the constant and apparently sincere promises frequently made by politicians of all parties that they would supply an "elastic currency" which would overcome all criticism and objections and would rectify every kind of injustice growing out of the maldistribution of wealth, unquestionably played a large part in retarding the growth of adverse public opinion and in preventing the inflation movement from coming to a positive head. In 1912, demand for some action calculated to relieve the unquestionably unsatisfactory banking situation, and at the same time presumably to afford more equitable access on the part of the United States to the use of credit and bank funds, was too strong to be resisted, and the election of President Woodrow Wilson to the office of chief executive was obviously in no small part dictated by the belief that his administration would undertake to apply long-promised remedies to a situation that was regarded as having become chronic in its failure to ameliorate the situation of the producer.

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T H E W A R AND INFLATION

It w o u l d be a difficult matter to estimate fully and wholly the effect of the W o r l d W a r u p o n the inflation movement in the U n i t e d States. T h a t it was undoubtedly the greatest single factor in the development of o p i n i o n on that subject, both politically and economically, is obvious. It is not yet possible, probably, to state with complete positiveness the exact character of the influence it exerted. Some of the major directions of its influence may, however, be confidently pointed out. O u r entry into the war, at first sight seemed likely to lay the whole currency and b a n k i n g situation on the shelf. T h e Federal Reserve Act had been adopted prior to our entry into the war, and was unquestionably intended as an answer to the complaints which had come from the farmer and from other classes in the community which regarded themselves as overburdened as a result of economic misfortune. W h e t h e r the administration of the new act w o u l d have been regarded as fulfilling these expectations, had the country continued its peaceful development, may well be questioned. T h e r e are many reasons for doubting whether anything of the kind could have been expected. Indeed, it is quite likely that a further development of the inflation psychology, and a demand for fresh concessions to it, would have been a feature of the years after 1913, had no European war been declared. Equitable and liberal administration of the Reserve banks might, perhaps, have mitigated the dissatisfaction with the administration of the banking system, and so have brought about a more rational attitude on the part of the farmer and producer toward the currency structure than that which actually prevailed. W h e t h e r it would have done so or not is a matter of conjecture, the fact b e i n g that, before the new system of b a n k i n g could be inaugurated, war had been declared, with the reflex effect in the U n i t e d States of a suspension of specie payment and application of the usual remedy—a large issue of irredeemable notes based u p o n n o n l i q u i d security. Outside danger and the obvious presence of disorganizing factors within the nation's economy, naturally led to temporary

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suspension of technical discussions; and before definite readjustment of conditions could take place the advent of tremendous European demands for commodities made itself felt in the United States, with the result of sharply rising prices and a throwing off of handicaps supposedly due to inability to settle debts. A temporary lull or suspension of the continuous current of demand for wealth redistribution through inflation methods was thus attained. How the war and the policies immediately after it led, in the United States, to a condition which became part of a general world state of affairs, with the reappearance of inflation psychology in all countries, has been already set forth in a preceding chapter (Chapter V). It remains at this point only to sketch briefly the special phases of the inflation situation which may be regarded as peculiarly important in the contemporary life of the United States. THE

PROBLEM

OF INTERNAL

DEBT

Under such conditions the problem of internal debt is that which has been most mentioned and of late years more particularly emphasized. As we have seen, the war itself was productive of a wholly unprecedented volume of debt, imposing upon the government of the United States the tremendous burden of interest on 26 billion dollars, while the same government acquired an unheard-of claim, amounting to close to 12 billion dollars, against the countries to which it had been allied in the war. T h e f u n d i n g and collection of this vast sum internationally, and the amortization and settlement of its own enormous domestic debt, was recognized by American financiers and public men from the close of the war onward as a problem of preponderating importance. They, however, did not view the situation in anything more than a purely parochial way, as is seen from the fact that without even a suggestion to the contrary, they permitted, and at times encouraged, the building u p of a domestic indebtedness vastly in excess of the international. Exactly how great a domestic indebtedness developed f r o m the beginning of 1918 on to the present time, will probably long be a subject of controversy; and the detailed investigation of it

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will continue to deserve m u c h more attention than it has thus far had. For the present purpose, however, the most available study of what has been done in this connection is the analysis of the volume and distribution, by groups of industries, of existing domestic debt, which has been made by the T w e n t i e t h Century Fund in a work entitled The Internal Debts of the United TABLE

v

AMOUNT AND PERCENTAGE DISTRIBUTION OF LONG-TERM DEBTS BY CLASS A N D YEAR • (In Millions of Dollars) CLASSES OF DEBT

Farm Mortgage Urban Mortgage Railroad Public Utility Industrial Financial Federal State and Local

'9'3'4

3.320 5.15' 11,186

192021

'9*9

9.469

7,858 8,968 13,216

27,616 14,065

5.249

9,251

(Percentages of Total) '93233

'9'3'4

8,500

9-'

14.1

27,554

4,820 6,740

10,170

14,264 11,225 10,450

19,767

21,919

4.75'

15.965 9.420

12,155 «6,556

18,685

9.0 10.3 11.1 2.1 13.6

Total Reported

36,448

72,236

"9,049

126,834

100.0

Total Estimated

37.989

75,158

'26,433

134,280

3.294 3.738

4,040 968

• S o u r c e : C l a r k , E v a n s , E d . , The

Internal

30-7

'4,237

Debts

of

the

192021 10.9 12.4 18.3

7-3

6.7

9-3

22.1 13.0

100.0

United

'929 8.0 23.2 11.8 7.8

8-5

16.6 10.2

193233 6.7 21.7

"•3

8.9 8.2

'7-3

'3-9

11.2 14.7

100.0

100.0

States

(Mac-

millan Company, 1933), p. 10. Owing to omissions in debt statistics, some of the figures represent the nearest year available; the exact nature of each figure and the method of arriving at the total estimated debt are discussed in detail in the original source indicated above.

States. As shown by this volume, the distribution of such debts and their growth d u r i n g the twelve years from 1921 to 1933 is presented in T a b l e V. A l t h o u g h the growth of this vast volume of debt had been recognized, it had not, as we have just noted, received any official attention, much less aroused any official antagonism. Indeed, it appeared to be regarded for many years as an evidence of prosperity or activity, and was often so spoken of. It of course implied that those enterprises and individuals that had incurred the debt expected to be able to continue the acquisi-

118

INFLATION

IN T H E U N I T E D

STATES

tion of income in a proportion substantially similar, or at all events sufficient to enable them to meet the obligations which they had thus created, or to cancel the interest thereon with at least a moderate provision for amortization of principal. It has been a singular phase of the situation that only the least important segment of this great group of indebtedness—namely, that outstanding against the farms of the country and amounting in the aggregate in 1932 to a little less than 9 billion dollars—had received for a good while any particular attention, or appeared to afford a background for devaluation. T h e burden of debt was, in fact, hardly felt as a direct load upon the community, until severe shrinkage in the prices of commodities began to make its appearance. T h i s shrinkage had, of course, started tentatively during the early years after the close of the World War, but had been arrested during the period immediately preceding the collapse of 1929 through unwise extensions of credit and efforts to peg the prices of specified commodities such as copper, and other nonferrous metals, rubber, coffee, sugar, and many others. Such efforts are always unsuccessful, and a definite downward drive in prices, which set in soon after the panic of 1929, was merely the actual reflection of the accumulated results of preceding years of maladjusted production and overexpansion of credit. T h i s sharp reduction of prices, however, called attention keenly to the difficulty of maintaining a fixed burden of obligations, represented by the interest on a great volume of bonds beside mortgages and other evidences of indebtedness. Accordingly, we must think of the socalled prosperity of the decade, 1919-29, with the hasty commitments in enterprises of various sorts which then occurred, as a directly motivating factor in the revival of the inflation psychology of previous years. T h a t the debt actually incurred was not, as a matter of fact, an exceptionally heavy one either in terms of principal or interest, when contrasted with the income and wealth of the people of the United States, is an important fact, but not one which was likely to figure very significantly in determining immediate political alignments and developments.

I N F L A T I O N IN T H E U N I T E D S T A T E S BANKING

119

DIFFICULTIES

Scarcely second in importance to the debt situation as a motivating factor leading to revival of the inflation demand, was the disastrous record of bank embarrassments and difficulties which was characteristic of the decade after the war. With rising prices and an exceptionally easy supervision of banking during the war years, it was easy enough for American institutions to present a nonfailure record; b u t upon the postwar withdrawal of government guarantees of credits, and followed closely by the readjustment of demand and the cessation of enormous government orders that had been the backbone of many an enterprise, banks began to find the utmost difficulty in meeting their obligations. This situation was particularly obvious in the United States on account of its widely scattered, highly industrialized, poorly supervised banking system. Serious failures, accordingly, began to make themselves felt almost with the conclusion of hostilities, and they continued at an accelerating pace u p to the panic of 1929. T h e collapse of 1929 gave the signal for much more serious embarrassment, owing to the impossibility of overcoming blunders already committed in estimating the worth of commodities and property. T h e result of the situation is the wellknown record of bank failures in the United States, comprising some 12,000 institutions u p to the beginning of 1933, while during the years 1933-34 a further reduction in the number of institutions by probably about 2,830 occurred. T h e outcome was the lessening of the total n u m b e r of American banks from perhaps a maximum of 31,000 in 1921 to about 15,000 at the end of 1934. In addition to the numerous failures already referred to, amalgamations and withdrawals from business still further reduced the n u m b e r of active institutions. T h e precise social and economic significance of this great transformation of American banking has never been precisely understood or represented. It will require much more study of its implications and effects to make perfectly clear its ultimate consequences. However, it is obvious that this vast number of

120

I N F L A T I O N IN T H E U N I T E D S T A T E S

bank failures had two serious effects from the standpoint of the inflation movement: (1) it deprived debtors all over the country of the cash balances upon which they had relied to meet their obligations; (2) it reduced the available credit machinery upon which such debtors could rely for the further accommodation they needed in carrying their obligations and maintaining themselves in a going condition. In both ways, the bank-failure movement was a powerful stimulus to the general group of ideas which must be classified under the head of inflation, and which from 1932 onward had begun to take form as a definite request for repudiation of obligations and for a realignment of ownership by other methods. Bank failures thus must be considered as directly and largely contributory to the renewal of a call for some method of reorganizing business and wealth ownership which would relieve existing debtors of at least a part of their burdens, and would, if possible, also provide a continuous means for enabling them to evade the economic mistakes which in the past had subjected them to losses and embarrassment. FAULTY

GOVERNMENT

FINANCE

It has been observed that, in all countries, particularly since the close of the World War, a very close connection existed between the inflation movement and faulty technique or method in government fiscal management. Shortage of revenue, resulting in a deficit, compels governments to supply tiieir needs either through direct borrowing or from additional taxation, and since the latter method cannot be instantly relied upon, the former is the one which must habitually be employed. Reliance upon borrowing, in such circumstances, is, almost invariably and unavoidably, a reliance upon bank borrowing. When funds are obtained at the bank in this way, the result is usually a corresponding decrease in the liquidity of the bank; that is to say, in its ability to meet its obligations promptly in the standard money of the country. As the banks become overburdened with government obligations, they become less and less able to redeem them. Faulty

INFLATION

IN T H E U N I T E D STATES

121

government finance thus, first of all, tends to promote bank failures and to curtail the available supply of credit which can be relied upon by private borrowers. In addition it must be remembered that, in times of depression or panic, there is an invariable call for government assistance to private business or for the extension of credit to individuals who are hard-pressed, with the result that a general psychology is produced in favor of the artificial loans based upon what is conceived as public necessity or expediency, rather than upon the prudent needs of business or trade. T h u s , for example, in the United States after 1929, when deficits began to be experienced by the United States Treasury owing to the great shrinkage of the income tax, resort was at once had to the banks for the means with which to meet government obligations. T h e effect of such borrowing was to produce a constant demand for further assumption of liability for unsuccessful enterprise on the part of the public. T h i s call for aid became articulate under the Hoover administration, in the organization of the Reconstruction Finance Corporation. T h e Corporation, however, was only one of various expedients demanded and supported by a widespread public opinion, looking in the direction of saddling the results of unsuccessful enterprise upon the public Treasury. That form of inflation, therefore, speedily became a prevailing philosophy with many persons who held that the unsuccessful outcome of business, and especially of business enterprises conducted by farmers and by other such supposedly depressed classes, should be assumed by the public. In the new administration which opened in March, 1933, this phase of inflation speedily became an accepted political philosophy. T h e larger part of American public finance is today devoted to the raising of money upon public credit—eventually, presumably, to be repaid out of taxation, the proceeds therefrom to be devoted to the carrying of unprofitable enterprises or the payment of subsidies to their owners by way of compensation for losses incurred by those engaged in such enterprises. Largely through these three major factors, but influenced by a multitude of auxiliary considerations, the inflation movement

122

I N F L A T I O N IN T H E U N I T E D

STATES

of the United States has assumed its present commanding importance, and has developed its apparent power to initiate a system of more or less extensive redistribution of ownership. DIRECTION

TAKEN

BY

INFLATION

It is now necessary to note with some care the actual direction taken by inflation in the United States. Thus far nothing has been said of the theory of the relationship between inflation and prices; and discussion of that subject is for the moment postponed. Preliminary to it, there is need for explanation of the precise manifestations of inflation. This leads to discussion of the much controverted question: what are the symptoms or indications of an inflationary condition of affairs? As to this, there has been much unnecessary discussion. As follows from the definition of inflation already given in the foregoing pages, monetary inflation may be either a change in the standard of value, or a change in the conditions under which possession may be obtained of the number of units of the standard, payment of which has been promised. There may conceivably, therefore, be inflation through a change in the standard of value without any immediate alteration in any other phase of economic relationship. T h i s would be true in most cases where a change occurs in such a standard of value, notwithstanding that the country is practically without banking facilities. Ordinarily, the greater part of all immediate obligations takes form as bank deposits, which are backed by notes, drafts, bills of exchange, and other short-term undertakings, or by long-term bonds and other obligations which have been bought for investment portfolios. If a change occurs in the standard of value, e.g., through reduction of the weight of the monetary unit, the net effect of it is to increase the number of dollars or units represented by the stock of gold of the country. Where there is no stock of gold, the effect of inflation may be to enlarge the underlying number of units of paper currency, provided that such currency is theoretically the representative of a specified gold unit. Incident to any such change, there lias usually been a growth in the total

I N F L A T I O N IN T H E U N I T E D S T A T E S

123

outstanding obligations of the bank, as compared with the total available number of units of gold or other legal tender money available for their redemption. Customarily, therefore, a condition of inflation is characterized eventually by a large increase in the obligations of the banks, not accompanied by a corresponding increase in liquidity or redeemability. If at any given time there has been no overt change in the weight of the monetary unit and no resort to arbitrary issues of fiat money, an inflated condition is indicated by the increase of irredeemable or long-term assets in the portfolio of the bank. T o sum up then, inflation may be reflected in bank assets, either through relative reduction of redemption power through a declining reserve ratio, or, what is the same thing, an increase in the length of life of the assets held by the bank in its portfolio. Tested in either of these ways, the steady advance of inflation in the banking system of the United States may be noted in Table VI, showing a comparison of the banking position existing in 1919 with that existing in 1932. Another mark of inflation to which a great deal of attention is ordinarily given is an increase of commodity prices. Almost all popular expositors of inflation represent it as being substantially identical with advance in commodity prices, and the expectation of such advance is not infrequently stated as a good argument in favor of the adoption of an inflation policy. As we shall later see, an immediate movement of prices is not necessarily a concomitant of inflation, but at this point it is especially worthy of note that an advance in prices, even when it does occur, may be either absolute or relative. That is to say, it may be an absolute increase from some designated level, or it may be a failure to fall from that level as would have been the case had it not been for artificial manipulation designed to maintain the price level. An examination of the price level of the United States from the close of the war to the end of the year 1932 shows, of course, a decided decline from the high figures existing just after the struggle. T h e highest point in our price level was approximately 250 with 1 9 1 3 taken as a base, and this figure was

124

I N F L A T I O N IN T H E U N I T E D S T A T E S

reached early in 1920. A sharp decline d u r i n g the two years f o l l o w i n g carried the level to about 135, while the subsequent advance carried it again to 160 at about the beginning of 1925. TABLE CHANGES

IN THE

COMPOSITION

VI O F ASSETS O F ALL

B A N K S , 1919 T O

NATIONAL

1932 •

( A s of J u n e 30 of E a c h Y e a r ; i n M i l l i o n s o f D o l l a r s ) LOANS ON SECURITIES

UNITED

TOTAL

REAL

STATES BONDS HELD

INVEST-

ESTATE

Gh

YEAR

0

g S O

%

«919 1920 1921 1922 '923 •924 "925 1926 1927 1928 '929 1930 »93' "932

LOANS ON

3.438 3,"8 2,699 2,907 2,983 3>io5 3,661 4.037 4.439 5."4 5>"4Î 5,626 4.663 3.379

e

g f w 0 u -1 « J H J 8. •
Z " a z
934), T a b l e s 121, 126, 128, 131. f T o t a l i n v e s t m e n t assets i n c l u d e t o t a l i n v e s t m e n t s , l o a n s o n s e c u r i t i e s a n d loans on real estate. J Loans on securities m a d e to b a n k s a n d trust companies not included.

Substantially, this same level was maintained until the middle of 1929, when a decline set in which with some interruption brought the wholesale price index down at the end of 1932 fairly close to the level established in 1913—a change of base to 1926 in the index showed a figure at the end of 1932 of 60, and a still subsequent increase of about twelve points occurred during the year 1933. A t the end of 1933 the price level was 73 per

I N F L A T I O N IN T H E U N I T E D S T A T E S

125

cent of what it was in 1926 and about 115 per cent of the figures of 1913. A study of the intervening postwar years throws light upon this checkered history. It was a period during which the general trend of prices should have been downward because of the increasing power of production and the tendency of goods to exceed in supply the current or prevalent demand for them at prevailing levels of prices. T o p u t this in another way, the output of goods due to decline in cost of production, was constantly becoming larger than could be absorbed at existing levels of prices, with the result that a constant tendency toward the establishment of lower levels in order to take the supply off the market and prevent an accumulation or congestion, was characteristic of the period. In order to check this downward drift, many expedients were resorted to. Very high tariff duties were imposed, the acts of 1922 and 1930 carrying the level of duties u p to an unprecedented point for the United States. An enormous n u m b e r of price-fixing arrangements and agreements were entered into. It has been authoritatively estimated that not less than 400 pricefixing organizations existed in the United States at the close of President Hoover's administration, all having more or less influence in regulating from time to time the prices of various commodities in general use. T h e existence of extraordinarily lax conditions of credit-granting at abnormally low rates of discount, while they did not cause an increase of prices, provided the means whereby other price-raising or price-holding factors could operate. In the case of copper, for example, an excellent illustration of this state of affairs is afforded. Ingot copper was for a long time held at around 18 cents per pound, largely through extensions of credit made by the banks which permitted such borrowing to be employed in purchasing and holding the surplus o u t p u t of copper, thereby keeping it off the market and for the time being enabling the maintenance of an unwarrantedly high price. We may thus say, with confidence, that throughout the whole of the postwar period prices reflected the influence of various artificial methods of maintenance or, in

126

I N F L A T I O N IN T H E U N I T E D

STATES

other words, that they were largely inflated, i.e., kept at levels which were not warranted by conditions of demand and supply as then established. In another way evidence of inflation was likewise to be observed. Levels of securities values are always cited as among the essential elements for study in connection with inflation. TABLE

VII

INVESTMENT EXPERIENCE OF THE HOLDERS OF COMMON STOCK OUTSTANDING ON J A N U A R Y 1, 1922 » C A P I T A L V A L U E IN

RELATIVE

C A S H R E C E I P T S IN

YEAR

l8 72 INALL DUSTRIAL PUBLIC CORPOUTILICORPORATIONS TIES RATIONS

1922 1923 '924 '925 1926 «927 1928 '929

Avg. Annual Rate of Change (per cent) • Source:

IOO 122 120

19« 252 335

IOO 125 123 '52 >97 208 287 402

+ 18.8

+22.4

I«

183

Mills,

Frederick

IOO I16 " 7 >31 •55 164 203

RELATIVE

NUMBERSf

NUMBERS

12 RAILROADS

IOO 121 I 12

138 166 .67

72 IN ALL DUSTRIAL CORPOCORPORATIONS RATIONS

IOO 87

IOO IO7

83 121 99

292

395

166 .89

II? 129 163 177 182

+ 10.5

+8.8

IOO

I I I

126

134 125 ISS

137 1 53 •95 25'

I16

194

255

216

229 286

+ 14.1

+ 11-5

+ I6-5

+21.8

Tendencies

in

C „ Economic

12 RAILROADS

IOO

188

18 PUBLIC UTILITIES

the

United

I48

States,

National Bureau of Economic Research, 1932. See Tables 197, 198, 199, and 200, pp. 4g6-gg; Table 202, p. 502. •(• Dividends plus cash value of rights. During the same period the cash receipts of bondholders rose from 100 in 1922 to only 101 in 1929, with an average annual rate of change of -)- 0.1 per cent.

Accepting such levels as a guide, we may glance in passing at the indexes of securities prices existing during the postwar period in the United States, as presented in Table V I I . From these figures it is clear that the prices of securities advanced in a marked way between 1919 and 1929, and that such advances were developed generally, in all classes of securities, notwithstanding that bonds and stocks are ordinarily thought of as influenced in value by different groups of factors.

I N F L A T I O N IN T H E U N I T E D S T A T E S

127

T h e high prices charged and obtained for securities during these years were broadly the result of the very low rates for money which enabled persons readily to borrow, and hence to obtain the funds necessary to buy stocks and bonds. They were also the outcome of apparently good industrial earnings obtained by enterprises whose stocks were listed upon the exchanges, but which had not made the necessary allowances for loss, shrinkage of capital values, and the like. T h e latter would have been necessary if the valuations were to be made semipermanent, rather than transitory, due to manipulation. The combined result of these factors, therefore, was the creation of levels of security quotation which, as compared with levels which existed either before or since the period named, must be regarded as out of line with the general trend of values. We are therefore fairly warranted in viewing the general level of security prices as indicative of inflation during the decade after the war. As it later appeared, moreover, the change in the portfolios of the banks had been markedly in the direction of accumulating long-term, slow and frozen assets, with the result that these assets were shortly proved unavailable in enabling the banks to provide funds with which to meet the claims of their depositors and others who desired liquidation. It may be possible to form a kind of index of inflation for use in measuring the change in condition of American bank portfolios during the postwar decade. Such an index may be formed by ascertaining the extent to which the slower and less liquid forms of bank holdings had invaded the portfolios of the different institutions during the ten years in question. If we prepare such an index by ascertaining the extent to which expansion of slow assets had taken place, we shall come to the conclusion that the invasion spoken of had resulted in a reduction of liquidity (or viewed from another angle, in an increase of inflation) by approximately 40 per cent before 1 2 9 9THE

INFLATION

OF

1933

Although, as we have seen, the banking and investment system of the United States had become greatly inflated in the

128

I N F L A T I O N IN T H E U N I T E D

STATES

sense in which we have been using the term, prior to 1933, a fact which was constantly attested by the recurring bank failures, the new administration which came into office in March, 1933, almost immediately declared itself in favor of inflation as a regular policy and it began at once to undertake the further aggravation of the highly inflated conditions already established. Let us note what was done in this particular direction: 1. First and foremost the reduction of the external value of the dollar by nearly 40 per cent through a policy which included the raising of the price of gold (in irredeemable bank credit and currency notes) from $20.67 to $35 an ounce, and the reduction of the gold content of the dollar from 23.8 grains of gold to 1 5 % ! grains of gold % 0 fine; 2. T h e elimination of practically all of the safeguards which had been relied upon to prevent Federal Reserve notes from being issued against slow assets and the continuous substitution of government bonds in the portfolios of Reserve banks for commercial paper and other quick assets; 3. T h e overloading of the rank and file of commercial banks with government bonds and the elimination of commercial paper from their portfolios, parallel with the corresponding elimination which was taking place in the portfolios of Reserve banks; 4. Continuous issuance of bonds and other obligations to meet recurring Treasury deficits, notwithstanding that no provision was made for taxation to retire the bonds and other obligations thus issued. In these major ways, and by various minor methods, the year 1933 witnessed a very great expansion of inflation in the financial and banking system of the United States. T h e inflation, as just seen, was reflected as a growth of nonliquidity and an increase in the total amount of outstanding obligations— largely governmental—whose ultimate redemption was problematical and in any case a matter of the far distant future. T h e adoption of the policy of inflation by the national government of the United States then simply resulted, during 1933, in the growing expansion and aggravation of a condition of general

INFLATION

IN T H E

UNITED

STATES

129

inflation which had already sprung up and developed during the preceding ten or twelve years, and which has resulted today in an enormously inflated and speculative position of financial institutions of all classes. NONAPPEARANCE OF CONVENTIONAL

SYMPTOMS

This analysis of inflation in the United States would probably be doubted by not a few, on the ground that there is a total absence of many of the usual conventional indications of inflation. One reason for undertaking the inflation policy, widely announced and indeed publicized after March, 1933, was the belief that it would result in an increase in commodity prices. No such increase has taken place. During the few months after March, 1933, and until about midsummer of that year, there was a decisive advance of such prices, owing largely to natural recovery from very low levels caused by temporary maladjustment of supply and demand and to various other factors in the situation. This increase was short-lived, and, later on, gave rise to a waiting period during which the level of prices continued for six or eight months into 1934 to show very little alteration. In the world at large, in fact, the drift of prices, measured in gold, has continued to be downward and the best price-forecasters are disposed to the belief that it is likely to continue downward for some time to come. This fact is frequently referred to in support of the belief that no inflation is taking place in the United States. As often set forth, however, no such conclusion is to be accepted. When we analyze inflation in terms of its characteristics and not in terms of extraneous symptoms, we find that in reality the evils of inflation are all present, even though in the United States the transitory symptoms which sometimes exhibit themselves—high prices and greater business activity—have not yet been markedly noted. EFFECTS OF L O C A L

INFLATION

A question is often raised as to the probable effects of local inflation such as has been above referred to. The statement is made that if it be true that inflation need not necessarily affect

130

I N F L A T I O N IN T H E U N I T E D

STATES

commodity prices and that if it be possible to bring bank failures practically to a close through methods of administrative control, no particular objection can be made against a change which merely involves some technical modifications of bank statements and portfolios, or which must simply introduce some innovations into the relationship of bank assets and liabilities. This, however, is a shortsighted view. As we have already seen, the essence of inflationary policy, wherever pursued, is that of changing the ownership of wealth. Eventual changes like those through which the financial institutions of the United States have been passing during the year 1933-34, are reflected in inability of banking institutions to liquidate, with corresponding losses to depositors, preceded as a rule by actual bank failure or in some cases a transitory advance of commodity prices, rendered feasible by the use of abundant credit in manipulating values to higher levels. T h e danger of inflation is deeper-seated than that which is thought of as reflected in changes of price levels. It is found in underlying changes of economic relationship, and especially of wealth ownership. These may not take effect instantly, but they are an eventual and inevitable result of the adoption of an inflation policy.

VII T H E PRICE C O N T R O V E R S Y 1 As already observed, nothing has been said in the foregoing discussion, of the question of prices as affected by inflation. In much current discussion, it has been taken for granted that the effect of inflation is to raise the price of commodities. This, as has been carefully pointed out, has been the prevailing popular view of the matter; and the fact that such price advance is expected to result from inflation is the reason why, in many instances, an inflation policy has been adopted, as well as becoming the leading argument used in currently reconciling the rank and file of the people to its application. Widespread acceptation of the view that inflation is identical with, or certain to lead to, an advance in commodity prices has been characteristic of the writings of many economists, and there are probably comparatively few who would not consider that an inflationary policy is invariably a factor, at least, making toward a higher price level. It is thus seen that the theory of prices so referred to has been generally, if not invariably, a factor in supporting inflationary policies, and in bringing about a condition of favor for the general idea of inflation which would not otherwise have existed. Indeed, it would usually be impossible to induce the rank and file of small traders and producers to exhibit much interest in the inflation question, if they were persuaded that it was a matter entirely divorced from their immediate business problems in so far as any effect upon prices was concerned. Broadly speaking, therefore, it is a fact that inflation has depended for its popular support upon a theory of prices whose acceptation is at any rate controversial. Perhaps the most surprising aspect of the policy has been the circumstance that it could gain so general a standing and popularity upon a basis whose support was open to grave question. It is therefore esseni By H. Parker Willis.

132

T H E

P R I C E

C O N T R O V E R S Y

tial to look carefully into the theoretic connection between inflation and prices, in order not only to form a definite opinion of the basis for inflation as a policy but to satisfy our minds regarding the position of inflation in any development of a formal price doctrine. HISTORICAL

ORIGIN

OF THE P R I C E

DOCTRINE

There need be no doubt about the historical origin of the price-raising doctrine to which we have made reference. It has always been apparent that a change in the weight of gold or of any other metal which went to make up the unit, made it possible to have a correspondingly larger number of such units in existence, or to produce a correspondingly larger number of such units from a specified supply of metal on hand. It has also been obvious that a liberal or lax banking policy which would admit to discount paper of long-term maturity, or of somewhat doubtful reliability, would often tend to place upon the books of banks a larger amount of discounts, and hence of "deposits," than would otherwise exist there. In the same way, it has been clear that the enactment of a governmental policy which made it easier for banks to divert or suspend their obligations, or to meet them in a more easily obtainable unit, was likely to lead them to increase the amount of their obligations under given conditions. Broadly speaking, therefore, it has been a favorite popular opinion that an inflation policy meant an enlarged supply of circulating media, or credit, or both, or at all events that it implied a condition in which an enlargement of the circulating medium or credit, or both, could more easily be provided. We may now glance for a moment at the so-called classical theory of prices. As stated by J . S. Mill, this theory held that, other things being equal, a larger amount of available money or purchasing power necessarily tended to a higher level of prices in any community. Combining this view with the recognized tendency of inflation already described, it is a fair corollary that the adoption of an inflationary policy, by helping to misuse the outstanding units of purchasing power, tends to en-

THE

PRICE

CONTROVERSY

133

large or raise the price level. From this it has been a natural enough conclusion that higher prices would follow the support and enlargement of the supply of money or credit; and that, if at any given time, a certain type of any monetary unit, e.g., gold, was "short," or insufficient in supply, the desirable step to be taken was either to substitute some other more abundant metal, e.g., silver, or to allow such metal to be used alternatively with gold as legal tender, or adopt at once the "easy" credit policies which would result in building up a larger supply of credit units—"deposits"—thereby putting into existence a greater volume of purchasing power which could (and probably would) be used in making a demand for goods as a result of which, "other things being equal," prices would rise. Up to a few years ago, therefore, it had become a kind of commonplace or accepted doctrine of some economists that, in order to raise commodity prices, the obvious step to take was the adoption of an "inflationary" policy by the government or the inculcation of such a policy through the banks of the country. T h i s doctrine, in the practical form just stated, has been accepted by the national administration of the United States, regardless of party, and has many times been reiterated as the reason for such policies as devaluation, lax credit, issue of greenbacks, and others of the same general group. T h e present movement toward inflation, then, which, as has been seen, is a phase of profound economic unrest, aiming at the redistribution of property or the shifting of industrial losses and costs from the shoulders of those who incur them to the community as a whole, has been given tangible form as a movement toward the raising of prices by the enlargement of credit and the reduction in the value of the currency unit. T H E BASIS OF THE T H E O R Y

Clearly the basis of this theory has been found in the assumption that "other things are equal." What are these "other things"? As stated by the classical economists, they include at least three important groups or categories: (1) the supply of and demand for goods; (2) the conditions under which such goods

134

THE PRICE

CONTROVERSY

are marketed—number of times that they necessarily change hands in passing from producer to consumer, etc., the restrictions upon competition and the like; (3) the degree of elasticity of the circulating medium. These elements in the price structure are all found clearly stated by most of the classical economic writers. T h e y constitute a direct qualification of the older or "truistic" quantity theory of money, since without them none, even of the classical economists, would be willing to accept the view that prices would rise if only purchasing power was increased. It is a fair corollary from what has just been said that if, at any given time, any one of these factors is undergoing rapid changes, a condition is set up in which the influences of changes in the supply of purchasing power are less likely to exert themselves than through ordinary channels. Few persons, if any, will deny that during the World War and the decade succeeding it, enormously great changes in invention and methods of industrial production, as well as in the organization of labor and the application of labor and raw materials, have taken place. Partly because of the social and political changes resulting from the war itself, and partly because of the rearrangements growing out of the alterations of technical productive methods already referred to, the period in question has itself been a time of unusually rapid alteration so far as concerns the available quantity and costs of commodities. It has so happened that the years in question have also been a time of very great alteration in methods of communication and of transportation. T h e general use of motor transportation and the introduction, at least, of the movement of mail and lighter freight by air, must always mark the second and third decades of the twentieth century as a period of remarkable change in the physical conditions of marketing. Altogether there would seem to be 110 escape from the conclusion that the time has been one in which it could not possibly be assumed that the other conditions to which the classical economists refer were even approximately equal over any considerable time. T h e older assumption, then, that the change in the number of units

THE PRICE

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of purchasing power available would be likely almost at once to bring about a corresponding change in price level has not found a favorable period for its application, and in fact the statistics of the situation do not in the slightest bear it out. W h a t they do indicate is that there is no warrant for asserting an immediate connection between changes in the volume of money and of bank credit on the one hand, and the price of goods sold, on the other. It may also be questioned whether modern conditions of financial organization iiave not done much to reduce whatever basis of association there has been in former years between the volume of purchasing power available and the price level of commodities. As we have already seen, the older economists attributed great importance to the elasticity and velocity of the circulating medium. J. S. Mill went so far as to view the velocity of money as a factor of importance equal to the quantity of metal available. T h e quantity of money he describes as the product of its supply and its velocity. Great changes in the velocity of circulation have attended the growth of the credit economy during the first quarter of the twentieth century. T h e rapid growth of central banking and the corresponding expansion of the clearing function have gone far toward raising the speed with which purchasing power may be used to accomplish its object. If, as some economists have expressed it, "money is that money does," there was never a time when money or a unit of any kind of purchasing power could do so much, or accomplish so many transactions, within a specified period of time as during the past twenty-five years. A very material reduction in the supply of money or purchasing power might thus, strictly or in accordance with the classical theory of prices, prove entirely reconcilable with enlargement of the price level, or falling off in the quantity of purchasing power, being offset by a more than corresponding enlargement in its efficiency or speed of circulation. Another set of factors needs also to be taken into most careful account. It has been shown, particularly by Hawtrey and Robertson, that the price equation is not merely a static analysis

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of the relationship between purchasing power and needs; it is rather a dynamic study of the factors which cause a price level to pass from one stage to another. These dynamic factors include many imponderable elements. Among those which have been especially emphasized by the writers referred to, as well as by others, are the habits of the community in the use of cash or bank deposits, the habitual requirements of banks with reference to the maintenance of a reserve ratio, and the practice of consumers in buying ahead or in limiting themselves to a hand-to-mouth policy in the supply of their wants. All these factors figure largely in the equation of exchange which has been presented by the contemporary school of writers on money and prices. T h e net conclusion from them would seem plainly to be that while, as no one (from the classical economists down) would deny, a change in the actual volume of money or purchasing power has its weight in the establishment of a level of prices, there may be at any given time many factors of vastly greater weight, while during the past decade or more several of these factors have obviously been of an importance greater than those arising from the side of purchasing power and changes therein. T o sum u p the situation briefly, it would seem that prices, as they have been developed within the past decade, have been the outgrowth of several primary sets of factors or influences, the more important of which are admitted to have been undergoing modifications and alterations of fundamental significance, at a rate or in a degree considerably greater than has been customary during the past century. It may have been the result of fortuitous circumstance that these great changes and these rapid rates of change coincided at the time they did, or it may be that certain of them were influenced or emphasized by certain others. Be this as it may, the fact remains that there has been no time for many years at which it was safe to assume that "other things were equal," and that, accordingly, one could at any moment isolate a given set of factors in the price equation. It has been true, throughout, that such isolation was impossible, and that at any moment it was essential to take into account the principal of the factors referred to, if a satisfactory appraisal

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of the tendencies that were at work in the price field was to be attained. In these circumstances, obviously, any theory of prices, or any practical effort to control or direct prices, which was applied solely through the medium of one of the factors or groups of influences tending to alter the price level, must necessarily be incomplete and unsuccessful. In the same way, any effort to direct the course of prices, however initiated, must recognize as one of its fundamental elements, the necessity of taking into account compensating or offsetting factors proceeding from the other elements in the problem and must, above all, avoid setting certain of these factors against others, thereby bringing about a cancellation of the steps that had actually been taken or, at all events, of some of them. DIFFICULTY

IN A P P L Y I N G

INFLATION

Inflation theories have, however, invariably assumed that practical results could be obtained by merely operating upon the monetary or purchasing-power element in the price equation. T h e assumption that other things were equal, tentatively made by classical economists as a basis of their analysis, could not be extended to the field of actual technique, since there was never any basis for such an assumption, and since within recent years particularly "other things" have been on frequent occasions, if not continually, of more immediate significance than the variations in purchasing power. Mere artificial alterations in the volume of money or of purchasing power have never, as we have seen, been theoretically regarded by any recognized group of writers on prices as the sole price-making factors. They were so regarded only upon the express condition that the "other things" referred to were to be considered equal. Since, again, as we have just seen, this hypothesis was never further from the truth than during the years after the World War, the conclusion seems inevitable that the acceptation of the theory of inflation through changes in purchasing power was never more difficult than during those same years. T h e inflationary background of thought has not been limited to the United States, although perhaps more generally to be

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recognized there than elsewhere. It has been very widely existent throughout the world, as the result of many years of incomplete statement of price theories among economists, and of very general tendency to accept in an uncritical way the hypothesis concerning prices and exchange values which, as already set forth, had been put forward and accepted by the older economists. In these circumstances, the rapid spread of the idea that nations could alter their price levels at will through the mechanism of money and banking, by a change in the volume of purchasing power, has been a quite natural corollary. Such a result was conspicuously to be expected in view of the fact that great changes in prices were occurring simultaneously with profound disturbance in monetary and banking systems, as had been the case conspicuously during the World War and to a greater or less extent ever since the conclusion of that struggle. It was a natural association of ideas that supported the opinion that the changes in money and banking systems thus occurring were the fundamental causes in the alteration of prices, since the ground had been prepared, intellectually speaking, for this view of the matter in the way that has already been outlined. Such certainly is the interpretation of the great growth of inflationary theory that appears to be warranted by the facts available. Theories and causes of action are often materially aided in their growth by the fact that they suggest or recommend easy methods of procedure. In the condition which has prevailed throughout the world of recent years, alteration of the basis of money and banking has been one of the easiest, hence obviously one of the most popular, methods of promising an alteration of the price level. Not a few persons have expressed surprise at the very general acceptation of what thus appears as an antiquated, if not totally erroneous, view of the nature of prices; but the situation in this respect is not different from that which exists in many other branches of theory.

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"PRICES"?

A study of inflation movements and of price theory in the United States cannot be complete without some attention to the underlying question, what is meant by "prices"? In every case in which abstract theory becomes popularized, or is made the basis for politically sponsored remedies, there is always great necessity for careful definition of the terms used, and for the avoidance of popular misinterpretations of every sort. In a great deal of the public and political discussion of the "price question," occurring d u r i n g the past half century, the assumption has been implicit that there was such a thing as a "price level," in the sense of a system or structure of prices intimately associated with one another and responding in substantially similar ways to impulses likely to bring about alteration. Such an assumption, or something analogous to it, was obviously clearly necessary on the part of the classical economists; and the existence of such a notion can be traced fairly connectedly and steadily throughout the nineteenth century. Indeed, an assumption of this kind was the natural outgrowth of the a-priori method of discussion which the older economists had selected. It harmonized with their other assumptions of a freedom of competition and a frictionless economic organization, remote as these actually were (and were known to be) from the true facts of existence. In the price field, however, these assumptions were peculiarly injurious to the attainment of sound conclusions. T h e entire idea of a price level is artificial, and is the result of an assumption that it is possible to obtain some kind of accurate mathematical means of comparing and analyzing things which in themselves are different. T h e underlying assumptions of the entire price-index technique are necessarily wide of the mark, and have succeeded in maintaining themselves in common use merely because of the difficulty of the problem and the absence of any other technique of superior character. T h e fact has remained that prices are very different in their origin and susceptibility to change in one group of commodities as compared

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with another. T h i s has been fully recognized through the contemporary attempt to introduce various indexes of prices. It has been commonly recognized that an index of retail prices of cost of living is quite distinct f r o m an index of wholesale prices; while special indexes have been devised for international comparisons and for the adjustment of wages to changing costs, as well as for other purposes. T a k e n all in all, it may be truthfully said that those concerned with the measurement of price fluctuations have become more and more aware of the faultiness of material with which they are working, and less and less inclined to regard prices as representing necessarily the same set of economic factors in different groups of commodities. Of late years, moreover, investigation has more and more shown that the influences which determine the rate of movement of prices are effective in very different proportions at different points in the upward or downward movement of the index. Some prices move only sluggishly within certain limits, b u t much more actively without those limits, while others which are responsive to outside stimulus in their lower levels move only sluggishly after fairly high levels have been attained. These variations of movement are the result unquestionably of varying responsiveness to changes in demand, or, in more technical language, to varying degrees of elasticity of demand, or of supply, as the case may be. T h e conclusion to be drawn from all such facts is obviously that an alteration in the volume of purchasing power must be much more influential in its effect u p o n prices at certain levels than at certain others, and far more influential in its effect upon certain classes of commodities than upon others. From this, clearly, the conclusion must be drawn that the effect of an artificially administered increase in the volume of purchasing power would be different in different places and at different times, different also at different levels of prices, besides being very variable in its relationship to "other factors" which go to make u p the price level. T h e general corollary of this reasoning, of couise, is that, even if we are to assume that at a given moment, with other tilings equal, a theoretical change of prices

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must be expected from a given change in the volume of purchasing power; the distribution of the effect of this change upon the different groups of commodities cannot be regarded as in any sense likely to be uniform or stable, but is in itself a matter calling for very different methods of investigation in its different aspects. T h e expectation, in other words, that, say, a doubling of the volume of bank credit available would result in the doubling of the price level, if it ever was partially warranted by facts, could not be even remotely expected to hold true in a world like the present in which the movement of prices is subject to the conditions already sketched, while the movements of varying groups of prices vary among themselves as has been roughly indicated. Study appears completely to have routed the idea that the level of prices can be regarded as at all homogeneous, either at given times or at given places, or much less as between varying times and varying places, so that attempts to treat or alter such levels of prices, based upon the assumption that they are homogeneous, are doubly doomed to defeat. Even if it were true that, through the proper administration of changes in volume of purchasing power, it might be possible to effect abstract changes in index numbers, so that prices, for example, would advance from a level of 60 to a level of 73, that fact itself would be of no interest from the point of view of a remedy of industrial evils. T h e problem of prices and price control is not fundamentally a problem of the control of the general level of prices, but is a problem of proper adjustment or relationship of different groups of prices. In the United States, for example, the most pointed complaint has long been made on behalf of the farmer, who was said to be getting a very much smaller return for his labor by way of the money value of wheat, cotton, and other agricultural staples, than he had received at a former time when he subjected himself to indebtedness, stated in terms of money and secured by his land. It has erroneously been assumed that an advance in agricultural prices would benefit the farmer, whereas in fact, the only thing that would assist him would be an advance in

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agricultural prices as compared with others. While it has been quite true that the wheat farmer, let us say, who borrowed $1,000 when wheat was $ 1 a bushel and who is asked to pay back $1,000 when wheat is 50 cents a bushel, is practically requested to make a return of double the sacrifice with which he parted, it is not true that by raising the price of wheat to $ 1 a bushel his condition is necessarily improved. Although he might abstractly dispose of his crop for the same number of dollars which he originally borrowed and so apparently free himself from debt with a sacrifice of labor and capital not greater than that which he received when he borrowed, this is evidently true only in a technical sense. If at the same time, for example, manufactured goods have greatly receded in prices, it is clear that in repaying $1,000 he is handing back to his creditor a correspondingly greater control over other consumable goods; or, conversely, if manufactured goods have not greatly altered in price, he is repaying the creditor a relatively smaller share of the goods with which the latter parted. Even if it were true that the advance in the farmer's product had had the result of bringing the price index back to the same average level at which it stood when his loan was originally made, the farmer would be benefited only in the event that he occupied the same relative position as a consumer at the time of repayment that he occupied at the time when he borrowed. In practice no such refinements are called for. T h e difficulty of the agricultural producer in the United States, as will be more fully set forth at a later point (see below, Chapter I X ) has been found in the fact that his price level was out of harmony with that of the manufactured goods which he bought. Despite the advance in agricultural prices which had occurred between March, 1933, and J u l y , 1934, farm prices were still nearly as distant from an average adjustment to manufactured prices at the end of the period as they were at the beginning. T h e bearing of this situation upon what is called "inflation" is thus evident. Inflation theorists almost universally assume that the effect of their remedy is to raise prices all around in about the same proportion. Indeed, if they were to assume that this

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were not the case but that some were raised more than others, they would be subject to fresh logical difficulties. If, however, they adhere, as most of them do, to the view that a "dose" of fresh money or credit—an increase of purchasing power—will operate fairly uniformly throughout the entire structure of industry, raising prices in very much the same way at retail and at wholesale, in agriculture and in business, they evidently do not provide even a theoretical remedy for the dislocations of prices which have brought about an injustice existing between social or economic classes. T h e y in no way improve the position of the farmer as contrasted with that of the business man, or vice versa; indeed, in some ways they appear to render this disparity more serious than it was at the outset. Inflation, in other words, as popularly viewed in the United States, does not, even theoretically, afford a means of relief from the evils which have been recognized as reflected in price variations. A T T E M P T TO PROVIDE M O R E SOLID BASIS FOR

INFLATION

While, as a rough-and-ready method of immediate relief from suffering caused by dislocation of prices, inflation thus appears as an ineffectual remedy, even when its fundamental assumptions are taken for granted and it is accorded the full face value of its claim to success, economic writers—particularly political apologists—have been reluctant to surrender what appeared to be so valuable a means of effecting the redistribution of wealth and so attractive a rallying cry in political discussion. T h e r e has, therefore, been—especially in the United States—an attempt to build a stronger foundation beneath the inflation proposal. They seek to substitute for the popular statement that by relaxing credit or debasing the currency, debtors would be relieved of their obligations, at least in part, the more general claim that "managed currency" or regulated inflation would provide a generally better and fairer state of things industrially, and would thus make it possible to introduce a more equitable basis for economic life. T h i s view of the case is undoubtedly the one which deserves most careful analysis and recognition at the present moment, since the older inflationary argument

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has proved itself far too crude—and too much out of harmony with actual performance—to enable it to hold its own very long. T h e experience of Great Britain between September, 1 9 3 1 , and the end of 1934 in going off the gold standard, but nevertheless finding her domestic price level little altered, indeed lowered, if anything, rather than raised, and of the United States in finding that the inflation policies of 1933 had no traceable effect upon prices, have necessarily had an influence on minds which formerly were inclined to accept rather uncritically the older inflation theories. Because of this failure of the cruder inflation ideas to prove themselves successful in experience, there has perhaps been a rather distinct increase in the disposition of various writers to establish a basis for a more discriminating advocacy of inflationary doctrine. Let us now see on what foundation the more refined inflation argument of the present moment has been built. Most persons admit, as was unavoidable, the obvious conclusion that prices do not all rise or fall in the same way and hence are not necessarily similarly affected at any given moment by inflation. T h e y freely admit further that great differences exist in the disposition of various possessors of money and credit to use their funds in buying. T h e general claim is nevertheless made by some that a policy of liberality in the granting of credit—a disposition to enlarge the supply of money and an inclination to make funds available practically when and as they are wanted—has the effect of liberalizing the operation of the industrial mechanism. In such cases, it is asserted, persons who see opportunities for the making of money are enabled to obtain the means with which to take advantage of these openings, while those who would otherwise monopolize industrial opportunity and would limit the field for enterprise to a comparatively small number of lines of effort, are prevented from thus establishing a partial monopoly. T h e effect of such a policy, it is further asserted, is to bring about a freedom of movement and activity in business and a disposition to adopt an enterprising attitude which would otherwise be lacking. According to this view of the situation, more conservative

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methods and attitudes necessarily imply a less active investment of capital and a lower degree of inclination to take risks. Ease in securing the enlargement of the supply of money, or liberality in the extension and granting of credit, and particularly the maintenance of a low rate of discount at central banks, have the effect of creating a psychology in the money market which is encouraging to active business men; and which, therefore, is likely to result in the enlargement of employment, with correspondingly favorable effects upon the laborer or employee. By inflation, in these conditions, is meant substantially the same as under the other conditions which have already been described, i.e., an enlargement in the supply of money and credit. T h e doctrine under discussion, however, introduces a modification in that the emphasis is obviously shifted from the mere supply of money and credit to the ease or difficulty experienced in the enlargement of such supply. More emphasis is evidently given, for example, to the attitude of the banker in extending loans than to the actual change in the amount of the loans which he extends. This, moreover, although unquestionably an important point of theory, cannot be regarded as altering the basic elements in the general problem of inflation which we have under discussion. It is rather a change in method of procedure that is thus contemplated than a change in the real elements of discussion. Now, let us see what is the actual outcome of the inflation doctrine as thus restated. In effect, what is thus asserted is that by providing with easily obtained funds borrowers who are business men, there will be a fair prospect of change under certain industrial conditions, so that as a result a more active state of affairs is more likely to be brought about with greater incidental demand for commodities and services, hence with a greater prospect of increase in the demand for labor. And so there may be expected advance in wages and greater distribution of purchasing power, hence growth of demand for consumable goods, and again of prices. Inflation, in the sense of a liberal attitude by bankers and lenders, resulting in greater ease of access to credit, or in a liberal attitude on the part of the

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government, the latter resulting in freer issue of notes or in the coinage of metals otherwise not available, is thought of as thus, in the long run, stimulating business and so raising prices as well as increasing employment. This, briefly stated, may be regarded as the form which the inflation demand has taken at the hands of not a few contemporary advocates of the policy, who have necessarily found themselves driven to admit the defects in the older and cruder forms of the theory. Such a view of the situation may be defined as "business inflation," or inflation through the adaptation of banking policies to the needs of business, as contrasted with inflation which comes about through a direct effort to increase the amount of money that is being offered for goods by simply paying it out more freely or by reducing the metallic value of the money unit. TRANSFERABILITY

OF

DEMAND

It is evident that, underlying any such view of the inflation problem, is the notion that demand for goods or services is perfectly transferable and flexible. For example, it is often argued that liberal loans in the stock market for speculative purposes do not result in any strain upon the banking mechanism, since the credit so extended is not used for the purchase of fixed capital and hence not "tied up." T h e making of liberal loans for speculation in stocks does result in enabling many people to gain access to a source of profit which would otherwise be closed to them and which in the last analysis is the result of the increasing wealth and broadening business opportunities of the country. Credit so advanced, or "released," is, however, believed to "flow" without hindrance out of the speculative market and into business,2 so that, in the final analysis, it is redistributed to trade and industry in the proportions which the latter desire, and so has the effect of enabling various kinds of business to get the advantage of the use of capital which would otherwise be denied to them. Here are several assumptions of first-rate importance, but for which in ordinary discussion not a scintilla of evidence is afforded. Of * This has been the attitude of the "economists" of some Reserve

banks.

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these the first is that a unit of credit placed in the hands of someone who wishes to operate in stocks will speedily find its way out of the stock market and into industry, so that the bank which adopts a low-rate-of-interest policy thus encourages business by enlarging the amount of credit which is "available." This is one of those vague assumptions which have been so common in the discussion of inflation, but which have no apparent warrant. T h e individual who borrows on collateral for speculative purposes may theoretically make a profit from his speculations, which he uses in buying commodities; or, he may determine after turning over his capital once or twice, to withdraw it and use it in an actual productive enterprise, although continuing to maintain his loan by leaving with his broker or banker the collateral that he has put up. Clearly, in such cases, the borrower is thought of as reaching a decision to shift his funds out of the stock market, either in the form of profit or of ordinary principal, and to put them into some other occupation. Such an individual could be induced to take a step of the kind only if he believed himself likely to get more satisfaction in business than he could gain by continuing in the stock market. If such a prospect is real, there is no reason why he could not have borrowed in the same way upon business paper; and if it is not real, we then have the bank merely enabling the individual to engage in a business transaction which is foredoomed to failure by reason of the fact that it is not based upon or does not control any definite area of demand. T h e underlying assumption here is too vague to be of merit. It does not correspond to the facts of business. If low rates of discount and liberality in the basis of lending at banks be conceived of as taking effect directly upon the accommodation granted to producers, the case is even clearer. As contrasted with the so-called conservative or "deflationary" policy, we must think of the proposed inflationary credit as one which is advanced upon a narrow margin of security, or merely in the belief that profits will be made, and without actual protection of any kind. "A," for example, might inspire his banker with the belief that water-front land in a Florida winter resort is quite

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certain to double in value, and the banker may, without any corresponding security, advance him the funds necessary to take up a large amount of such land. T h e result undoubtedly is for the time being to make a strong demand for the real estate in question and, of course, to provide its original owners with funds which they may, if they choose, freely spend for consumable goods, with the result of raising prices and making local business satisfactory. T h i s procedure, it is clear, can be successful only up to the point where it is evident that losses will not have to be incurred or written off. T h e inflationary doctrine holds good then, only on the assumption that no losses have to be carried and hence, that no writing-off of such losses is necessary. This, obviously, is an assumption without foundation, as is often illustrated by the development of a boom psychology, which carries a group of producers and consumers forward upon a wave of business activity to a point where confidence is lost through realization that the capital supplies thus afforded have been swept away. Advances of prices which have occurred in such a condition, are invariably short-lived. T h e y are, in fact, by their very nature self-defeating, since they are not part of a general advance of prices and would not be desired if they were. T h e y are temporary local or partial increases of prices or values, and as such, subject to the transitory influences which will in due time disappear and leave the situation subject to recession. Advocates of credit inflation as a means of making business good cannot, of course, reasonably advocate their proposal if obliged to admit that its influence would be merely that of temporary or sporadic advance of prices. What they have asked for is not diat, but is continuous advance, or at any rate advance of the price level to a higher basis, at which it may be able to maintain itself. They have not asked and could not reasonably ask for a merely transitory or speculative increase in money values, which by its very nature was likely to be cut back again.

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INFLATION

With such views widely accepted by so-called economists as well as by business theorists, and in many cases by "business executives," and widely asserted during and after the "new era" of economic thought, which culminated in 1929, it is easy to see that there has been a very large field for political propaganda and for the misrepresentations of those politicians who have professed themselves able to lift the price level of the country back to the point it had reached in some preceding year, selecting this year at will and merely applying a process of "inflation" (either price or business) until the industrial mechanism had been keyed up to the requisite speed, or until exchange was taking place at the requisite level, at which the process might be discontinued, or the reverse, as the case might be. T h e whole conception, as has just been seen, has found its origin and support in theories of the kind which have been described, nebulous as they are, and lacking in logical solidity as they must be recognized as being. T h e effort to organize various groups in the community for the purpose of insisting upon or demanding inflation as a deliberate policy has been the outgrowth of opinion that, by such policy, results of the sort here contemplated could be promptly attained. T h e discussion has naturally centered around the idea of a rising price level, unrestrained by the now admitted fact that any such level is an abstraction of no special value in economic discussion, except upon a very qualified basis—the real question at issue being the conditions of supply and demand, of production and distribution—which make given commodities able to command more or less than other commodities, and hence to give to their owners or producers a better or less satisfactory status in the general credit field.

VIII SPECULATION AND PROSPERITY1 IN earlier chapters the history of inflation in the United States was briefly sketched, and the way in which inflation has, from time to time, affected our monetary and banking systems was indicated in general terms. In these chapters considerable attention was devoted to the profit motive in business and industry. In this chapter an attempt will be made to show the relationship between inflation and speculation. T h e history of the United States offers many periods of speculative activity which took various forms and occurred in various types of business enterprises as well as in industry in general. Speculation has been especially prevalent in the field of investment financing and stock-exchange transactions, as well as in the organized commodity markets. Real-estate speculation has taken place at one time or another in practically every part of the country. T h e term "speculation" is used generally to refer to the use of funds for the purpose of controlling goods or securities with the ultimate object of making a profit. Such use of funds does not involve the management or operation of the business controlled or the interest held. Security speculation is generally thought of as the process of buying or selling securities which may be purchased outright, or on margin, in anticipation of a rise or fall in the market price so that the transaction may be closed with a profit to the speculator. T h e use of funds in speculative activities is not restricted to any particular type of property. It may take place in the purchase and sale of securities, commodities, or real estate. No effort is made, therefore, in speculative transactions, to facilitate the production of goods or services, but the operator merely seeks to obtain a profit by taking advantage of a change in the market price. Speculation is based upon the theory that prices will fluctuate, and by taki By John M. Chapman.

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ing advantage of these changes in price the speculator may secure a profit. In not a few recent cases the speculator by reason of his command over credit or purchasing power has been able to buy up a sufficient supply of goods, capital or real estate to create a "corner" 2 and thus force those who have sold short (of the cornered property) to buy through the market at an enormous price in order to complete their contracts. This type of control has existed in the grain market in Chicago, in the gold market of New York City, and in the purchase of real estate which was located at a strategic point or points and thus placed the holder in a position to name his own price. T h e risks such a speculator faces are many: his ability to secure control and obtain sufficient funds to carry the transaction through to completion, market fluctuations by reason of changing economic conditions, and opposition from groups in the community. There appears to be a deep-seated belief in this country that speculation is desirable. T h e country has had an abundance of national resources, the development of which has afforded unusual opportunities for exploitation, for the making of excessive profits, and for the accumulation of immense fortunes by many individuals or groups of individuals. T h e building up of huge corporations, in one form or another, by a number of individuals, or groups of individuals, has acted as a stimulus or inspiration for hundreds of thousands of citizens who have felt the desire to attain great riches by short-cut methods. These short-cut methods, which seemed to promise so much but which have been so uncertain, have resulted in losses for many of those who assumed extraordinary risks in the secu2 T h e wildest type of speculation is frequently seen in the efforts of certain cliqucs to secure market control of certain securities or commodities, together with the existence of a large "short interest," and then to force the short interest to accept their terms. They thus sell out for a large profit. This was tried in 1869 in gold. It resulted in immense losses to those engineering the affair. T h e results were so bad that that day, Friday, September 24, 1869, has since been known as "Black Friday." Similar efforts have been made in the manipulation of the prices of wheat, as for example, the Leiter corner which affected both London and New York. Other examples may be seen in the Stutz Motors episode in 1920 or the Piggly-Wiggly Stores incident in 1923.

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rities markets, the commodity markets, or in the purchase and sale of real estate. One of the unfortunate results of speculation has been heavy losses by those who were least able to endure them. These failures have not been, moreover, convincing evidence of the futility of such speculative activities to the many who have been blinded by the huge profits realized by the few, and who, as a group, go on, generation after generation, hoping against hope that they will be in the end lucky. T h e psychological element has been, no doubt, a very important factor in the attitude of the American public toward speculation in general. T h e fact, as we have just pointed out, that many fortunes have been made in a very short time has been a controlling element in the actions of some who have, in turn, been an influence on others. This phase of discussion has been never more forcibly demonstrated than by what took place in the United States during the decade 1920-30. Speculation was rampant in the securities markets and in certain other markets. Practically all classes of individuals participated in the orgy. Many of those interested directly in stock exchange operations possessed only very small incomes. They included many classes who at best enjoyed only limited resources. This particular group of speculators had little real knowledge of the intrinsic value of a large portion of such securities. They got their "tips" in many cases from unscrupulous dealers who wanted to unload on the public doubtful or worthless securities. Speculation has been very prominent in the East on the security and certain commodity exchanges, where prices change rapidly and where there is supposed to be a very wide and active market in types of property. These periods were especially marked in New York City just after the close of the World War, after which prices of securities slumped tremendously with the result that losses were extremely heavy to the larger number of die participants. In Chicago speculation was pronounced in grain, as well as in securities. T h e same was true in Minneapolis, Kansas City and other cities. In Iowa and Florida land was the chief form of speculation. In Florida land prices were marked up at unheard-of rates. People engaged in land

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speculation bought such land and sold it to others who hoped to find still others who would pay an even higher figure, not because such property was capable of producing anything like an adequate income from such a valuation, but because there was hope that the land could be sold for a profit. T h e land was frequently bought on credit and sold on credit, with the result that there was a pyramiding of credit, but the final reckoning had to come, and when it did arrive, the holders of the property, whether it had been paid for or not, had to bear the losses. Dealers could not sell, the prices began to fall, and with each sale the prices went lower. Confidence in the future was practically destroyed for the time being. Banks could not collect upon the loans which had been secured by such overvalued real estate. Bank assets were thus frozen, which, in the end, drove many banks into suspension, for they were unable to meet their own demand liabilities. 8 T h e general result, so far as the banks of Florida were concerned, was to force large numbers to close. This land speculation took place during the period in which there were tremendous booms in security prices. T h e land boom in Iowa occurred not long after the close of the World War—a period in which, according to general agreement, inflation existed in a very extreme form. During the war the government fixed agricultural prices at a very high figure. Upon the basis of such prices, many people purchased land, feeling that the war-time prices would continue and that the value or market price of land would rise relatively to the high productiveness of such real estate, based upon these war prices. Current speculation in certain parts of Iowa and other states differed from the Florida speculation only in degree. Similar conditions existed in other parts of the country, as for example, in the tobacco and cotton-growing sections of the South. T h e land was in fact purchased by two classes—one a group who expected to sell almost immediately * More recent experience and facts have shown that many of the loans made to foreign borrowers—both long- and short-term—were nonliquid and could not be collected. In fact, the interest could not be collected on much of the longterm foreign obligations sold in the United States.

154

SPECULATION

AND

PROSPERITY

for a profit, and another group which wished to till the land but had entered the field of speculation because of the high prices. T h e latter prevailed at the time the land was purchased and buyers hoped they would indefinitely continue. EASY MONEY AND SPECULATION

T h e term "easy money" is generally used to refer to low interest rates. T o many easy money is a sort of panacea for all economic ills and, if provided, will mean a return of prosperity. According to this line of reasoning, business men will borrow money to expand their business because it may be had at low cost—a condition thus indicating that "money" is plentiful and adequate to meet the increased needs of a revival of business. Therefore, the whole matter of recovery is reduced to very simple terms—the proper remedy to apply when we get into a depression is the lowering of interest rates whereby in the course of time business activity will increase. T h e underlying thought is that merchants and dealers will increase their stocks of goods and that will, in turn, increase goods demand, and manufacturers will expand their operations, thus increasing the amount of wages, which will result in larger consumption. T h i s theory seems to be the basis for the argument advanced in the summer and fall of 1933 for an increase in wages. T h e larger incomes thus received by those employed would expand consumer purchasing power, which in turn would increase the demand for goods, and hence lead directly to prosperity and the abatement of the depression. T h e campaign of "buy now" during the same period was based upon a similar false assumption. What was wanted was not a spurt in buying, but a normal flow of goods into the hands of the consumer which he could pay for out of income. T h e buy-now program at best could be effective only for a short time, after which, assuming it was a temporary success, there would be a sharp decline in the volume of sales leaving the merchants overstocked with goods. But merchants will ordinarily increase their inventories only if they may reasonably expect a larger demand for goods. T h e y will not do so because of low interest rates alone.

SPECULATION AND PROSPERITY

155

Cheap money and speculation frequently play an important rôle in the upward trend of security prices. This was notably true in the United States following the lowering of the rediscount rate at all the Reserve banks in 1927. T h a t was a signal for the rapid advance of security prices during the next two years—until the crash in the fall of 1929. T h e large volume of profits then anticipated by speculators induced them to borrow heavily for purposes of stock manipulation. Theoretically, the speculator who is anticipating large profits will not be disturbed by the rate of interest which he must pay to secure the necessary funds to carry on his operations. T h e cost of the funds borrowed usually forms a very small percentage of the hoped-for profits. One of the disturbing elements, however, in a rising interest rate is that it is generally taken as indicative of a growing scarcity of funds. Such scarcity may lead to the appearance of genuine difficulty in securing the amount needed. For that reason speculation in securities is generally checked to a certain extent when interest rates are suddenly increased. This is especially true if the central bank increases its rediscount rate—a fact well illustrated by recession in security prices after an increase in the rediscount rate at the Federal Reserve banks. On the other hand, when the central bank lowers or maintains a low rate of interest, it is apt to create the opinion that there is abundance of funds and that traders will experience no difficulty in securing all the funds needed to carry on their activities. There can be no denying the fact that the action of the Reserve system in 1927, in lowering the rediscount rate at all the banks, led directly to an upward swing of security prices at a time when earnings did not warrant such an advance. Easy money sometimes acts as an inducement to business concerns to borrow and to expand their operations for current activities—a step which they might postpone for a time, at least, if the cost of bank funds were high. This type of borrowing may, if continued, tend to develop overproduction along certain lines and induce producers and merchants to speculate in commodities in much the same way that the stock-exchange

156

SPECULATION AND

PROSPERITY

houses engage in security speculation. Sometimes, indeed, easy money is desirable when business is at a standstill and when the depression has about run its course. At that time a low interest rate tends to encourage an expansion of business, which may lead to a business revival. Under such circumstances, easy money may perform a useful function, but the rate should be advanced at the inception of a period of speculation if the bank is to check an overexpansion of business. Easy-money policy is seen in the efforts of administrators at different times to prevent or stop a depression. This policy was followed at various periods in the past. Shortly after the crash in security prices in 1929, reserve interest rates were lowered in order to encourage business, on the theory that a serious business depression could be avoided by easy money.4 At that stage in the business cycle, the trouble is not principally a matter of cost, but rather a question of confidence. T h e future is uncertain and the business man wants to know what is ahead. Under such circumstances, the adoption of an easy-money policy will fail to accomplish the desired results. Yet, it has been frequently resorted to in the past. Prosperity and speculation are easily associated by a very considerable number of people, while not a few regard speculation as prosperity itself. T h e past history of business revivals shows that in a broad way prosperity has been accompanied, to a certain extent, by speculation in one form or another. In 1835-36 there was a tremendous amount of "feverish" speculation in land, which was followed by unemployment, many failures, and the collapse of the cotton market.® In 1856 there was active speculation in commodities, 6 and in 1869 in gold. 7 A period of prosperity in 1899 was described as follows, * T b e policy of the Hoover administration in the fall of 1929, in refusing to recognize the seriousness of the depression and in expecting that business should "carry on as usual," is illustrative of this type of reasoning. C h e a p money and half-hearted assurances of business executives were not sufficient to offset the ravages of a serious depression, following in the wake of ail orgy of wild speculation throughout the country. " T h o r p , W . L., Business Annals, National Bureau of Economic Research, Inc. (New York, 1926), pp. 121-22. 6 Ibid., p. 126. t Ibid., p. 130.

SPECULATION AND PROSPERITY

157

"Easy money tightens, summer; wild speculation on stock exchange sends stock prices to peak." 8 Dr. Thorp, referring to the depression in England in 1799, stated that "inactivity continues; after feverish speculation, prices of imported goods collapse; decline in imports, active exports." 9 Again, he says, referring to the period of prosperity and recession of 1810. Activity and speculation continue to crisis, July; wild price fluctuations give way to general decline; many failures; manufacturing paralysis and unemployment, autumn; record imports with little increase in exports. Money tight; bank failures, summer; gold advances to large premium.10 He describes the situation existing in France in 1880 as a period of prosperity with the following characteristics: "Widespread activity; commodity prices rise; promotion active, including the floating of company for making Panama Canal; renewed speculation; revival in railroad construction, . . . money easy." 11 QUANTITY

THEORY

OF

MONEY

Closely associated with the doctrine of easy money is the socalled "quantity theory of money." Those who hold to a rigid quantity theory of money maintain that an increase or decrease in the total volume of purchasing power will be followed by a proportionate increase or decrease in the price level. Therefore, if they would have easy money—which is regarded as a necessary factor in revival of prices—they should simply find ways and means of expanding the volume of money or bank credit, or both, which would bring about a large supply of "money," which would, in turn, tend to lower interest rates. T h e lower rates should, then, lead to heavier borrowing by entrepreneurs, in order to increase production. Prosperity should accompany an expansion of business activity. During die latter part of the Hoover administration and the beginning of the Roosevelt administration, the Federal Reserve banks bought huge quantities of government securities in the »Ibid., p. 138. •Ibid., p. 15».

10Ibid., p. 154. " Ibid., p. 191.

158

S P E C U L A T I O N AND P R O S P E R I T Y

open market on the theory that such a policy would keep interest rates down and make money easy, and would so be an incentive for entrepreneurs to borrow money to expand their businesses. If such results had followed, then business would have improved, and there would have been a return to business prosperity, or at least improvement in business conditions. T h e huge increase in the holding of government obligations was based upon the quantity theory of money, in that by enlarging the volume of bank credit a proportionate increase in the price level would be induced. Some of the officers and directors of Federal Reserve banks accepted this idea and believed that enlargement of credit was a sure way to secure higher prices at that time. PROSPERITY

AND

HIGH

PRICES

Growing out of the ideas of cheap money and the quantity theory of money is the belief on the part of a large number of people, who regard high prices as a sign of prosperity, that the obvious way to insure a return of prosperity after depression has set in, is to get higher prices. In the minds of those who follow this line of reasoning, the means used to attain the end are not of material consequence—the one thing to be attained quickly and at all costs is a higher price level.12 This group of thinkers, of course, overlook the fact that what is important to the entrepreneur is his net return, not the gross. Likewise, the important thing to the employee is the purchasing power of the income which he receives. What an income will buy is the real test, not the price level. T h e volume of goods any country can consume is a direct function of what that country can produce over a period of years. It is this misconception of the price level that has led a number of individuals to contend that what is needed is a slowly but continuously rising price level. This idea prevailed among many business men during the so-called "new era" decade from 12 T h e primary and avowed purpose of the administration's gold-buying policy put into effect in the latter part of 193», was to raise prices. T h e object underlies in theory the purchases of silver at the present time (July and August,

•934)-

SPECULATION

AND

PROSPERITY

159

1920 to 1930. A n essential part of this doctrine is that an active m a r k e t is n e e d e d to k e e p securities and c o m m o d i t y prices moving, hence the o b j e c t i o n on the part of the business c o m m u n i t y to any action o n the part of the g o v e r n m e n t or banks which w o u l d tend to r e d u c e the activities of the market or b r i n g a b o u t a reaction in the price level. SPECULATION AND INFLATION Speculators are generally f o u n d on the side of inflation for the reason that a period of rapidly rising prices seems to offer the greatest o p p o r t u n i t i e s for profit. Some operate on the ass u m p t i o n that rising prices mean prosperity and, under such conditions, operate o n a large scale in anticipation of huge profits. U n d e r such circumstances, the speculator usually finds it comparatively easy to secure all the additional bank funds necessary to finance his undertakings. Interest rates may rise, b u t that is of m i n o r importance in so far as the actual cost of his business is concerned. In the securities markets experience has taught the large professional speculators that the best time to interest the p u b l i c in b u y i n g securities is d u r i n g a prol o n g e d period of rising prices. 13 T h e y assume that outsiders, after w a t c h i n g the prices rise h i g h e r and higher, will finally be i n d u c e d to participate. W h e n this occurs, frequently the professional speculator will sell out very largely to the p u b l i c and try t o protect himself. I n this, of course, he may or may not be successful; b u t at any rate high prices are deemed essential for the purpose. A n o t h e r factor of considerable importance is the fact that in the past bankers have been inclined to lend more freely d u r i n g periods of rising prices, and so in turn have facilitated the operations of this g r o u p of traders. Moreover, as the market value of the collateral rises, it gives the speculator a larger

"market

e q u i t y " w h i c h enables h i m to c o m m a n d still larger loans, and is Extensive use is made of bank credit during a period of high prices and widespread speculation in securities. In other words, the public is induced to come in and use, in the same way that speculators do, bank funds to operate in the stock market.

160

S P E C U L A T I O N AND P R O S P E R I T Y

in this way he is enabled to expand still further his operations. During a period of rising prices, merchants are likewise inclined to overbuy on the ground that the price will immediately rise still higher, and even though they are unable to dispose of their merchandise in the regular turnover period, they will profit in the end for the reason that prices will appreciate materially in the meantime. Examination of financial statements frequently shows that a concern is speculating in inventory. Such a practice is dangerous, for there is never assurance that prices will continue to rise, and if they do, it will most likely lead to greater excesses and consequently greater losses in the end. Under conditions of this kind, it is of the utmost importance for the banking system that such borrowers be curbed before prices decline to such an extent that the creditor may be forced to take heavy losses as a result of the failure or inability of the debtor to pay off his obligations. These conditions developed in the United States to a marked extent following the close of the World War. Many banks in this country, and especially certain banks financing the production and sale of cotton, sugar, and certain other commodities, found they had overextended their lines of credit in relation to the value of the commodities financed, and that since the higher prices no longer existed, they were under the necessity of forcing their borrowers to liquidate. Many could not do so, with the ultimate result that the bankers lost very heavily, and in not a few cases had to take over the business and, where possible, continue to operate it or liquidate at a loss. In other cases the banker was not able to handle the situation, and hence was forced to endure such heavy losses that his own bank failed with attendant sacrifice to depositors and shareholders. What seemed to be a prosperous inflationary period, as so often happens, therefore proved to be very expensive to the whole country. I N F L A T I O N , POLITICS AND S P E C U L A T I O N

During periods of depression in this country, it has on the whole been comparatively easy for the so-called "cheap-money crowd" to command a strong following. All those who have fol-

SPECULATION AND PROSPERITY

161

lowed the history of the United States covering the past hundred years realize how dangerous is the formation of an alliance between those who engage in speculation and favor higher prices, and the politicians. Such a situation existed in the period covering the panic and depression of 1892-93. T h e depressed prices, the large amount of unemployment and the difficulty of balancing the national budget, gave rise to conditions which, in the minds of not a few, called for higher prices. A large group in Congress wanted to increase the volume of currency in circulation." One group of politicians, of course, placed the blame upon their opponents and demanded a "full dinner pail." T h e silver supporters in Congress took the position that the trouble was largely monetary, and that the way to overcome it was to enact new legislation to give silver a more prominent place in our monetary system. This hasty program took form in 1890 in the so-called Sherman Silver Purchase Act, which provided that the government should buy a certain amount of silver each month. T h e cost was to be covered by printing press, namely, the issue of certificates by the government to pay for the silver thus purchased. These legal-tender treasury certificates were issued to buy silver, but were redeemable in gold. There was, in addition, a strong sentiment in favor of printing paper money. President Cleveland, an ardent advocate of "sound money," opposed any steps which might be used to lessen the stability of our currency and banking systems. However, the silver question was carried into the presidential campaign of 1896, when William J . Bryan was a candidate on a platform calling for the coinage of silver at a ratio of 16 to 1. He was opposed by McKinley, who favored a gold standard. Another phase of the problem which has proven serious, is 1« T h e People's Party, later known as the Populist Party, composed largely of the same element that had made up the Greenback Party of earlier days, declared for the issue of paper money against wheat and other farm products. T h e presidential candidate of this party in the 1892 campaign received more than a million votes and carried four states. T h e party failed to get into power, of course, but the extent to which it was supported shows how easy it is for a political party to gain votes for an inflationary program.

162

S P E C U L A T I O N AND P R O S P E R I T Y

seen in the type of man favored for public office. In view of circumstances, it is a fairly easy matter for the unscrupulous politician to maintain that the capitalist class holds all the wealth and by so doing is depriving labor of that which it should rightly have.

IX THE THERE

FARMER AND INFLATION

1

has been a marked tendency upward in the acreage of

land cultivated in the United States. T h i s expansion, which has been in progress for many decades, has not shown a tendency to change with the variation of production in other fields. TABLE

VIII

IMPROVED LAND

FARM LAND

IMPROVED LAND

293.561 407.213 407.735 536,082 623,219 838,592 878,798 955.884 924.3>9 986,771

I 13.033 163,111 188,921 284,771 357.617 414,498 478,452 503.073 505.027 522,396

15.6 AI-4 21.4 28.2 32.7 44.I 46.2 5O.2 48.6 51-8

6.0 8.6 9-9 I5.O 18.8 21.8 25-J 26.4 26.5 27.4

38-5 40.I 46.3 53-1 57-4 49-4 54-4 52.6 54-6 52-9

1.449 2,044 2,66O 4.OO9 4.565 5.737 6,362 6,448 6.372 6,289

202.6 I99.2 '53-3 «33-7 136-5 146.2 138.1 148.2 «45-1 1569

RURAL POPULATION AS PERCENTAGE OF TOTAL

ALL FARM LAND

AVERAGE ACRES PER FARM

1850 I860 1870 1880 1890 1900 1910 1920 1925 •93°

P E R C E N T A G E OF T O T A L A R E A OF UNITED STATES

PERCENTAGE OF FARM LAND IMPROVED

YEAR

AREA THOUSANDS OF ACRES

NUMBER OF FARMS (IN THOUSANDS)

THE GROWTH OE AMERICAN AGRICULTURE, 1850-1930 •

... • .

•

65.0 57-E 51-7 45-3 40.1 38.2 36.4

• Source: Commerce Yearbook, 1933, United States Department of Commerce, I, p . 1 3 2 . For a n explanation as to how the various items were compiled, see notes to the original table, in the source indicated.

Acreage fell off following the depression of 1920-21 (see T a b l e V I I I ) , but the total in 1 9 3 0 exceeded that of 1920. These figures indicate a trend and not an exact picture of growth. If we may assume that this estimate is reasonably accurate, it seems clear that the extent of our agriculture has advanced steadily when we consider it from a long-run point of view. T h e percentage 1 By J o h n M. Chapman.

164

T H E

F A R M E R

A N D

I N F L A T I O N

of all farm land improved has changed materially for several decades, being 53.1 in 1880 as compared to 57.4 in 1890, 52.6 in 1920 as compared with 52.9 for 1930. It is worth noting, however, that rural population has shown a continuous decline, as a percentage of the total population, since 1880, when it was 65 per cent. In 1930 it had dropped to 36.4 per cent. T a b l e VIII shows the changes in acreage and population in the United States from 1850 to 1930. It has been consistently urged that inflation would increase the price of farm commodities, which would in turn lessen the burden of mortgage debt. T o advocate seriously an inflationary program to lessen the debt burden is to assume that all farmers —or at least a majority of them—are in debt and, further, that their debt is so great as to be a primary economic factor with them. There can be no doubt that the farm debt is in many cases exceedingly heavy, but reliable figures show that less than three-fifths of our farms are mortgaged. 2 T h e r e is a strong demand for inflation in this country to lessen the financial burden of the farming class. How has inflation affected the agriculturist in the past, and, furthermore, how will he be affected in the future by inflation? F A R M P R I C E S AND T H E W O R L D

WAR

T h e Bureau of Labor Statistics' index of wholesale prices based upon the 1926 average for farm products rose 0.3 during the year 1915, while the average for all commodities advanced 1.4. During the years 1916-19, inclusive, the average price index for farm products rose sharply, reaching a peak in 1919 at 157. T h e average for all commodities was 138.6 for the same year; but it reached a peak of 154.4 *rl »920—a year later than the peak for farm products. From these data, as well as from Table IX, it will be seen that farm prices advanced 2 T h e gross farm debt in 1932 a m o u n t e d to $12,000,000,000, which consisted of $8,500,000,000 of farm-mortgage debt a n d $3,500,000,000 short-term debt. S e e The

Internal

Debts

of the

United

States,

ed. by E v a n s C l a r k

( M a c m i l l a n Co.,

'9S3)- P" T h e present mortgage d e b t on f a r m properties is a b o u t $8.5 billion or 25 per cent of the value of all f a r m land and buildings or about 40 p e r cent of the value of all mortgaged farms," ibid., p. 24.

T H E F A R M E R AND

INFLATION

165

rapidly to a level higher than the average for all commodities. Certain other articles included in the general index of the Bureau also rose above the level for agricultural products. T h i s , for example, was true of chemicals and drugs, fuel and lighting, hides and leather products and miscellaneous commodities. T h e advance in the prices of farm products was due to the huge demand made by the American government and the Allies for war purposes. In addition to this heavy demand, there was a general impetus to rising prices from other inflationary forces, which resulted in part from the methods of financing employed both by the United States and by the Allies. Inflation manifested itself in the United States in an enormous expansion of bank credit and by a very considerable expansion of Federal Reserve note currency; chiefly, however, by bank credit, which was due to the action of the Treasury through the Reserve banks in marking up credit on the books of banks through the sale of short-term certificates or long-term bonds to the banks, which had paid for these securities merely through book entries as just indicated. War prices of farm products were so high as to result in very large profits for farmers, which in turn enabled them to expand still further their operations and to continue these operations following the close of the war. Large postwar crops resulted directly in decreasing the prices of agricultural commodities. T h e farmer thus stood at a great disadvantage compared with the manufacturer, as well as with other factors in industry. These conditions account for the very serious efforts which were made during the years 1920-23, inclusive, to improve the financial position of farmers. During the period following the war, farmers suffered rather severely in practically all farming regions. Many were unable to hold their high-priced land. When business revival came in the twenties, the status of the farmer was not improved to the same extent as that of the manufacturer. T h e actual position of farmers may be more clearly seen by comparing changes in the prices the farmer received for the products he sold with

166

T H E FARMER AND

INFLATION

the changes in the prices of the commodities he bought." T h i s relationship is presented in T a b l e IX. T h e reader will observe that the base years of the two tables are not the same. T h a t in the text it is based upon 1923-25 average, while the data in the footnote on this page are based on the 1910-14 average. Table I X shows that the farming class enjoyed a distinct advantage during the war period, 1915-20. T h e farmer was enjoying prosperity greater than that accruing to those from whom he purchased commodities. Prices of farm and manufactured goods were more nearly similar. Table IX shows that the farmer fared better than the manufacturing group for the period 1910-14, whereas the other data indicate that the two classes of prices were almost the same when averaged for the full period, agriculture having a very slight disadvantage. Both tables, however, show that the farmer has suffered distinct disadvantages, since about 1920, in purchasing power. Herein lies the primary source of the farmer's difficulties. His prices have fallen further than those of the goods he must buy. One serious 3 See Recent Economic Changes (McGraw-Hill Book Co.), II, 548, from which the following is abstracted, showing index numbers as indicated (1910-14 = 100):

YEAR

igiO igil igia '913 '9'4 '915 1916 '917 1918 1919 1950 1921 1922 19*3 1924 1925 1926 192;

PRICES RECEIVED FOR FARM PRODUCTS 103 95 99 100 102 100 " 7 176 200 209 205 116 124

PRICES PAID B Y FARMERS FOR COMMODITIES BOUGHT

R A T I O OF PRICES RECEIVED TO PRICES PAID

98 101 IOO IOO 101 106 123 150 178 205 206

I06

156

134 147 136

152 •53 '54 '59 156

13'

^54

135

93 99 99 101 95 95 118 112 102 99 75 81 88

FARM W A G E S PAID TO HIRED L A B O R

97 97 101 104 101 102 112 140 176 206

T A X E S ON FARM PROPERTY 1 9 1 4 = IOO

IOO 102 IO4 IO6 Il8 130 '55 217 232 246

87 92

239 150 146 166 166 168

87 85

171 170

253 258

249 250

T H E

F A R M E R

A N D

I N F L A T I O N

167

obstacle to recovery in the price of his commodities is found in his enlarged production during the World War to meet wartime demand, which was not reduced to correspond to the reduced demand following the war. This disparity continued up to the beginning of the depression in 1929 and has become more serious since that date. TABLE

IX

P R I C E S R E C E I V E D A N D P R I C E S PAID BY F A R M E R S (1923-25 = 100)*

YEAR

1910-14 1915-20 1921-25 1926-30 1920 1921 1922 >923 1924 1925 1926 1927 1928 1929 '93° 193' 1932

PRICES PAID BY FARMERS FOR COMMODITIES BOUGHT

PRICES RECEIVED FOR FARM PRODUCTS BY FARMERS

TOTAL

FOR LIVING

FOR PRODUCTION

72 121 94 95 147 83 89 97 96 106 98 94 100 99 84 58 4'

65 104 IOO 99 '33 IOI 98 99 99 103 IOI 99 IOI IOO 94 81 70

6l 102 IOO 98 '39 IOI 98 99 99 IOI IOI 99 99 98 93 79 67

69 I06 99 99 121 98 97 98 99 103 99 99 IOI IOI 97 84 74

• Source: Commerce Yearbook, 1932, United States Department of Commerce, I, p. 137. Computed from indexes of the Departments of Agriculture and Labor; and five-year averages from Statistical Abstract of United States, 1933, p. 568, Table 541. A G R I C U L T U R E DURING T H E

WAR

Farmers enjoyed an advantage during the war by reason of high agricultural prices in comparison with the general price level. They were able to sell practically everything they could produce. Demands made by the governments of this and other countries were so great that prices rose in an unprecedented way. High prices were not themselves an unmixed evil, but certain unfavorable results were present in the depression of

168

T H E F A R M E R AND

INFLATION

1920-21. Many farmers were led to believe that war prices were permanent and that farmers would be enabled to produce large crops and at the same time realize very high prices. T h i s belief encouraged an era of land speculation among farmers. Not a few farmers borrowed heavily from banks, mortgaging their farms to buy new lands to expand their operations. In this way, many otherwise prosperous farmers became heavily indebted, through the advice or financial support of the bankers of their respective communities. Following the close of the World War, farmers who had failed to use their war profits to retire their indebtedness and who had, instead, purchased more high-priced land, found their situation growing worse. T h e y received a rude shock when prices began to recede after the war. Foreigners were unable to buy our surpluses, since they were unable to pay for them. T h e domestic market shrank also, leaving farmers in many cases unable to sell their crops for cost of production—in some cases for even the marketing costs. T h e y were then no longer in a position to pay interest on the debts contracted in purchasing new land and in not a few cases, moreover, they were unable to pay either their bank loans or the interest thereon. T h i s condition gradually grew worse as prices declined. T o make matters more difficult, prices of agricultural commodities, as pointed out earlier in this chapter, fell further than the prices of the goods and commodities which farmers were forced to buy. When the price of land fell sharply, the market for agricultural land largely disappeared in many communities. Foreclosures became frequent, with the result that many farmers lost their equity. T o avoid complete loss, many farmers induced sellers to take back newly purchased land, on condition that the buyer would lose all he had paid, to which some sellersrealizing the situation—readily agreed. In such instances the farmer was able to salvage something—perhaps his old farm. In other cases where the seller refused to take back the land, the farmer saw both his new and his old farm go to pay off the purchase price of the new farm plus any outstanding bank loans. Such a situation was of frequent occurrence among farm-

T H E FARMER AND INFLATION

169

ers who h a d gone into d e b t to b u y new land owing to a belief in the p e r m a n e n c e of new prices a n d of a "new era" for farming. T h e u n d e r l y i n g cause f o r this condition was to be sought in the inflation of agricultural commodities which accompanied t h e W o r l d W a r . Farmers were victims of conditions over which they had originally n o control, though they might, as a g r o u p , have avoided postwar losses t h r o u g h self-restraint. T h e y failed to recognize the situation a n d e m b a r k e d u p o n an experiment in speculation. T o be sure, the f a r m e r was enjoying high prices, b u t he m a d e the mistake of assuming that those high prices came as a result of sound economic changes or methods of production. I n many cases h e purchased new cotton or tobacco l a n d on the basis of high-priced commodities b u t commodity prices fell, also the price of land. Many farmers sold o u t a n d " t o o k " their losses, while thousands of others, who were in somew h a t better financial condition, were able to pay a little each year, a n d so to retain control. T h e situation failed, even over a period of years, to right itself, a n d debts became more b u r d e n some. Falling prices of agricultural commodities and lack of markets in m a n y cases, together with a f u r t h e r failure of t h e prices of commodities purchased by farmers to fall equally, combined to r e n d e r the operations m o r e difficult. T h e general farm condition raised a political issue. F a r m i n g was regarded by some as a basic industry, and, as such, to be supported at all costs. H e n c e t h e r e gradually came into existence a strong desire a m o n g politicians to subsidize the f a r m e r . I n 1922-24, it was urged that he needed better marketing facilities. T h i s view gave rise to cooperative m a r k e t i n g organizations which were designed to find ways and means for enabling the f a r m e r to carry crops u n t i l that season of the year when he could get the highest price, or to hold t h e m so as to secure "orderly m a r k e t i n g " which seemed to promise a higher average price. T h a t m o v e m e n t created a widespread interest, b u t it did n o t solve the f a r m p r o b l e m . Still later, effort was widely m a d e to afford cheap credit so that t h e farmer m i g h t carry his mortgages.

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THE FARMER AND

INFLATION

Farmers entered the depression in 1929 in a less favorable condition than did merchants and manufacturers. T h e efforts put forth by many to produce what they could when their income from various sources was shut off, tended to make it more difficult to sell what was produced. Agriculture, for this and other reasons, declined more during the depression than did many other businesses. Farmers were placed in a very vulnerable position, being threatened in many cases with the loss of their farms. It is thus clear why the farmer was regarded as being in a more serious plight, and therefore to be singled out as entitled to special attention through a cheap-money program. THE

FARMER

AND C H E A P - M O N E Y

PROPAGANDA

Conditions in the field of agriculture which had been seriously depressed so long, as described in the preceding pages, placed the farmer in an unfavorable position. Following the close of the World War, relief first took form in providing more and cheaper credit, on the assumption that farmers would thus be able to market their crops in a more orderly way, and so to secure a larger return for goods produced. T h e Federal Intermediate Credit banks, which placed the emphasis on marketing rather than production credit, were established under the act of 1923. T h i s assisted some farmers, but it failed to solve the problem, since the trouble was not largely financial. President Hoover's administration tried to assist farmers in various ways, through an organization known as the Federal Farm Board. T h i s Board undertook to maintain the prices of certain agricultural products by buying and holding the products—thus keeping them off the market—through the use of government funds. T h e policy resulted in serious disturbance of the market for these commodities, to say nothing of heavy expenses and losses incurred by the Federal government in carrying out the program. T h e plan failed; the difficulties still existed when the Roosevelt administration came into power. Those who believe that higher prices will bring better results, generally favor any method designed to produce a rise in

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prices which, of course, means a cheap-money policy or, for this country, a "cheap dollar." T h e "tinkering" with the price of gold and silver has been regarded by many as a method which was certain to improve the financial position of the agricultural class. T h e failure of the monetary policy to render such benefits has led to the use of other methods, such as controlled production, to boost prices. Still later, the "home-renovating" campaign, by which it is hoped to give such an impetus to business as will improve the economic conditions of the various classes in the community, has been put forward with enthusiasm, though with little beneficial result. UNWARRANTED

EXPECTATIONS

Recent efforts and campaigns for cheap money and credit have placed the farm group in a position to expect "relief," in one form or another, which will enable them to borrow funds for the purpose of holding commodities off the market and for the purpose of securing higher prices. Where higher prices were actually realized, farmers generally increased production which, in turn, increased the difficulty of disposing or marketing the products, resulting in a still larger stock, which had frequently to be carried till the following year—if not for a longer time. Under our competitive economic system, rising prices have very often led to an increased production and, in order to prevent such a situation in the future, some type of control is deemed necessary. It is useless, as a national policy, to expect farmers voluntarily to reduce their production after having spent years to perfect it. They may, and doubtless will, accept pay for letting a part of their acreage lie idle, but even this will not prevent an intensive cultivation of the remainder of their land. One of the most serious aspects of the agricultural relief policy is seen in the fact that it is intended to be largely temporary in character. Such relief, or help, fails to solve the more serious problem facing the agricultural class—that of adjusting supply to demand. Farmers as a group want to increase their production in order to increase their consumption of other

172

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INFLATION

goods which they can secure in exchange for their own commodities. Farmers, as is the case with practically all other members of the community, still have many wants unsatisfied, and these can be satisfied, in the long run, only by a greater volume of production. Cutting down production may aid in some cases temporarily, but it cannot be considered seriously as a solution of a perplexing problem. Inflationary forces may be used to bring about higher prices by depreciating the currency in terms of which the price is expressed, but such a change will not necessarily mean that when the commodities are thus produced and exchanged, the farmer will get any more in terms of other goods than he would have, if prices of farm products had been stated on a lower level. Of course, if we assume that agricultural prices can be raised without a corresponding rise in other commodities, the farming class will benefit. T h i s is not likely, except for very short periods of time. Where inflation is deliberately resorted to, on the assumption that it will raise prices, farmers are led to believe that they will receive benefits, but these cannot be permanent. Farmers, under such circumstances, will generally feel that they are being benefited by reason of higher prices. T h e y frequently fail to appreciate that what is actually taking place, is only a proc ess of marking up prices in terms of currency. Moreover, they fail to realize that the higher prices affect all commodities— those which farmers buy as well as those which they sell—with the result that, relatively, they may be no better off than before prices were artificially driven up. In the long run, of course, the agricultural class will be worse off, by reason of the derangement of trade which must follow a period of inflation. T h e fact that some may be able to reduce the amount of their mortgages by reason of cheap money, will not prevent them from being led into the position of expecting far more dian can be secured either on a long- or short-term basis.

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FARMER

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INFLATION

173

POLITICS, FARM PROGRAM AND INFLATION

As we have earlier stated, the prices of the commodities which farmers have for sale declined faster after the war than the prices of the commodities which they had to buy. This unfavorable situation became more intense as the depression continued, with the general effect that the farmer was unable to show a profit. Under such circumstances, many farmers became discouraged and demanded that something be done to make it possible for them to dispose of their crops on a profitable basis. This help has, as we have endeavored to show, been granted in the form of cheap credit or of loans designed to enable farmers to hold their crops off the market in the hope of receiving higher prices. In some cases, as, for example, during President Hoover's administration, such assistance was to be provided by a corporation organized and financed by the government with the object of controlling prices through the purchase and holding of large quantities of products. Farm relief may be drawn into politics in two ways at least: First, through the farmers' representatives in Congress, who appreciate the importance of considering the question of financing the farmer; second, by politicians anxious to gain favor and hold the political support of farm groups, which is important in certain states where agriculture is a leading industry. T h e desire of certain politicians to assist this class leads them frequently into the false position of assuming that higher prices are the equivalent of prosperity. If such an attitude be assumed, the next step is to find ways and means of raising prices. Currency depreciation seems to offer a solution, but such a method will usually be avoided, at least directly. Soon, however, excuses are found for raising prices on the basis that they are too low, and that a period of "reflation" is needed to restore prices to a normal level. T h e effort to raise prices generally means inflation, or a depreciation of the currency, or both.

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FARMER

AND

INFLATION

T H E FARMER AS A F F E C T E D BY INFLATION

T h e farmer, in the long run, is not helped by inflation. In the short run, some may be relieved of a part of the debt burden. C h e a p money tends to reduce the debt burden and may rid farmers of mortgage obligations. Farmers may, moreover, by reason of the heavy demand for products, enjoy an advantage for a time, relatively speaking, as a result of inflation. T h e outlays for labor and fixed expenses do not advance as rapidly as agricultural prices. Farmers may thus gain at the expense of the laborers and the consumers in the community. T h e fact that the purchasing power of consumers' dollars declines sharply during a period of inflation will of necessity reduce the demand for goods, hence leave the farmer in a position of losing at least a part of the advantage gained through the earlier disparity of prices and costs. T h e foreign markets for agricultural commodities will be disturbed and, sooner or later, the exports, if any, must decline. W h e n the period of inflation is ended, as it finally will be, the farmer must reduce costs and prices to meet the lower price level which follows every period of inflation. T h e n , he must readjust himself to the new price level. T o the extent that this readjustment is not effected, the farmer will be unfavorably situated, just as he was in this country at the close of the W o r l d W a r , or as he was in Germany following the stabilization of the mark in 1923. It matters not a whit whether we have controlled or uncontrolled inflation, in so far as the principle is concerned. Of course, the effects will be the more serious, the further inflation is carried. If the government stops before the currency is completely thrown into the abyss, as with France in 1926, it will, as a matter of fact, have less damage to repair than did the people of Germany in 1923. It is a matter of degree, not of principle. If we devalue our currency, it is held that there will be a larger foreign demand and that exports will expand. T h a t was true of France following her stabilization. Such a result should not be regarded as a gain for home producers. It is, in fact, a loss

T H E FARMER AND I N F L A T I O N

175

to the producers or sellers of domestic goods, since they are selling their goods abroad and receiving less than their value. In short, the domestic producer is suffering a loss, while the foreigner who gets such commodities derives to a great extent the benefit. T h e United States cannot secure even that questionable advantage at this time because of the many restrictions on the movement of goods into other markets. Foreignexchange restrictions, quotas, and allotments, are all being used by certain foreign countries to protect their own currencies, and prevent others from realizing advantage. Conditions were different in France in 1926, when most countries were striving to return to a gold standard, the monetary system prevailing generally before the war. Severe restrictions such as exist today were not then imposed on international trade.

X T H E BUSINESS M A N A N D I N F L A T I O N

1

MERCHANTS, dealers and manufacturers invariably find that a fluctuating price level is not conducive to the sound operation of a business enterprise. D u r i n g a period of inflation, they are never able to judge with any degree of assurance the future markets for their commodities; consequently, they are not in a position to buy in advance to best advantage. Inflation almost unavoidably tends to make a speculator out of an otherwise conservative business man. M a n y w o u l d probably prefer a slowly rising price level, if it could be maintained, b u t lacking that, what is most desirable from the commercial point of view is a price level in which there are few changes—a stable price level. D u r i n g past periods of inflation, the business man has found it necessary at times to change his practices in selling goods. A good example of such change is afforded by mercantile practice following the Civil W a r . Prior to that war, the use of the trade acceptance was fairly general. T h e cash discount system is a more recent device. D u r i n g and immediately following the Civil War, when prices were rapidly rising and were fluctuating as a result of the inflationary policy of the government of the United States, business men were inclined to follow the policy adopted in Germany in 1923 w h i c h was to convert all transactions into cash as quickly as possible in order to lessen the risk and to enable merchants immediately to employ such funds in the purchase of other goods before a market change in prices occurred. Such urgency in the collection process was necessary to shorten the period of time between the sale of one batch of goods and the purchase of another. Merchants endeavored to keep as little as possible of their assets in the form of cash and credit. In order to induce buyers to pay cash, the sellers initiated the practice of offering a cash discount to the buyer if 1 By John M. Chapman.

T H E BUSINESS MAN AND I N F L A T I O N

177

he would pay cash within a given time. T h e rebate for cash was so fixed as to be worth while, even though the buyer himself might find it necessary to borrow from his own bank in order to take advantage of the offer. T h e primary object of the method was not to introduce a new system, but rather to lessen the danger of loss under the existing system—a danger resulting from inflation which had been forced upon the country as a result of the methods followed in financing the Civil War, with consequent uncertainty regarding the future value of money. A by-product of this effort at self-protection was the socalled cash-discount system, accompanied by a reduction in the use of trade acceptances. 2 Incidentally, no doubt, the decline in the use of trade acceptances had some influence in similarly contracting the use of bankers' acceptances, though a more important factor in checking the latter was the National Banking Act, the provisions of which practically prohibited national bankers from accepting such instruments. Another example of the effect of inflation upon business practice may be seen in the volume of foreign trade of countries which have adopted an inflationary policy. T h e exchange rate of the country pursuing a policy of that species, as compared with the rates of those maintaining a sound monetary system, is generally sharply downward. While it is perhaps true that some communities may have gained a temporary advantage of a kind from currency depreciation, the final results have been to derange the whole international trade of such a country. Speaking of the results of inflation upon the international trade of France and Italy the economist of the Chase National Bank of New York City says: During the post-war years when their exchange rates were falling, French and Italian exports were hampered, not helped. Between 1919 and 1926 they amounted to only 74 per cent of imports in the case of France, and 56 per cent in the case of Italy. With the benefits of stable currency at work these figures rose from the 192731 period to 89 per cent and 73 per cent, respectively. Figures are 2 For a discussion of the cash discount system, see Steiner, W. H., The Mechanism of Commercial Credit, D. Appleton and Co. (New York, 192s), pp. 69-87.

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T H E BUSINESS MAN AND

INFLATION

available in terms of quantities for Belgium and Germany. It appears that Belgian exports increased more than 30 per cent in the three years following stabilization of the currency, while German exports increased no less than 160 per cent. In 1931, a year of deep depression, but firmly maintained currency, German exports were more than four times what they were in 1923, the banner year of depression. Similarly, the increased trade expected by countries which left the gold standard in 1931 did not develop. Comparing exports of the three leading non-gold countries of Europe for the first nine months of 1931 with the first nine months of 1932, we find a decline of 7 per cent in the case of England, 19 per cent in the case of Sweden, and 22 per cent in the case of Denmark. These percentages are in terms of domestic currencies; in terms of gold, the decline is much more striking. 8 O n e of the arguments advanced in the United States in favor of a "devalued" dollar has been that it would bring about a lower exchange rate, the dollar being depreciated or lowered in terms of foreign currencies. This, it was urged, would make the United States a favorable place in which to buy, b u t not in which to sell goods, so that there would be an expansion of exports which would help restore prosperity. As proof of this contention, advocates pointed to what had taken place in France after 1926, when the franc was stabilized at a rate below its internal purchasing power. Exports then increased and enabled France to build u p large foreign balances. These advocates neglected at least two important factors: (1) that this increase in exports amounted to a sale of goods at less than their real value, the loss being borne by the citizens of France, to the advantage of the rest of the world; (2) that such an advantage as was realized by France as a whole was only temporary, and not a permanent solution of any economic problem. A further weakness in the current argument of the present demand for devaluation in the United States is seen in the action of other countries in creating, against the importation of goods, one barrier after another, which did not exist in 1926 when France stabilized her currency. Inflation is, then, an obstacle—not an aid—to the deveiop» Anderson, B. M., The Chase Economic Bulletin,

May 9, 1933, pp. 6-7.

T H E BUSINESS MAN AND I N F L A T I O N

179

ment of either domestic or foreign trade. Exporters and importers, as well as domestic traders, are well aware of the uncertainties common to all countries where inflation is taking place, which grow out of a depreciated or fluctuating currency. Inflation, moreover, must be regarded as a special hindrance to the proper growth and expansion of international trade. In view of the great disadvantages which result from inflation through the disruption of trade and commerce, it might well be supposed that business men would, at all times, be opposed to any form of inflation. Such is not the case, however. Business men sometimes mistake rising prices for prosperity and when once prices start upward, temporarily showing a money profit somewhat in excess of that realized on sales or business during more normal periods, they are inclined toward any policy that promises a still higher level of prices. If such a return is not realized, the shortsighted will advocate a type of inflation calculated to bring about a greater volume of business. At such times, they profess to find some reason for believing that the price level is below normal or that there is "not enough money in circulation." During the past year or more, in the United States, this type of advocate has termed such a desired expansion "reflation." T h e desire for an expansion of business is no doubt basic in the efforts or wishes of many business men to secure a higher price level, or, as they term it, "inflation." Not a few have accepted the thought that a rise in prices would naturally follow an expansion in the supply of money. They have failed to realize the importance of bank credit, as well as the difficulty of getting a larger volume of currency into circulation and keeping it there. Thus a severe depreciation of the currency frequently occurs before such business men actually experience the higher price level desired. In this gradual process many business men are drawn into the net of inflation while others support it for reasons of personal profit. They have perhaps become heavily indebted or their property has shrunk in value so that there appears to be little chance of their being able to meet their obligations. Higher

180

THE

prices a n d

BUSINESS MAN inflation seem

AND

to p r o m i s e

INFLATION a reduction

of

their

b u r d e n , a n d t h e belief g r o w s that if d e p r e c i a t i o n b e carried far e n o u g h it w i l l practically w i p e o u t d e b t . S u c h a c o n d i t i o n has b e e n d e v e l o p e d in t h e past, w h e n a c o u n t r y a d o p t e d a speculat i v e p o l i c y of d e p r e c i a t i o n . O n e w r i t e r describes t h e situation in F r a n c e in 1791 as follows: T h e great debtor class, relying on the multitude w h o could be approached by superficial arguments, soon gained control. Strange as it might seem to those who have not watched the same causes at work at a previous period in France and at various times in other countries, while every issue of paper money really made matters worse, a superstition gained ground among the people at large that, if only enough paper money were issued and were more cunningly handled the poor would be made rich. Henceforth all opposition was futile. 4 T h e same writer, r e f e r r i n g to t h e effects of an inflationary p o l i c y u p o n the m a n u f a c t u r e r s i n F r a n c e at that t i m e , said: Manufacturers at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce. From time to time there was a revival of hope caused by an apparent revival of business; but this revival of business was at last seen to be caused more and more by the desire of far-seeing and cunning men of affairs to exchange paper money for objects of permanent value. As to the people at large, the classes living on fixed incomes and small salaries felt the pressure first, as soon as the purchasing power of their fixed incomes was reduced. Soon the great class living on wages felt it even more sadly. 5 A g a i n he c o m m e n t e d , as follows, u p o n the effects 011 the great m e r c a n t i l e class: T h e mercantile class at first thought themselves exempt from the general misfortunes. T h e y were delighted at the apparent advance in the value of the goods upon their shelves. But soon they found that, as they increased their prices to cover the inflation of currency and the risk from fluctuation and uncertainty, purchases became less in amount and payment less sure; a feeling of insecurity spread throughout the country; enterprise was deadened and stagnation followed. «White, Andrew D., Fiat Money (New York, 1933). p. 32. »Ibid., pp. 63-64.

Inflation

in France,

D. Appleton and Co.

THE

BUSINESS

MAN

AND

INFLATION

181

New issues of paper were then clamored for as more drams are demanded by a drunkard. New issues only increased the evil; capitalists were all the more reluctant to embark their money upon such a sea of doubt.8 Some still insist upon inflation, despite its past history, on the ground that we are better able to manage and control it today than was formerly possible. Moreover, it is urged that if we deliberately set out with a definite goal and keep well within the limits of our policy, we shall realize good results and avoid those evils that follow excess. In addition, some maintain that what is now wanted is an expansion of effective purchasing power in the form of credit, asserting that such expansion differs essentially from the issue of paper money. Such advocates fail to realize that the two are the same in principle. T h e former is the more subtle and insidious, while the latter is more easily recognized by the rank and file of the community. T h e truth of the matter is that the two techniques differ only in degree, not in theory. Merchants and manufacturers, as well as other types of business men and investors generally, have found that inflation is essentially the same, regardless of form. INDUSTRIALISTS AND INFLATION

It is recognized and admitted that inflation results in a redistribution of wealth—indeed, the policy is ordinarily pressed for that very reason. T h e sum total of wealth of a given country, or of all countries, will not, as we have seen, be increased by resort to inflation; yet, relatively, certain groups in the community may, and frequently do, benefit at the expense of others. Those best able to take advantage of a rapidly changing economic situation are those most likely to win at the expense of their neighbors. So the question naturally arises, which group or groups in our economic system occupies the most favorable position and can, therefore, take advantage of inflation and increase the sum total of its wealth, while others less fortunate may lose all or a part of their property? During a period of inflation or of rapidly rising prices, it is 8

Ibid., p. 64.

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T H E BUSINESS MAN AND

INFLATION

not for the best interest of the individual borrower or corporation to pay off indebtedness, but rather to increase it in order to use a larger volume of goods or productive power. T h e purchasing power of the funds borrowed in terms of the depreciating currency falls, while the goods are used to secure advances in terms of currency. T h e debtor will be able, therefore, to pay off his debts at a later date and still retain a large part of the goods secured by borrowing. In those cases where inflation is carried to its utmost limit, as in Germany in 1923, the debtor may finally find his debts reduced practically to zero by reason of the worthlessness of the currency in the terms of which his debts were originally contracted. In the United States today we are encouraging the process of borrowing to satisfy various economic groups, while the Federal government is itself borrowing extensively, forcing its own obligations into banks throughout the country. At the same time, many are intent on reducing the value of the currency in which such debts are stated. T h e group which is best situated to take advantage of the conditions thus outlined includes large industrialists 7 who usually have an excellent credit standing at the banks and will therefore be most likely to secure the use of such credit, though it must be admitted that entrepreneurs have followed no such policy in the United States during recent years. In other countries they have often had the lion's share of working capital when inflation began clearly to manifest itself. T h e y were not only able to secure credit, but they already had outstanding large volumes of bonds and debentures which could be retired during the later stages of a period of inflation for a small fraction of their original value. T h e industrialist group then, more " T h e industrialist class was unable to increase the physical e q u i p m e n t of the plant in proportion to the amount used for that purpose. Still, they plowed large sums back into the plant and equipment, rather than risk them in cash or on deposit with the banks. In some cases such expansion was very uneconomical and resulted in additions that were not suitable for f u r t h e r production after stabilization had been elfectcd. Angel! sa\s, " t h e physical v o l u m e of production . . . remained almost continuously below the 1 9 1 3 level." See The Recovery of Germany, p. 45. H e adds (p. 46) (hat " t h e general state of industrial technique deteriorated, both relative to the position of other countries and even in absolute terms."

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MAN

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183

than any o t h e r class, m a y u l t i m a t e l y increase their h o l d i n g s of p r o p e r t y a n d w e a l t h . T h i s has b e e n t r u e d u r i n g t h e periods of inflation in t h e past in o t h e r c o u n t r i e s a n d w i l l c o n t i n u e to b e true i n the f u t u r e . In discussing t h e s i t u a t i o n w h i c h existed in G e r m a n y in 1923, Professor A n g e l l says: T h e class which lost least and profited most from the inflation was the industrialists. T h e principal reason was that the money income of the industrial firms, their receipts from the sale of their products, usually increased much more rapidly than their money expenses, and left them with correspondingly larger profits. After each new rise of the foreign exchanges, the first thing that usually happened was a new advance in the principal wholesale prices. Wages, salaries, rents, interest rates, and taxes rose only later and much more slowly, and in the interval the increased spread between them and prices was clearly pure gain for the industrialist . . . Finally, the manufacturer also profited enormously insofar as he was able to operate on borrowed money. W h e n the time came for repaying the loan, he nearly always found that he was giving back a much smaller real value than he had received. 8 O t h e r g r o u p s w h o b e n e f i t e d at t h e e x p e n s e of the

wage

earner, t h e business m a n , a n d the salaried class, are the speculators, a g r i c u l t u r i s t s a n d o t h e r b o r r o w e r s w h o w e r e a b l e to take a d v a n t a g e of t h e use of a v a i l a b l e b a n k credit. T h e

farmer

w o u l d b e n e f i t o n l y to t h e e x t e n t that there w o u l d be an advance in the p r i c e of the c o m m o d i t i e s he was selling, greater p r o p o r t i o n a t e l y than his costs. H e w o u l d also benefit by reason of his a b i l i t y to pay off his m o r t g a g e indebtedness w i t h a c h e a p e r m o n e y . If he be a creditor, as m a n y w e r e and are today, h e w o u l d suffer a loss on such o b l i g a t i o n s in just the same way that all o t h e r creditors u n d e r g o a loss. T h e so-called m i d d l e class usually suffers the greatest losses, surpassed in e x t r e m e cases, perhaps, b y the w a g e earner w h o is u n a b l e to secure a sufficient i n c o m e w i t h w h i c h to b u y f o o d and o t h e r necessaries of life. T h e small saver a n d fixed-income r e c i p i e n t , t h e life-insurance-policy

h o l d e r or

savings-account

o w n e r , w i l l suffer heavily. T h e g e n e r a l c o n t e n t i o n that inflation w i l l increase business and b e n e f i t the w a g e earner is the ' Angell, J. W . , The

Recovery

of Germany,

pp. 34-35.

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T H E

B U S I N E S S

M A N

A N D

I N F L A T I O N

reverse of the facts. On the other hand, while inflation may help the farmer to a certain extent, the class that is able to benefit most is that which already has a distinct advantage—the large industrialists. EFFECT

OF

HIGHER

PRICES

MONETARY

BROUGHT ABOUT

BY

MANIPULATION

One of the evil effects of forcing prices higher through a manipulation of the monetary system appears in the abnormality of the type of business that prevails in many regions. Such an expansion means not an increasing value of goods, but rather a depreciation of the currency. Under such conditions, a considerable volume of the business transacted represents money in flight from the depreciating currency. People buy as soon as they control purchasing power. As soon as the period of inflation shows signs of approaching its end, the volume of business declines and is likely to remain stagnant for some time to come. T h e business man is then unable to keep his inventories u p to normal and realizes a small profit, if any, in the business he does transact, since the value of his money depreciates quickly. Usually he would have been better off if he had kept his goods instead of selling them in the hope of replacing thern at a favorable price. Causes leading to inflation through the issuing of paper money are often found in an unbalanced national budget and in the opposition to a higher tax burden. Such taxation seems to be a more painful method of providing funds for a necessitous government. As a matter of fact, the higher prices brought about by depreciation fall, as we have seen, heavily upon the business man and wage earner, and amount in the end to a very serious burden—so heavy at times that the small wage earner's savings are completely destroyed, while the business man finds his capital gradually worn out or wasted away with no available means of restoring or replacing it.

T H E BUSINESS MAN AND I N F L A T I O N ALLEGED BENEFITS OF H I G H E R

185

PRICES

Serious efforts have been made in the past, both in this and other countries, to show the business community that a period of rising prices was beneficial to all classes in the community. Some have contended that if prices slowly advance there is an incentive to f u r t h e r productive and business activity. Profits are presumably more certain and the business man becomes more desirous of increasing his volume and of expanding his operations in various directions. A feeling of confidence pervades the community, and both capital and labor will receive larger returns for the contribution each makes toward the product brought into existence for consumption. Such a period is certainly more favorable to the operations of speculators since they base their operations primarily u p o n anticipated fluctuations in the prices of the various commodities or securities in which they happen to be speculating. A familiar argument in favor of higher prices, as pointed out elsewhere, is that such prices induce the entrepreneur to expand his operations in the hope of greater rewards. T h i s expansion will call, in turn, for a greater n u m b e r of laborers and longer employment, and at the same time will increase the demand for raw material or goods to carry out the policy thus adopted. T h i s demand for larger supplies will spread throughout the community and result in a larger production of goods of various kinds, each, in turn, to bring about a larger volume of income for labor which will be spent to a considerable extent for the goods so produced, thus taking them off the market for consumption purposes and making room for the production of still other goods. T h i s movement, it is contended, will spread, once it gets momentum, until all classes find an opportunity to use their efforts to the fullest extent for the creation of goods and services. T h e income thus realized will not all be consumed, b u t the prosperity and confidence of the community will lead directly to the saving of large sums which will be made available in the form of investment funds to provide the means for expanding

186

T H E B U S I N E S S MAN AND

INFLATION

fixed plants, and to furnish the funds needed not only for replacing worn-out machinery and equipment, but for capital necessary to introduce new methods of production and to expand the old plants in addition to keeping them in repair. T h i s line of reasoning has been carried a step further by advocates who have contended that higher prices were essential, at least desirable, and who further have recommended or urged the spending of large sums of money, if necessary, by the Federal government in order to bring about a revival of business activity. A weak spot in this line of argument is seen in the assumption that once the government accepts this program, private capital and initiative would stand ready to take over the burden of pressing it to a conclusion. Advocates of this view have failed to see the difficulty in thus shifting the burden of the Federal government. In the long run, private capital will be employed to produce goods and employ labor only if there is a demand for the goods thus produced. Capitalists will not assume the risk unless there appears to be a demand for the goods and services thus created. T h e uncertainties developed around the government policies of relief and "making work" have been such as to leave the business man in grave doubt as regards the future demand for goods. Furthermore, the uncertain monetary policy adopted by our government has left the business men of the United States unwilling to assume risks and to carry on the business which they formerly did. T h i s being the attitude of the business community, the government has been expanding still further its spending program and entering other lines of activity on the ground that it was necessary to provide employment. INFLATION

DISAPPOINTING

TO

COMMERCE.

As pointed out elsewhere, one of the early effects of inflation is that of acting as a stimulus to business activity. T h i s is too frequently accepted by the business community as a sign of prosperity. As volume of business expands, there seems to be an increase in the level of profits, which is often taken as a prima-

T H E B U S I N E S S MAN A N D I N F L A T I O N

187

facie reason for further expansion of business, and gives support to such a program of inflation. Goods seemed to increase in value within a very short time. T h e increased trade made necessary the replacement of inventories which were soon sold out or disposed of. Such buying encouraged manufacturers to expand their operations in anticipation of still greater demand from merchants and the public. T h i s "era of good feeling" was destined, as we have seen in all classes of inflation, to be short-lived. Those who have been engaged in commerce and industry in various countries where inflation existed, soon realized, to their great disappointment, that what had appeared earlier as profits was a mirage. T h e total volume of business resulted in net returns smaller than they had enjoyed under more normal conditions and the purchasing power of their income dwindled at a rapid pace. T h e circumstances and uncertainty surrounding the operation of business under such circumstances were disturbing and placed a far greater risk u p o n the entrepreneur than he had ever before experienced. T h e entrepreneur, under such conditions, undertook to reduce his costs to a m i n i m u m and to conserve his resources as far as possible. In order to accomplish this end, he curtailed wages and employment and thereby reduced to a considerable extent the income of the laboring class, and consequently lessened the purchasing power of the community. This, in turn, reacted upon the merchant himself, in the form of unpaid bills and a smaller volume of sales. Another result of such a policy was evidenced by still f u r t h e r retrenchments and higher prices. This step, like its predecessor, serves only to bring about another decline in the real purchasing power of the community. One writer has said that under these circumstances all business became a game of chance, and all business men, gamblers. In city centers came a quick growth of stock-jobbers and speculators; and these set a debasing fashion in business which spread to the remotest parts of the country. Instead of satisfaction with legitimate profits, came a passion for inordinate gains. . . . There was no longer any motive for care or economy, but every

188

T H E BUSINESS MAN AND

INFLATION

motive for immediate expenditure and present enjoyment. So came upon the nation the obliteration of thrift.* A n o t h e r d i s a p p o i n t m e n t to m e r c h a n t s c a m e in t h e f o r m of s h r u n k e n inventories. Prices rose, a d d i n g e x t r a b u r d e n s to those w h o f o u n d it possible to secure a v a i l a b l e s u p p l i e s a n d t o maintain their stocks o n h a n d . M a r k e t s f o r t h e i r p r o d u c t s d e c l i n e d a n d m e r c h a n t s f o u n d it m o r e a n d m o r e difficult, as t i m e w e n t o n , to m a k e a profit. In m a n y cases, m a r k e t s practically disa p p e a r e d . T h i s a p p l i e d to g o o d s restricted to domestic

trade

a n d c o n s u m p t i o n , as w e l l as to those g o o d s w h i c h e n t e r e d i n t o i n t e r n a t i o n a l trade a n d c o m m e r c e . M a n y m e r c h a n t s e n g a g e d in t h e e x p o r t business f o u n d t h e m s e l v e s h e d g e d in b y the most r i g i d restrictions i n v o l v i n g d u t i e s u p o n g o o d s f o r e x p o r t . T h i s was especially t r u e of G e r m a n m e r c h a n t s d u r i n g the p e r i o d of speculation w h i c h reached a p e a k in 1923. T h e s e disappointm e n t s w e r e m e t in m a n y cases b y a p u b l i c d e m a n d f o r a f u r t h e r dose of inflation. T h e a d d e d s t i m u l u s seemed to o f f e r some a d d i t i o n a l h o p e . Issues of p a p e r m o n e y f o l l o w e d o n e a n o t h e r in r a p i d succession and, w i t h each a d d i t i o n a l i n c r e m e n t ,

the

m e r c h a n t s f o u n d their position m o r e a n d m o r e difficult a n d depressing. T h i s process k e p t o n u n t i l business was n e a r l y destroyed. A g e n e r a l w r i t i n g - d o w n was necessary a n d a fresh start was called for. Still a n o t h e r phase of this w h o l e c y c l e calls for a t t e n t i o n . R e f e r e n c e is m a d e to the capital i n v e s t m e n t m a d e in t h e business or businesses i n v o l v e d . M e r c h a n t s a n d traders, as p o i n t e d o u t a b o v e , h a d little, if any, profit o u t of w h i c h they c o u l d m a k e r e p l a c e m e n t s of w o r n - o u t e q u i p m e n t , or r e p a i r that w h i c h was still in use. M u c h of the fixed e q u i p m e n t b e c a m e obsolete. T h i s process, if it was of sufficient d u r a t i o n , was certain to result in the p l a c i n g of m a n y industries in a c o n d i t i o n in w h i c h

they

w e r e practically helpless and, in m a n y cases, forced o u t of business. Since profits w e r e thus r e d u c e d , or absent a l t o g e t h e r , t h e r e was little, if any, i n c e n t i v e o n t h e p a r t of those w h o had additional capital f o r i n v e s t m e n t p u r p o s e s to s u p p l y such f u n d s to a business w h i c h was d e a d o r s l o w l y d i s i n t e g r a t i n g b y reason of o White, Andrew D., Fiat Money Inflation

in France, p. 65.

T H E

BUSINESS

MAN

AND

INFLATION

189

inflation. In the end, such an inflationary policy was practically certain to leave many merchants in a position in which, to all intents and purposes, they were no longer able to carry on their business affairs. When the complete breakdown came, business men generally found themselves with a much-reduced volume of fixed capital and consequently were able to earn far less than before the period of inflation had set in. Wages and incomes were smaller, and the community as a whole was in a position in which it was actually forced to consume much less. Viewed from any angle, inflation from the point of view of the business man is seen to be ruinous to this group. SUMMARY

In general, the business man may and should be regarded as an opponent of inflation. In some cases in the past he has been misled by the temporary effects of a sudden rise of prices as a result of an inflationary policy. He is usually a victim, regardless of whether he is favorably or unfavorably disposed toward inflation. Those engaged in foreign trade find exchange rates demoralized and risks increased in the importation of goods. All too frequently, restrictions imposed by the government are so severe as to make it too costly to get goods out of the country. T h e group that suffers most from the evils of inflation is the middle class, including small business men, wage earners, salaried men and those who have savings accounts, or fixed incomes. Bondholders and those carrying insurance undergo equally heavy losses. Industrialists often suffer less than others, while farmers with mortgages outstanding may benefit by reason of the decline in their indebtedness relative to their purchasing power in general. Speculators and others who can borrow are usually benefited relatively to the middlemen.

XI INFLATION

AND

INVESTMENT1

THOSE who desire to invest in some form of capital goods are in the position of having saved or accumulated certain funds 2 usually, so far as American practice is concerned, consisting of balances in commercial or savings banks, but often, no doubt, held in the form of cash. T h e ordinary investor will seek first of all the safety of his funds, but the degree of safety which he may hope to realize will depend upon his attitude toward income. T h e higher the safety factor that is present, or is demanded, the smaller—other things being equal—will be his income. Such an investor is in the position, therefore, of so applying his funds as to receive as large a return as is consistent with safety. Serious difficulty will be encountered in carrying out such an investment program if inflation is concurrently taking place. It will be difficult to place funds in a type of investment whose value will not shrink relatively as the price level is forced higher and higher. Unless the investor holds a share in the ownership, he may find the relative value of his investment declining at a very rapid rate. T h i s will be especially true should he purchase bonds or fixed obligations of any sort. O n the other hand, should the investor resort to the purchase of stocks either common or preferred, he will take a risk which, oftentimes, and for similar reasons, may prove to be great. I n later stages of a depression, income from such shares, as well as their real value, usually shrinks. W h e r e such a condition has developed, the investor must forego any purchasing power resulting from income, which is, of course, one of the essential i Bv J o h n M. Chapman. * For the i m m e d i a t e purpose of our disc ussion at this point, it makes n o material difference whether this fund has been saved from a regular i n c o m e in t h e form of salary 01 wages, or income in the form of profits from business enterprise. T h e essential thing i« that the fund exists in ready purchasing power and is available for investment.

I N F L A T I O N

A N D

I N V E S T M E N T

191

parts of an investment program. If funds should be invested in real estate, as a " h e d g e " against inflation, the investor is likely to find it difficult to forego present income and, at the same time, to freeze his funds in a type of wealth that is not marketable, and which he may not easily convert into another form after inflation has run its course. D u r i n g a period of inflation, the investor is therefore in a trying position. H e may at times be able to protect his principal, but most investors will find difficulty in accomplishing even that. THE

INVESTOR'S

ATTITUDE

TOWARD

PRICE

CHANGES

T h e bona-fide investor, as already defined, who is seeking to secure an income from his funds, will not be, in the last analysis, interested in the price of his securities—which of course eventually represent an ownership of capital goods used for further production. T h e price he must pay for his interest in a business enterprise in which his savings are to be invested, will be of little concern to him, provided the returns are satisfactory. Many investors will expect to get the same income, proportionately, from high-priced as from low-priced, obligations. T h e y may own a larger part of a given business enterprise, or they may own a smaller interest comparatively in a larger business, if each unit is selling for a high price. In some cases it should be added, however, that stocks or bonds may be sold for so high a price, or bonds may be issued in denominations so large, that the small investor may be unable to participate because his volume of savings is small. T h e investment trust has, however, made it possible for a group of investors to pool their funds and, in this way, participate in a large list of securities representing various types of business. T h e investor will, in many cases, be seriously interested in the question of the marketability of his investment holdings. F r o m the market point of view, the price the investor will pay is a measure of ability to convert his savings thus employed into a form which will enable him to use them for consumption or otherwise, should the occasion arise. If the investor is to protect himself in this regard, he will, or should, select a security

192

I N F L A T I O N AND

INVESTMENT

that is listed on a well-recognized exchange, or perhaps he may leave such funds with a savings bank, accepting the small interest return in order to make more certain its availability. H e may also attain the same ends by placing his savings with an TABLE

x

INVESTMENT Q U A L I T Y O F BONDS, PREFERRED AND C O M M O N STOCKS FOR LAST YEAR O F T H E TRUSTS, BASED ON 184 T R U S T S «

u 0 •< È

*8

3 * 'S H < a.

All Bonds All Preferred Stocks All Common Stocks U. S. Government Bonds State and Municipal Bonds Railroads: Bonds Preferred Stocks Common Stocks Utilities: Bonds Preferred Stocks Common Stocks Industrials: Bonds Preferred Stocks Common Stocks Financial: Common Stocks

M 0

H O

a a

u 0

ë s

g U

ë

ë


'79

21.2 5.702 7 29.052 35-8 5.677 7.0 5.964 7-4 4,116 5-1 12,020 14.8 16,136 >9-9

14,210 18.8 5,661 7-5 27.794 369 5.815 7-7 5.795 7-7 3.475 4.6 11,127 14.8 14,602 "9-4

10,542 16.7 4.738 7-5 24,622 38.9 5.649 8.9 4.3'3 6.8 2,752 4.4 9,102 14.4 11.853 .8.7

6,840 14.0 3.383 6.9 20,302 41-5 5.49" 11.2 2,588 5-3 1,865 3-8 7,024 14.4 8,890 18.2

T o t a l income paid out

81,136

75.410

63.247

48,894

• Includes m i n i n g , m a n u f a c t u r i n g , construction, steam railroads. P u l l m a n , railway express and water transportation. See Sen. Doc. 124 for e x p l a n a t i o n of t h e items in this table.

As expressed in percentages of 1929, the three main divisions (including rents and royalties under "profits") moved as follows: 7 T h e reader is referred to B u l l e t i n 49, issued by the N a t i o n a l B u r e a u of E c o n o m i c Research. T h e figures are discussed from the banker's point of view in the A p r i l , 1934, issue of the m o n t h l y bulletin of the N a t i o n a l City Bank of N e w Y o r k . T h e figures are analyzed in detail in Senate D o c u m e n t N o . 124, 73d Congress, 2d session, National Income, 1929-32, p. 14.

DISTRIBUTION TABLE

OF

INCOME

257

15

I N D E X E S O F I N D I V I D U A L I N C O M E S , 1929-32

Wages, Salaries, etc Profits, etc Dividends Interest Cost of Living *

19*9

193°

I93 I

193 2

100 100 100 100 100

92.0 91.0 97.2 102.4 96.2

77.5 73.7 72.3 99-5 86.7

59.7 55.6 43.4 9^-7 77.7

* National Industrial Conference Board.

During this period of tremendous profit deflation, the main factor making for rigidity was interest, the total payments in respect to which remained remarkably stable throughout the depression. T h e proportion of the whole paid out in interest then rose very considerably; the proportion of entrepreneurial withdrawals (mainly profits from noncorporate businesses) remained stable, and that of dividends fell considerably. T h e share of labor income as a whole rose slightly, but in those industries for which separate estimates are available, the share of wages fell even more rapidly than the share of dividends, while that of salaries kept fairly constant. On the whole, it may be said that the middle classes have suffered least, and the wage-earning classes most, during the depression. Property owners have suffered considerably, with the important exception of certain salaried officials of corporations; and in addition they have undergone business losses which have impaired their reserves. By living on their capital, however, they have been able to maintain their standards of living very much better than the poorest classes. I N C O M E DISTRIBUTION AND T H E R E C O V E R Y

PROGRAM

One of the chief ostensible reasons for setting up the complicated administrative machinery of the "New Deal" was to bring about a redistribution of the national income, which would spread purchasing power and so set industry in motion again. It is far too early to judge whether this objective is being attained; whether, that is, wages are increasing faster than profits, and agricultural faster than industrial income. There are, however, a few preliminary indications which make it difficult to believe that the violent distortions of the past four or five years are being rectified as quickly as would seem desirable.

258

DISTRIBUTION

OF

INCOME

According to figures given by the National Industrial Conference Board (which are, however, not comparable with those given above) labor income was in 1933 about i\/z per cent higher than in 1932, while the cost of living declined by 3.7 per cent. N o estimates are given as to other kinds of individual income, but it is probable that they have increased, in view of the recovery from the lowest depression level. Since the spring of 1933, there has been a very sharp recovery, both in industrial profits and pay rolls, which has accompanied the price advance since that time. In the case of the latter this has been associated mainly with a very considerable increase in industrial employment, and in the case of the former, both with the price inflation itself and also with the general encouragement of monopoly practices by the N R A . Between March, 1933, and November, 1934, the index for industrial pay rolls increased from 36.9 to 59.5, a rise of 61 per cent, but they were still 21 per cent below the March, 1931, figure of 74.9. O n the other hand, according to a chart prepared by the National City Bank of N e w York, 8 industrialcorporation profits were actually somewhat higher in the second quarter of 1934 than in the first quarter of 1931. Since then profits have fallen somewhat, but there is indication that in the last four years profits have fallen considerably less than pay rolls. While, therefore, labor income is undoubtedly increasing, largely owing to the rise in employment, there is little evidence that its proportion to the whole is very much changing, or that the big distortion in income distribution is being rapidly set right. 9 A s regards real wages, a report of the American Federation of L a b o r shows that in March, 1934, average weekly wages were up 9.7 per cent from March, 1933; while the cost of living had risen by 9.4 per cent. For workers in employment, therefore, living standards have not risen, in spite of all the efforts of the administration; the gains have been entirely on account of the unemployed. In raising the share of the total income received by agriculture, the efforts of the administration have met with greater success. Gross farm income was estimated to have risen from $5,143 millions in 1932 to $6,360 millions in 1933, or 23.6 per cent. T h e latter amount includes $300 millions received from the government in the form of rentals, benefit payments, etc. T h e ratio of prices re8 Monthly Bulletin, National City Bank of New York, May, 1934, p. 75. 9 Federal Reserve Bulletin, Dec., 1934.

DISTRIBUTION

OF INCOME

259

ceived by farmers for goods sold, to prices paid by farmers for goods bought, was 80 in December, 1934 (having been 64 in 1933 and 61 in 1932), as compared with 101 in 1914, 1 1 7 in 1917 and 95 in 1929. 10 Much, however, still remains to be done. T h e period from March, 1933, has been one of price, profit and income inflation. In the extension of governmental activity, it is comparable only with the years 1917-20, but in other respects the two periods are very different, the one starting at the very bottom of a depression, and the other at the very top of a boom. T h e consequence is that the rising profits and employment of the later period are not found in the earlier. With such very different conditions, it becomes impossible to argue that the experience of the earlier period, i.e., of sharply rising labor incomes relative to total incomes, is likely to be repeated, and indeed the presence of an active profit inflation points rather in the other direction. INEQUALITY IN INCOME DISTRIBUTION

So far income distribution has been considered only as regards its effects on the rewards to the various factors of production. Evidence has been given which suggests the possibility of certain deductions as to how various types of inflation will redistribute income among the factors. But it is clear that from the point of view of the individual such a study is to some extent unreal, particularly in a country such as the United States, where there is as yet no clearcut division between capitalists and proletarians, and no perfect correlation between the pairs of opposites, rich—poor and property income—labor income. It is necessary, therefore, to consider next how the national income, as it is earned by individuals, is distributed among the various income classes, and whether inflation or deflation can be said to have any effects on this type of distribution, or, to put it concisely, any effect on economic equality. At this point it may be well to emphasize the fact that under the current assumptions of economic theory a greater equality of income distribution is desirable in itself, not merely for social, but also for purely economic, reasons. This is because the higher an individual's income, the less additional utility will an extra dollar of income bring him. On the assumption then—and it is well to admit at once that, while the assumption is implicit in economic 10 Figures published by the Bureau of Agricultural Economics, United States Department of Agriculture.

260

DISTRIBUTION

OF

INCOME

theory, its strictly philosophical basis is open to attack—that the object of a society's economic effort is the maximization of the welfare of the whole society, it is evident that this will not be brought about simply by the maximization of the total real income in terms of purchasing power, for the total social welfare will be partly dependent on the distribution of the total income among the members of society. Various suggestions have been made for measuring this factor of inequality, as it may be called, a discussion of which is outside the scope of this chapter, 11 but it is well to bear in mind its practical importance at times when governments are actively legislating to secure prosperity through a better distribution of income. Of course it may be that a change in income distribution toward greater equality will have such an adverse effect on total output, as some theorists hold, e.g., by discouraging saving, that the final effect on social welfare will be adverse; nevertheless total social welfare depends on equality of income distribution as well as on total output. It is evident that apart from its effect on the size and distribution of incomes, inflation will have the same effect as a regressive tax, for it will bring about reductions in real incomes roughly proportional to the incomes themselves, and this, as Dalton suggests,12 will increase inequality. Thus suppose a government has to levy a tax for some totally unproductive purpose (e.g., the collecting of gold to ship as tribute to a foreign country) and decides to do this by debasing the coinage, such a tax will increase inequality. This fact is of course the reason why all sound income-tax systems are progressive. Inflation then is, in its essence, destructive of welfare in so far as it increases inequality, though in the real world its effects are so complicated that no such final judgment can be made without a close scrutiny of the actual facts, applicable to each case. Unfortunately statistics as to the number of income recipients in the various categories are extremely meager except for the higher incomes. For the vast mass of society no detailed information is available. A study covering the years 1916-26, made by the National Bureau of Economic Research 1 8 does, however, provide valuable material on the basis of which certain suggestions can be made. In 11 For a discussion, see Dalton, H., The Inequality of Incomes, ledge & Sons, Ltd., London, 1929. 12 Dalton, The Inequality of Incomes, Appendix, pp. 9 f. is Bulletin No. 34.

George Rout-

D I S T R I B U T I O N OF INCOME

261

this study the total number of income recipients is divided into four classes: 1. T h e richest 1 / 1 0 0 per cent of all income recipients 2. T h e richest i / i o pier cent of all income recipients (excluding class i) 3. T h e richest l per cent of all income recipients (excluding classes i and 2) 4. T h e poorest 99 per cent of all income recipients Relative incomes per capita (1916 — 100) are given as follows, first in terms of current dollars, and then in terms of 1913 dollars, suitable cost-of-living indexes being chosen for the different classes: table

16

PER CAPITA INCOME INDEXES, 1916-26

YEAR

«916 I9I7 1918 1919 1920 1921 1922 «923 1924 1925 1926

IN CURRENT DOLLARS

IN i q i 3 DOLLARS

4

3

2

/

4

3

2

I

IOO

IOO

IOO

IOO

IOO IOO

IOO

IOO

IOO

118 140 '52 '74 148 148 165 166 170 •75

"9 118 144

«5' 102 '35 '44 »55 182 '79

106 77 94 80 73 86 89 99 126 124

92 75 74 54 P 62 61 74 106 110

99 92 94 94 102 112 112 112 "5

105 9' 97 89 05 9° 95 103 118 116

95 61 65 49 4b 57 58 66 82 81

83 59 52 33 27 4' 40 49 69 72

These figures speak for themselves. During the war and the immediate postwar years, persons in class 4 gained relatively, but by the end of the period the gains in class-3 incomes were actually greater, while incomes in the two higher classes were very rapidly making up their lost ground. Table 17 shows the percentages of total incomes received by the various classes. From these figures indexes of inequality can be obtained by the Lorenz curve,14 which will give the general trend during these years. T h e "measurements of inequality" for these years are given by the following coefficients: 1916 '9'7 191 8 191 9 14

1310 123' 0921 0987

1920 1921 1922 1923

0927 0723 °934 0880

Dalcon, The Inequality of Incomes, Appendix, p. 7.

1924 1925 >926

0966 1162 112a

262

DISTRIBUTION

OF

INCOME

T h e movements in this index of inequality agree roughly with the movements in the percentages of wages and salaries to total incomes, but it must be remembered that such an index, which lumps together 99 per cent of income recipients, has only partial significance. However, it is reasonably certain that during the war inflation, and the postwar deflation, income inequality decreased considerably, and that this process was reversed with the so-called prosperity period. T h i s conclusion is, of course, in sharp conflict with the view currently held that a rise in prices generally leads to more unequal distribution. Indeed during the price inflation of 1916-20, there was a very sharp fall in the share of the very wealthy, table

17

PERCENTAGE OF TOTAL INCOMES, 1916-26 YEAR

4

191 6 191 7 191 8 191 9 192 0 192 1 192 2 192 3 192 4

85.86 86.75 89.84 89.05 90.76 91.83 89.69 9023 89.37

192 6

87.84

192 5

3 6.66 6.82 5.91 6.58 6.12 4.94 6.33

2

I

6.48

4.30 3.91 2.47 2.70 2.09 2.26 2.60 2.43 2.68

3.17 2.52 1.79 1.61 1.03 .98 1.38 1.23 1.47

6.98

3.13

2.05

6 1 1

7*3°

3-a®

2-02

which was particularly marked after the cessation of the 1916-17 profit inflation. O n the other hand, after the depression of 1921, profit inflation turned the scales the other way, in spite of comparative price stability, and, while no comparable figures are available, it is probable that this movement continued in an accentuated form between 1926 and 1929. In the war and the immediate postwar years, the beneficial effects of comparatively vigorous labor unions and of reasonably high taxation are evident. H o w far is the experience of those years likely to be repeated in the 1933 recovery program, which at its inception had the more equitable distribution of income as one of its chief objectives? A priori, we should expect very different results for various reasons, among which the following are perhaps the most important: 1. T h e very severe unemployment will make effective struggles

DISTRIBUTION

OF

INCOME

263

for higher wages by the labor unions far more difficult than in the war years, in spite of the encouragement ostensibly given to the unions by the N R A . For this the N R A codes, in spite of their m i n i m u m wage provisions, are an ineffective substitute, partly perhaps because of the failure to secure and adequately to operate effective "clauses of equitable adjustment." 2. T h e taxation policy of the present administration has, if anything, tended to be regressive, while the policy of high income and excess-profits taxes of the war years was progressive. A l t h o u g h income taxes have been somewhat increased, it must be remembered that the additional burdens of indirect taxation, and in particular the processing taxes levied in connection with the A A A , are acting as important factors in increasing income inequalities. 3. Available statistical evidence, slight though it is, points to a greater increase in profits than in wages, owing to the encouragement of monopolistic practices by the N R A . T h i s may, however, be partly offset by Federal relief doles. It must be emphasized, however, that the failure of the present recovery program to decrease income inequality (if indeed it has failed) is not necessarily due to the price inflationary elements of that program. It is due much more to the failure to raise taxes to a proper level, and to the encouragement of monopoly and restrictive practices which are rapidly bringing back the super profits of the boom period. Price inflation will, of course, normally bring about a redistribution of income among classes, but whether this will tend to increase or to decrease inequality depends much more on the instruments—whether credit and profit inflation, or properly planned government expenditure—whereby it is brought about. T h e question fundamentally then is not whether inflation is good or bad from the point of view of its effects on equality, but how an inflationary policy can best be controlled to give the desired results, for it is only in its actual workings and by judging its ramifications that its merits and demerits can be properly evaluated. THE

SURPLUSES OF BUSINESSES AND

GOVERNMENTS

For the present, attention has been concentrated on that part of the national income which is paid to individuals. It is evident, however, that in a society in which a major part of industrial and distributive activity is carried on by collective organizations, whether governmental or corporate, or even by simple business associations

264

DISTRIBUTION

OF

INCOME

and partnerships, such bodies will, by their control over the sources of income, vitally affect the actual incomes of individuals by saving or by drawing on past savings. T h u s in the case of corporations, the large reserves built up in times of prosperity are used to pay dividends which were not earned during depressions, while governments, even if they balance their budgets during booms, often pile up debts at other times in order to increase the incomes of those individuals for whom the present economic system cannot properly provide. T h e more this is developed, the less is the total income of individuals a complete guide to the total amount of new wealth created by the economic system as a whole. T h e case is made more clear if only such short periods as one year are taken, though for longer periods there is closer approximation. An illustration of this is the estimate recently given by the United States Department of Commerce for income produced in 1932, which, owing to business losses, falls short of the total of individual incomes by over ten billion dollars. Even this, however, overestimates the real production of new wealth, because of the large net increase in governmental debts, which implies a very real "business loss" for the nation as a whole. There is insufficient statistical evidence of a reliable character to make definite estimates of business savings during the periods of inflation under consideration in this chapter, but the following figures, taken from the estimates of King, give some guide as to the trend of corporate savings: TABLE

18

C O R P O R A T I O N SAVINGS, 1914-28* (In Millions of Dollars) YEAR

SAVINGS

I9I4 «915

624 2,174

>917 1918

6,327 4,128

'9'6

4.773

YEAR

SAVINGS

191 9

5»'9°

192 0 192 1 ig22 1923

• Source: Nerlove, S. H., A Decade Chicago Press, Chicago, 1932.

2,762 2,500 2,121 2,962 of

Corporate

YEAR

192 4 192 5 192 6 192 7 192 8 Incomes,

SAVINGS

'. 8 54 3>463 2,741 1.570 * 3,000 * University of

As might be expected, corporate savings follow closely the course of profits, but it is interesting to note that they remained comparatively stable during the profit inflation of 1923-28, contrary to the view generally held. Indeed it was in the war years, and not in

DISTRIBUTION

OF

265

INCOME

the so-called prosperity period, that the most marked accumulation took place. T h e part played by governments, Federal, state and local, is more difficult to estimate. In the war years, huge deficits were piled u p against which little in the way of new capital assets can be set. In later years, estimates for total public construction are given in Planning and Control of Public Works,15 These figures, however, include various expenditures for maintenance, and do not therefore strictly represent net expenditures on new capital assets. T h e price inflation of the war years was to a large extent brought about by heavy governmental expenditures, which resulted in the following increases in millions of dollars in net governmental d e b t s : 1 4 191 4 191 5 191 6 191 7

62 284 142 955

1918 1919 1920

9.9^7 14,280 1,836

In the years 1923-28, however, the increase in governmental debts, which was entirely a result of increases in state and local debts, as Federal debt was being paid off rapidly, was probably more than offset by new capital investments, in the form of public buildings of all kinds, and particularly of roads. TABLE

19

NET INCREASES IN GOVERNMENT DEBT AND NET EXPENDITURES ON PUBLIC CONSTRUCTION, 1923-28 (In Millions of Dollars) ... N E T INCREASE IN " ™ G O V E R N M E N T DEBTS

VEAR

192 3 192 4 192 5 '926 192 7 192 8

1,288 1,668 1.689 1,364 1,377 1,421

NET E X P E N D I T U R E ON PUBLIC CONSTRUCTION , \ (INCLUDING SOME MAINTENANCE)

1,993 2,500 2,594 2,847 3,488 3,599

T h e very great influence of budgetary policy on the national income is obvious. D u r i n g the war, the rising incomes of individuals and the large amounts saved by corporations were to an enormous 18 16

Published by the National Bureau of Economic Research. Calculated from figures given by R. R. Doane, in his Measurement of

American

Wealth.

266

DISTRIBUTION

OF

INCOME

extent offset by t h e fact that the nation as a whole was mortgaging its f u t u r e . T h i s does not m e a n t h a t it was in any sense carrying o u t the impossible task of living on its f u t u r e production, b u t merely t h a t there was a general w r i t i n g u p of values of all kinds, a n d t h a t t h e real increase in income was largely illusory. U n f o r t u n a t e l y this writing u p of values, instead of a p p e a r i n g as an increase in the d e b t of the m a i n beneficiaries of the inflation, i.e., the corporations, was carried by t h e nation as a whole. T h e creation of credit for inflation always implies the creation of debt, which u n f o r t u n a t e l y was not, in the war years, balanced by a sufficient creation of new capital assets, either public or private. Do these facts throw any light on the policy of the present administration? I n a very real sense they do, because they offer b o t h a w a r n i n g a n d a lesson. Increase in governmental indebtedness is not in itself a b a d thing. T h e government of the U.S.S.R. a n d many municipalities in E n g l a n d a n d in other countries have in recent years very considerably increased their debts; b u t they have something to show for them in the way of capital assets. Such debts are often as good investments as those of the best private corporations, a n d r e t u r n a handsome surplus to the public authorities concerned. In some degree, the present h u g e Federal deficits are being offset by the creation of new investment in the shape of public works, or by debts d u e to the R F C , which may ultimately be repaid. T h a t p a r t of the deficit which is not covered in this way is, however, a business loss for the nation, a n d will have to b e subtracted when t h e final reckoning for the total national income is made. CONCLUSION

In this survey, attention has been drawn to the changes in income distribution which have taken place d u r i n g certain periods of inflation. N o theory as to cause a n d effect has been suggested, partly because the material is too scanty to allow of any thoroughgoing logical induction, b u t partly because the subject in itself is p e r h a p s too concrete a n d too wide in its implications to fit exactly in any scheme of purely economic abstractions. T h e distribution of income is in reality, as has been suggested, the whole subject m a t t e r of economics, b u t it is also to a large extent the subject m a t t e r of politics, and, in particular, it is the center a r o u n d which the f u n d a m e n t a l conflicts of society turn. W i t h the d r i f t away f r o m laissez faire, it therefore becomes more a n d more difficult to think of in-

DISTRIBUTION

OF

INCOME

267

come distribution solely in terms of pure economic theory, because it becomes less and less true that the distribution is carried out according to the marginal productivities of the factors of production. T h i s view again is emphasized in the fact that it has above all been necessary to distinguish among various types of inflation before attempting to make an analysis of the changes in income distribution. It is not sufficient merely to ask what effects inflation will have. T h e fundamental question is how inflation is brought about, that is, by what agencies, and through what channels purchasing power is expanded. It has long been urged that the creation of purchasing power, like the creation of currency, is a function too important to be left in the hands of private individuals and organizations. We have seen, for instance, that in the years following 1923, the extension of credit by banks was accompanied by a redistribution of income which was antisocial because it increased inequalities and failed adequately to raise the standards of living of the masses of wage earners and farmers. It is possible that an extension of governmental control in the sphere of finance will in the future, as it has at times in the past, make the expansion of credit a powerful instrument which governments can use to implement their general social policy. More and more is inflation becoming a question for public, rather than for private, finance. But even if it is desirable, governmental control over financial policy will of itself mean nothing. At every point social questions of all kinds will arise which will reflect the strength of the various conflicting interests in society. T h i s is well illustrated by comparing the last two years with the war period. And this leads back once more to the conclusion that the distribution of income is the fundamental social and economic problem for society, and that it can be effected by a financial policy operated by a central authority only in so far as all the policies of the government are working together in harmony toward one common end.

3 INFLATION

AND

BY M . A .

OVERPRODUCTION HEILPERIN

1

INFLATION and overproduction are words whose meanings are too unsettled in current usage to be at all clear. Inflation itself is a particularly uncertain term, for it is a word that can be made to mean almost anything. Some speak of inflation as equivalent to an excessive issue of greenbacks; others prefer to use it in relation to credit. Some apply it in both connections; while still others call depreciated exchange, inflation. Elsewhere, rising prices, or even exaggeratedly high profits, are intended. W h a t is common in all cases is the conception of overexpansion of some economic factor. Possibly an exception might be found in depreciated exchange, which sometimes is a consequence of monetary overexpansion, while sometimes it is not. In no case, however, ought exchange distortion be called inflation. It should be limited to definite cases in which it appears as a consequence of inflation. Overexpansion is not an absolute notion, but must always be used in relation to some standard of comparison which is taken as normal. It may be that by stating what is normal, we shall be led to conclude that a deviation from it, due to monetary factors, is inflation, if it consists in an expansion, and deflation, if it consists in a contraction. T h e term overproduction, likewise, calls for analysis. It clearly offers another comparison between a state of things considered as not normal and some state of things to be considered as normal. Moreover, the deviation from normality is thought of as moving upward. Such an analysis, however, cannot include in its scope every phase of economic phenomena that may be considered by all or by some as features of inflation. It must, rather, be limited to defining those monetary developments which are properly to be called inflation in their relation to production. First of all, however, it is desirable to consider what is meant by normality. W e shall speak of it in terms not of a static state, but i T h i s c h a p t e r was w r i t t e n in answer to t h e specific q u e s t i o n s : W h a t is t h e r e l a t i o n of inflation to o v e r p r o d u c t i o n , a n d is it possible, as m a n y assert, to use inflation as a cure for o v e r p r o d u c t i o n ?

OVERPRODUCTION

269

of a dynamic process. A process should be called normal if, throughout its course, it maintains a state of interior balance. 2 A state of moving balance of the economic system signifies a process in which balance is maintained between: (1) costs and prices and (2) income and debt; and in which, furthermore, there is no cumulative unemployment and no accumulation of commodity stocks. This definition implies a number of other features of the system, one of which is its working at an "optimum" average employment of technical productive capacity. This definition set forth, it is now desirable to define, on the one hand inflation, and on the other, overproduction. T h e following propositions will lay a foundation for these definitions. 1. What is called overproduction or underconsumption is the result of an absence of balance in the cost-price structure. While supply price is based on costs of production, demand price is a result of the structure, both of individual utility schedules and of the income structure of society. Within a given experimental period of time, the former can be assumed as given, while the demand price will depend upon the structure of incomes. It must be further added that demand price and supply price are not independent. What is seen from one angle as income, constitutes somewhere else, cost.8 Every income figures twice in economic bookkeeping—once as cost and once as income. T h i s consideration shows immediately how fallacious it is to think that a disequilibrium in the cost-price structure (due to insufficiency of incomes to realize a demand price which would equalize costs and, therefore, a supply price) can be corrected by merely increasing incomes. An increase of incomes becomes also an increase of costs. It is then not at all sure whether, after such an increase of costs and incomes, the relation between costs and prices will be more closely balanced, or less closely balanced, than before. This will depend upon the structure of costs and the structure of income schedules. 2. T h e balance between debt and income covers a number of elements which are often stated as separate problems. When we speak of "overindebtedness," we have in mind a situa2 If, on the other hand, we call normal, that condition which occurs most frequently, then of course it would mean in economic terms, a state of changing interior unbalance. Such a definition would not be of much use for the purpose of the present discussion. * We are speaking in this essay, of course, of monetary cost and incomes, not of real costs and real income.

270

OVERPRODUCTION

tion in which current income cannot pay carrying charges on the outstanding debt of income earners, without influencing effective demand for goods. This applies to any demander, whether a consumer in the strict sense of the word, or a producer. T h e debt service, however, contributes an element of income for the lenders of the original capital or their successors. So a readjustment of the income-debt relation, by cutting down debt, affects another sector of the community's income; while readjustment, by increasing income, affects costs and therefore cost-price structure. So, ultimately, the problem of economic balance is a matter of equilibrium between costs and market prices of commodities and services, and a matter also of the distribution of national income. With a given income schedule, the direction of incomes into different channels may affect the economic balance. T h u s arises the much-discussed problem of balance between savings and investment, the analysis of which need not be repeated. Let us, however, observe that, even if there is over a period of time a balance between savings and investments, there may occur a situation in which "excessive" invested savings will result in overinvestment. This might happen if, owing to the investment—over a period of years—of a certain proportion of the national income, the remaining part should finally prove insufficient (in spite of the increase of the national income) to absorb finished products (mainly consumption goods) when they arrive in the market, at a price which would cover costs of production. If this argument (stated though it be in skeleton outline and reviewed here only for the sake of completeness and because it seems to involve an important issue) is correct—then the maintenance of economic balance and the avoidance of overinvestment would also assume the maintenance of a rate of savings to be regarded in every economic period of analysis as optimum. We may, accordingly, assume that that thesis is correct which postulates, as a condition of equilibrium, a balance between savings and investments. According to this assumption, there may be two sources of relative overinvestment, followed by relative overproduction. Relative overinvestment means that there has been created a situation in which the optimum output of the built equipment cannot be sold at remunerative prices, i.e., at prices covering costs of production, while restriction of output below this optimum point

OVERPRODUCTION

271

would increase overhead costs per unit and thus further distort the cost-price relation. There are different lines of economic development along which such a situation of relative overinvestment may be arrived at. Leaving aside the controversial and insufficiently explored case of absolute oversaving, there remain two alternatives. One of these is universally recognized and usually designated by the name of inflation. T h e other—seldom if ever mentioned in this connection—is deflation. T h e circumstances in which relative overinvestment may be produced by either of these processes are different. We shall show, however, why it is absolutely necessary, in any study of inflation and overproduction, to assign an important place to deflation. Let us now consider a monetary development which leads to a temporary increase of the community's purchasing power (in terms of money) beyond what it would have been "normally" earned in the given situation. Such increase induces an increase of demand for goods and a tendency toward building up a larger equipment than that which would otherwise have been provided. Prices rise, or fail to fall, with decreasing costs. Industry, getting unusually high profits,4 determines to bring about more investment while, taking the community as a whole, the phenomenon of forced saving sets in. Thus a part of the community's purchasing power, which would otherwise have been spent on consumption goods, is being diverted into investment. In the first stage of this process, more is invested than is actually saved. In the second stage, consumption is cut down by "forced saving." However, inflationary investment was originally induced by the assumption that the effective demand 5 would go on increasing, and would be rendered possible by additional profits, owing to the fact that prices were increasing faster than costs. These are contradictory assumptions, for costs mean income; and, if prices rise more than incomes, effective real demand must ultimately fall, with the inevitable consequences of such recession. Such a fall is always to be noted where inflation ultimately breaks down. Even if we stop short of a real breakdown, the additional equipment has no market for its produce, pending an economic development leading to an increase in the national income. Then, also, owing to the distribution of income and other dynamic factors, 4 1

What Keynes calls "windfall profits." See A Treatise on Money, 1930, I, 125. Real demand, i.e., demand in terms of goods.

272

OVERPRODUCTION

some parts of the equipment created in the period of inflation may not be needed by the economic community. 6 One point of especial significance in the preceding analysis must be emphasized: we have assumed that the initial expansion of purchasing power, beyond what may at that time be the money income of the community, occurred to disturb a previous position of balance of the economic system. L e t us add that the effect of a relative overinvestment, so obtained, is, if the additional capacity be used, a relative overproduction of the finished product. I f this capacity remains unused, the increase of overhead makes it impossible to maintain the same cost of production for the output that was being developed prior to the new investment. As indicated above, relative overinvestment may, however, also be a result of deflation. In this sense deflation means a decrease of the amount of money spent in a given unit of time, i.e., of effective money demand below what it was in the preceding time unit, other things remaining the same. O f course, if starting from a position of balance, deflation sets in, other things do not remain the same. O n the contrary, the products of existing equipment cannot be sold in the same quantities and at the same prices as before. If prices fall, industries cannot cover their costs, and if prices remain but real demand falls off, then overhead costs per unit of output increase, and the price-cost balance is destroyed. T h u s we have again a case of relative overcapacity or relative overinvestment, and the external effects are much the same as those which are witnessed when the effects of inflationary overexpansion make themselves felt. From the monetary point of view, deflation means hoarding, i.e., withdrawal from circulation of a part of currently available purchasing power. W e have thus shown that relative overinvestment can be the result of either inflation or deflation. Usually, however, overinvestment in the economic system is attributed to prior inflation. Some, using the term "underconsumption" as opposed to "overproduct i o n " (which follows overinvestment), attribute it to deflation. As a cure for depression, the former group of theorists advocate deflation, the latter inflation. W e have seen, however, that the mere observation that there is 8 This process is generally recognized. A very able analysis of what happens as an outcome of an inflationary development from an initial position of economic balance is given by Professor F. A. von Hayek, in Prices and Production.

OVERPRODUCTION

273

a relative overinvestment, followed and expressed by a relative overproduction or (at this stage it is one and the same thing) by a relative underconsumption, is not a sufficient diagnosis of the cause of maladjustment. Such a cause may lie either in a prior inflation or in a deflation. What is even more important is that it may lie in both. Indeed, in economic depressions, as they are observed in reality, inflation and deflation have both their share in bringing about a sizable relative overproduction. In testing the course of reasoning thus set forth, we may properly begin with an inflationary course of economic development. When it breaks down, inflation is followed by deflation. Production then breaks down. Capital-goods industries suffer first. Unemployment becomes chronic and cumulative. Considering that prior to inflation most unemployed were in gainful employment, the fact that they now have incomes next to nothing is itself a deflationary phenomenon. But in other groups incomes shrink also to preinflation levels and below. This is deflation, not only as compared with the peak of inflation, but even as compared with a hypothetical balanced situation. Of course, consumption goods and service industries suffer also. Production falls off, not only as measured by what was induced by the process of inflation, but more. This is well known, but it means that the relative overinvestment of the depression is the effect not only of the prior inflationary building up of means of production, but also of a non-utilization caused by deflation. It is understandable that a breakdown of an inflation, by being a considerable economic catastrophe—happening in a primarily unbalanced situation and therefore causing unemployment and losses of income—by discouraging the spirit of enterprise and inciting hoarding, finally causes progressive deflation. If, as we have attempted to show, the relative overinvestment and the apparent overproduction are due to two sets of causes—effects of (1) inflation, and (2) deflation 7—it is not possible to correct the situation by any simple remedy based on a diagnosis of one of these two phenomena as the sole cause of depression. T h e effects of inflation evidently cannot be cured by more inflation; and yet there are many who advocate such a remedy, putting upon deflation the whole burden of responsibility for the depression. * T h e fact that deflation has been induced by the effects of such brokendown inflation, does not alter the fact of such a duality of causes.

274

OVERPRODUCTION

On the other hand, however, effects of deflation cannot be cured by more deflation; and yet this remedy also finds many advocates, those, namely, who see the whole cause of the trouble in the preceding inflation. What happened is, in fact, that one illness of the economic system has produced another; but once this has happened, we have two diseases to cure instead of one. T h e two economic diseases are of such a nature that one could cure the other. Contrary to many current views deflation is not a cure for inflation, and inflation is not a cure for deflation. They are two diseases and need each a particular and well-adapted cure. Let us call "liquidation" the cure for inflation, and "reflation" the cure for deflation, and see what is then involved in each of these terms. Liquidation T h e net result of inflation is twofold: (1) a change in income distribution and in the structure of prices (we shall disregard this aspect in the present discussion); (2) the building up of excessive productive equipment. This implies that the process of readjustment must consist in the provision of a waiting period, during which the progress of economic growth will make an excessive plant "normally" necessary, and during which some of the plant will become obsolete and thus destroyed. From the point of view of capitalgoods industries, it is important that the process of obsolescence should take place; for pending such obsolescence, there will be but a limited new demand for capital goods. A postinflation economy resembles a child which has received, besides the suits of clothing he immediately needs, some that are too large. If a waiting period is granted, the too-large suits will fit him in due time. But some may never be worn because their shape becomes unfashionable, while the cloth of which others are made will not keep in good condition long enough. T h e economic system comprises, however, not only the child, but also the tailor—and it is to the interest of the tailor that new suits should be ordered both next year and the year after. Pending the material readjustment which would absorb into the "normal" economic process a part of the excessive equipment, and destroy another part by making it obsolete, it is most important that production be continued on the highest possible level. In order to realize this result, the capital invested in the excessive equipment must be written down to as near zero as possible. Should it not be

OVERPRODUCTION

275

so written down, overhead costs for the output of the previously existing plant will be increased by the interest charge on the additional equipment, and thus the price-cost structure will be disturbed over a longer period. 8 T h u s , the financial liquidation of inflation consists in writing down industrial debt and industrial capitalization to what corresponds to their real earning capacity. 9 T h i s means a loss of capital to some owners, of course. But such loss is merely the acknowledgment of a previous bad investment. A n economic system may be inflated financially over long periods of time, if the accumulation of debt exceeds the earning capacity of the indebted plant. If such accumulation goes on long enough, the ultimate result is an exaggeration of costs of production and a disturbance in the cost-price structure which leads to more or less considerable difficulties. It may be said that inflation, as defined in this study, creates such an overindebtedness, 10 but there are other ways in which overindebtedness (or overcapitalization) may arise. 11 T h e readjustment of it is very clearly an important element i n the liquidation. W e shall later note some at least of the practical aspects of liquidation. Here it is sufficient to say in conclusion that liquidation is the proper cure for an inflated economy. L e t us now turn to reflation, the proposed corrective of deflation.

Reflation A s already stated, deflation consists in a shrinking of business activity below the level which would exist in a state of economic balance. T h e flow of purchasing power slackens. Less is invested than is saved. T h e balance is hoarded in one form or another. Deflation may result from purely monetary factors, such as restriction of the circulation of money by increasing the rate of interest, more restrictive and discriminating credit policy of banks, and so on. It may also be due to the falling off of business activity, reflected in * T h e balance of the cost-price structure is obstructed in any case because of the induced deflation. Here we assume that no such deflation has occurred, but we shall revert to this situation later. »Again under the assumption of no induced deflation. 10 T h e reader should here disregard such sweeping inflations as the postwar ones in Germany, Poland, etc., which practically annihilated much of the industrial debt. 1 1 See Jones, Bassett, Debt and Production, New York, 1933.

276

OVERPRODUCTION

a diminished demand for currency and credit facilities. These are the results of a breakdown of confidence, caused by whatever factor. Political unrest, expectation of troubles of all kinds, last but not least, the effects of a breakdown of inflation—may provoke a state of mind unfavorable to business enterprise and conducive to deflation. T o fight deflation means to stimulate business. Stimulated business will require a larger amount of monetary purchasing power than would business in its depressed condition. "Dishoarding" follows previous hoarding. Here an important point must be stressed. Dishoarding is by no means analogous to inflation. It is true that when business is recovering from deflation, prices will have an upward trend, monetary circulation will increase, and so, too, will production and trade. These are also among the symptoms of inflation. T h e main difference is that reflation is thought of as a movement toward more balance in the economic system, while inflation is a movement away from balance. Contrary to what is often said about it, reflation is not primarily a monetary policy. It is an economic policy in the broadest sense of the word. It consists in stimulating the productive activity of the community. 12 Monetary expansion follows—when the requirements for money increase—but it does not precede activity in trade. One cannot achieve reflation by merely stimulating the flow of money through the economic system. Deflation is the result of destruction of business confidence. It is vain to hope that an aggravation of panic, resulting possibly in a "flight into commodities," will restore the economic balance. Hence, the means of reflation are twofold: first and foremost, the creation of more confidence among private producers, so as to induce them to resume their activity; second, pending this resumption, a wise use of public funds to finance private production for public use. This may mean a temporary diversion of "idle funds" into the channels of public expenditure; the ultimate objective, however, to be borne in mind is the stimulation of private initiative and enterprise. It should be observed, also, in this connection, that a reorganization of public finances, with a view to taking into account 1 2 T h e reader will observe that the word "reflation" used in this way has a different meaning from the word as used by many economists who call reflation an increase in the money income of the community induced by public spending.

OVERPRODUCTION

277

the fluctuations of business activity, is most helpful in applying reflation policies. What government can do to help the process of reflation depends, however, upon specific situations. It is not possible to say, generally and abstractly, which types of public works are appropriate and which are not. In any case, they should be so oriented as to be most efficient as stimuli and most rapid in their effect. They should incite private business and then be discontinued, progressively, as the activity of private enterprise is reestablished. Residential-building and capital-goods industries are usually better outlets for public spending than consumption-goods industries and the financing of consumption. In deflation, capital-goods industries suffer most, and their recovery stimulates directly consumers' goods and service industries. In still another way can a government be helpful to a revival of confidence—namely, by adopting an appropriate system of guarantees to reduce the high-risk premium of the depression. When the fear of loss is greater than the expectation of gain, the entrepreneur will not embark on a productive venture. T h e danger that a permanent governmental guarantee against loss entails, must be fully realized; yet it is certain that the wise use of such a device might be a useful (and not too costly) method of inducing business revival. From this outline of the theoretic relationships of inflation and deflation, liquidation and reflation, it is clear that in business depressions, as we know them, both causes are present and that therefore correctives for both must be applied. In older days, when economic life was represented by a large number of relatively small units, and when depressions did not strike at its very fundamentals, taken as a whole, a spontaneous process, called "automatic," often brought a remedy. Its technique was liquidation through bankruptcies and forced sales, on the one hand, and through revival following the building up of confidence, on the other. But this recovery was possible only because of the small size of individual units, because of the great flexibility of the economic system, and because of the smaller geographic spread of the depressions and of their lesser intensity. In the depression which began in 1929, these prerequisites of spontaneous recovery were not present. In older days, there was hardly an adequate analysis made of what really happened during the depressions. In

278

OVERPRODUCTION

the actual process, there must have been even then a combination of progressive liquidation with progressive reflation. In our economic condition, in view of the size of units involved, in view of the rigidities of the economic system, and in view of the scope and intensity of the depression, both liquidation and reflation must be carefully planned. T o leave the necessary liquidation to "its own course" may result in an all-destructive deflation, while reflation, of course, must be a matter of very careful and thorough study. It is clear why inflation and the ensuing breakdown provoke deflation. But there is no necessary scope in the depth of deflation that follows an inflation. It does not necessarily follow that because there was overinvestment, there must afterwards be a falling off of production much below "normal." It is not essential that those who were gainfully employed prior to inflation, shall be unemployed (millions of men over a series of years) after it has broken down. T h e r e is no unavoidable necessity for the national income to shrink by a high percentage from its normal size during the period of liquidation. T h e deeper the deflation, the greater the liquidation. T h e object of reflation is thus to minimize the loss in national income during the period of liquidation of a previous inflation. T h i s does not imply that liquidation ought not to be thoroughly carried out. Bad assets must unquestionably be eliminated, and the liability side of every balance sheet must be adjusted to the earning value of assets. In the present structure of our economy, such a process implies a very carefully devised program of action. Overinvestment and overproduction are thus shown as results, both of past inflation and current deflation. T h e causes being complex, so must be the correctives. Inflationists and deflationists alike take a too-narrow view when they ignore one part of the situation. T h e i r advice is, therefore, inadequate. T h e cure of industrial evil lies in a combination of liquidation and reflation. In carrying out such a combined and complex policy, much is, of necessity, a matter of judgment. T h e theory, as outlined here, does not hint at easy and simple methods of getting out of the depression. Inflationists and deflationists have both in turn suggested general and simple solutions—one group advocating more or less indiscriminate public expenditures; the other, an unhampered course of "salutary" deflation. Neither of these methods is sound nor satisfactory; yet it is impossible to

OVERPRODUCTION

279

state any alternative panacea; a depression being a complex phenomenon, the cure is also necessarily complex. T h e r e is no general method of reflation. A practical policy destined to achieve proposed ends must, as already intimated, be devised in relation to the existing state of the economic system, and must be based on a careful analysis of this given situation.1® l s Some financial measures of liquidation, available for use at the low point of deflation, may be enumerated as follows:

1. T h e fixed interest-bearing securities of "productive enterprise" should be converted into equities. T h e y w o u l d thus automatically have the value of the assets remaining after a hypothetical repayment of other liabilities, and they would be remunerated only in proportion to the effective earnings of the company. It would then also be easier to reduce the valuation of the productive assets of the company by reducing the capital at the same time. T h i s method is particularly important in the case of United States railroad companies. 2. Mortgages present almost more problems and difficulties than the bonded debt of industrial enterprises, railroads and utilities. T h e principle of assessment of the value of land should probably be modified, as the now-prevailing principle makes it too easy to finance land and real-estate speculation by mortgage credit. T h e ultimate aim is to get a new assessment based upon the earning value of land and real estate, and to reduce the face value of mortgages to fit in with that new valuation. T h e way leading to it would be to diminish by law the interest on mortgages, so as to make the capitalized value of this interest correspond to the new assessed value. Furthermore, the making of future mortgages should probably be restricted to loans invested in improvements of the earning capacity of the mortgaged property and the period of repayment should be established according to the duration of the improvements thus financed. Something of the sort existed, e.g., in Germany, in the seventeenth and early part of the eighteenth century, and the subsequent change was not a betterment of the mortgage technique. (See Hegemann, W., Das steinerne Berlin, Berlin, 193«, pp. 168-78.) 3. T h e liquidation activities mentioned in paragraphs 1 and 2 would necessitate some financial adjustments within insurance companies, some banks, etc., and such adjustments might be very serious. T h i s necessitates a further very careful investigation. 4. As to governmental and municipal indebtedness, the necessary readjustments would affect the interest rate, rather than the principal, and can be best effected by the method of conversion.

4 INFLATION

AND

DECREASING

COSTS

OF

PRODUCTION BY

FRITZ

MACHLUP

"THOSE empty boxes," commented upon by English writers,1 are sometimes found in discussions on inflation. The box with the label "Decreasing Cost of Production" is often thrown at the heads of anti-inflationists to make them admit that inflation is not always detrimental. The arguments run along various lines: that one should not fear inflation because the tendency toward rising prices is counterbalanced by decreasing costs of increased production; that one should advocate inflation because it will aid in the emergence of the benefits of decreasing costs; that one should urge inflation because it will offset the deflationary effects of decreasing costs of increased production. Since words have different meanings, it may be useful to enumerate and to distinguish the different concepts which are covered (and hidden) by the equivocal expression "decreasing costs of production." A list of these concepts will always be incomplete and overcomplete at the same time, because some ideas overlap and some conceptions wear the label rather improperly. Decreasing costs of production are conceived as a function of the following: (1) the proportion of factors of production (increasing the number of units of variable, combined with fixed, factors); (2) "spreading of overhead" (increasing utilization of the given capacity); (3) "progress" 2 (increasing the effectiveness or the quantity of the factors by (a) better technique, (b) better organization, (c and d) more capital and more labor, as a condition of utilizing better technique or division of labor,® and as a cause of diminished money rates of compensation for the services of the factors); (4) "internal economies" (increasing the size of the plants—partly covered 1

Clapham, D. H. Robertson and others. T h e use of the word "progress" does not imply any evaluation of the facts comprised. This is especially clear in the case of an increased supply of labor. Some writers prefer, instead, to speak of a "function of time." But time has its r6Ie in all phenomena. » This case is sometimes thought of by saying that a growth of the population takes place under increasing returns. 2

D E C R E A S I N G COSTS OF P R O D U C T I O N

281

by cases under the third heading); (5) "external economies" (increasing the volume of whole industries of a certain kind or in a certain area—partly covered by cases under the third heading). In short, the conceptions differ, among other things, in the assumptions which are explicitly or implicitly made, and in the point of view of the observer. There are considerations of the short and the long run, of total and partial equilibrium, of perfect and monopolistic competition. These circumstances may be considered when we are examining each case for its qualification as an argument for inflation. 4 (1) T h e law of proportions is the modern title for the old laws of increasing and decreasing returns. It is concerned with changes in the physical productivity of a set of the factors of production, if the proportions of their combination are changed. If additional units of a factor are combined with fixed quantities of other factors, the product will increase, up to a certain point, more than in proportion and, after that point has been reached, it will increase at a rate less than in proportion to the increase in the quantity of the variable factor. At given values or prices of the factors and products, increasing or decreasing returns may be expressed in terms of decreasing or increasing costs. This, however, is not necessary. Estimates in money costs are relevant only if the cost elements are heterogeneous. But here the physical product is considered simply as a function of one variable factor. T h e whole principle is independent of money prices. Under the assumption of sufficient divisibility, the factors are always combined in the most efficient proportions. Hence the increased application of any variable factor can lead only to decreasing returns. It is most misleading to handle the law of proportions in terms of money cost. There is no possible interrelation between this law and an increasing supply of money or credit. (2) Pure technological facts, as they are stated in the law of proportions, make the incremental cost of production decrease for the first unproportionally small volumes of production. In a given plant with a given equipment, which is qualified for an output of 300,000 units of produce per year, it is unlikely that anyone would think of producing only 1,000 units per year. There is a certain * Many definitions of inflation anticipate a certain hypothesis about its effects (upon prices or interest). T h a t is avoided by defining inflation simply as an increasing quantity of money in its widest sense.

282

D E C R E A S I N G C O S T S OF

PRODUCTION

minimum volume of business below which the plant would not be operated. It is between the first unit and this minimum quantity of output that the total variable cost of production increases slower than the output. T h e downward slope of the incremental cost curve (differential cost curve, marginal cost curve) has no practical significance other than to determine the minimum volume of business. From this point, hence from the very beginning of the practically relevant volumes of output, increments obtained by the increased combination of variable factors with given fixed equipment meet increasing increments of total costs. T h e upward slope of the incremental cost curve determines the relative optimum volume of business which a firm is willing to take, under the current conditions of the market. T h e incremental cost curve is not influenced by any fixed costs. T h e overhead costs, which are relatively fixed in the short run, may be spread over more or less units of business. This circumstance leads, up to a certain point, to a decrease in the average total cost per unit of output. After that the average total cost curve runs upward, since the average variable costs increase faster than the average fixed costs decrease. T h e lowest point in the curve of the average total unit cost is sometimes called the "economical optimum," and the respective volume of output "normal capacity." If the actual output is smaller, one speaks of unused or idle capacity. In this case, an increase in business would meet decreasing average total unit costs. Such "economies of spreading overhead costs" over a greater number of units of output are sometimes erroneously considered relevant points in price theory. They are not. 8 It is wrong to believe that an increased production will be undertaken, owing to the economies of spreading of overhead, at lowered prices. Each volume of output is determined by the advantages and disadvantages which are expected by the producer from increasing or decreasing the output. It is generally assumed that a producer will increase his production if he anticipates net benefits from the additional output. If, however, the cost of producing one unit more would exceed its expected receipt, the production would not be undertaken. T h e "cost of producing one unit more," the incremental cost, increases, regardless of the decrease in the average ®It is of course misleading to label the case as a "decreasing cost" case. For a more detailed exposition, see Machlup, Fritz, "A Note on Fixed Costs," Quarterly Journal of Economics, XLVIII, 559.

DECREASING COSTS OF P R O D U C T I O N

283

of total costs per unit of output. T h e fixed burden is absolutely the same at any volume of production and, since it does not influence the cost of producing one unit more, it does not influence the price or the output at a given price. It is understood that any reasoning about fixed overhead necessarily considers the short run. But so does the reasoning about inflation and the utilization of capacity. T h e hope that inflation may make competing producers increase their output with unincreased prices is without foundation. If, and in so far as, some monopolists may stand ready to offer more products at constant prices, their policy is to be explained by other factors. (3) T h e tendency of costs of production, in the long run, to decrease owing to "progress" or "growth," raises a number of complex problems. T h e i r most general relation to the supply of money is broadly discussed under the heading of "stabilizing the dollar." Since any growth in the effective supply of productive factors, as well as in the technique or organization of their application, causes a growth in the quantity 8 of goods supplied, some prices (and the average of prices) must drop, if the money supply is held constant. A constant amount of money buys an increased quantity of goods, only if some prices are lowered. T h i s circumstance is sometimes considered as an argument for an increase in the quantity of money, if it is desired to keep the price level fixed. Inflation of the circulation of money is advocated in order to prevent the so-called deflation of prices. It has been shown, however, that the decline in prices, which is the result of decreased costs, is neither pernicious nor disturbing to the economic system. Furthermore, it has been advanced that a credit inflation designed to prevent such a decline in prices, would cause some specific disturbances (business cycles). As to the latter point, we refer to recent discussions. 7 T h e first point—that a price fall which comes about by a decrease in cost is no disturbing factor in the system—should be clear. If an industry produced 100 units at a total cost of $1,000, 8 Better qualities which result from the same causes do not raise this problem, because the changes in quality are not shown by the index numbers of prices. 7 See Hayek, F. A., Monetary Theory and the Trade Cycle, London, 1933; Machlup, Fritz, Borsenkredit, Industriekredit und Kapitalbildung, Wien, 193«; Haberler, Gottfried, "Money and the Business Cycle," in Gold and Monetary Stabilization, "Lectures on the Harris Foundation," ed. by Quincy Wright, Chicago, 193«.

284

DECREASING

COSTS OF

PRODUCTION

and now produces, owing to a decrease in cost, n o units at a total cost of $1,000, it is not hurt at all if the price of the product drops by about 10 per cent. Its total money receipts and its profits are unchanged. T h e difficulties raised by elasticities of demand, greater or smaller than unity, are entirely the same as those caused by any shifts in demand for various goods. They have nothing to do with the fall in the level of prices. Changes in technique or organization sometimes call for a decrease in the money rates of wages, if the money supply is constant. Such pressure on money-wage rates may be the outcome of certain labor-saving innovations. At great elasticities of substitution, even a growth in the supply of capital (savings) may have the same effect. And certainly a strong pressure upon wage rates is effected by an increased supply of labor. From all these cases, unemployment ensues if, owing to some social institutions, wages become rigid. In order to avoid labor troubles, social warfare and permanent unemployment, inflation is suggested. An increase in the money supply is then to make up for the failure of money wages to adapt themselves to the situation. If an increase in supply of labor is at the same time an increase in the number of pockets in which money is usually held as an unspent cash reserve,8 then even the postulate of neutral money would allow for that decrease in the quantity of effective money. But the question of managing the real wage rates by inflating the money circulation and definitely dispensing with flexible money rates is of another sort. T h e increase in the money supply brings, doubtless, new disturbances which are not to be solved by further inflationary management. When a decrease in cost of production is connected with the fact that labor is set free in one line, and to be reemployed for other lines of production only at reduced rates, then a policy of credit inflation would lead in the direction of further substitution of capital for labor. T h e collapse of such management seems unavoidable. T h e task of building up an economic theory in which a managed supply of money is substituted for the flexibility of wage rates is more than complicated. It is most likely unsolvable. An analysis is hardly worth while, since the same forces which make for "sticky" wage rates would probably make the wage rates run ahead of the managed inflation. 8 O r , if a change in technique or organization is at the same time an increase in the number of firms and concerns which usually keep unspent cash reserves.

D E C R E A S I N G C O S T S OF P R O D U C T I O N

285

So far we have discussed the argument that inflation should make up for certain effects of progress or growth. Another argument considers inflation not a response to progress, but a means to bring about progress. The changes in technique and organization which may be introduced upon the incentive of credit inflation, involve regularly an induced demand for the apparently abundant capital. More money capital is supplied, in order to create new investments. The sequence of events may be of one sort, if a vast supply of unemployed labor exists, and of another, if labor is more fully employed. This was brought forward against the trade-cycle theorists who hold that the breakdown of the prosperous investment period is inevitable if the "progress" was artificially financed by more money, i.e., by inflation, instead of by genuine savings. The differences between the case of labor switched from one line to another, at increasing wage rates, and the case of more labor employed at unchanged wage rates, are, of course, indisputable. The crucial points of the theory of collapse, however, seem to hold true in both cases, if not very unrealistic assumptions are introduced. But it is not a proper place in which to expatiate on these problems, for the easy money which is offered by an inflationistic credit system is hardly to be interpreted as a factor of decreasing cost of production. If inflation is advocated as a means for stimulating recovery in the midst of depression, it is rather with the intent of promoting a fuller utilization of given capacity than with that of promoting progress. Neither of these ideas has been proven tenable. (4) There is another angle from which to observe the problems of decreasing cost. One may concentrate his attention upon the tendency of costs of production within single firms within certain industries rather than upon the equilibrium of the whole economic system. There are sometimes economies which a firm can expect to realize by increasing the size of its plant, if the demand for its products increases. These so-called internal economies are likely to be limited to concerns in a more or less monopolistic position. According to the assumptions of pure competition, the producers would never leave untried measures expected to secure economies. Under monopolistic competition, where the suppliers conceive sloped demand curves, economical expansion or innovation may be postponed until an increase in demand is realized. Can we find here a case for inflation?

286

DECREASING COSTS OF

PRODUCTION

More specific assumptions would be needed for giving specific answers. Among other things, we should need to know the expectations of the producers as to the future development of demand and of costs under the régime of inflation. But generally it may be said that under normal conditions, with resources fairly employed, not the least evidence can be given for an increase in social income by "switching" the productive factor from one line into another, and still less for the probability that inflation might "switch" the factors direct from industries with increasing supply prices to the industries with decreasing supply prices.9 Under depressed conditions, with resources widely unemployed, and existing capacities largely unused, the question of the economies of increasing the size of the plant is irrelevant. (5) External economies are realized for an industry, as a whole or in a certain area, if an increase in demand for its products causes, with the growth of the volume, a growth of certain facilities of production. What has been said for the internal economies holds still more true for the external ones: We do not know when and where substantial external economies are attainable. T h a t a controlled transfer of the factors from lines with less prospective economies to lines with more prospective economies should be managed by the way of inflation, is not imaginable. And again, the social benefit of such a transfer would be disputable. If productive services are abundantly available for expanding one industry without restricting another, we may assume that plenty of idle capacity is available, and consequently economies of a "growth" of the industry have not to be taken into account. There is one important case of external economies in a depression. If, in a country with large unemployment, relief or dole is paid to the unemployed and the funds are raised by taxes on industry, the tax burden may be alleviated by an increase in employment. T h e saving in doles and relief payments is, by the decrease in taxation, distributed to all industries. It is felt only as an infinitesimally small portion by the firm which increases its pay roll. T h e social net gain of the new employment exceeds the private net gain. Provided the taxes in question are somehow proportionated to the output, e.g., by excises on some means of production or on the pay roll, and are therefore a part of the direct (or prime) • T h e less complicated attempts of Marshall and Pigou to theorize similarly with taxes and bounties have never produced a convincing clue.

DECREASING COSTS OF P R O D U C T I O N

287

costs and not a part of the overhead (or supplementary) costs, then the reemployment is a genuine "external economy." This external economy is realized as an element of decreasing cost of production, if more employment is achieved by inflation. Whoever thinks that one should place much emphasis upon this case, would have to make sure that the inflationary expansion is accompanied by a decrease in taxes of the type mentioned, and would have to have proof that this element of decreasing cost is not offset by other increasing cost elements. T h i s proof can hardly be forthcoming. But also another point is not to be overlooked. If, owing to the dole-tax-mechanism, employment produces more employment, and, of course, unemployment produces more unemployment, and if the "first" reemployed man is paid by i n f l a t i o n then the process reverses itself, once the inflation is discontinued. T o stop inflation voluntarily will end the upswing and will start the new crisis. T o proceed with inflation will cause, sooner or later, the breakdown of the monetary system; inflation is, then, stopped involuntarily. T h e collapse seems inevitable—or at least not avoided by the decreasing costs—in either event. T h e r e may be found arguments for inflation, constructive brains might invent some theoretical assumptions and fanciful conditions, which allow for an inflation without breakdown. T h e conceptions of the decreasing costs, however, form neither such arguments nor such conditions.

5 INFLATION BY

A.

IN

SECURITIES

WILFRED

MAY

IN an inquiry into particular periods of boom and depression, or of expansion and subsequent liquidation, it seems advisable to examine primarily the pertinent long-term antecedent forces leading up to the period specifically under discussion. This approach also takes into full account the many psychological factors involved in the development of booms and depressions. Security speculation, despite the combined efforts of analysts, statisticians, and economists, never was and never will be an exact science, because no charts or figures can be devised to gauge or control the cumulative mental processes of a purchaser or seller of securities, either before he has made his purchase, or—of f a r more importance—after he has acquired his speculative position. Therefore, in this discussion of security inflation since the close of the war, it is proposed first to analyze the credit expansion upon which it grew, examining our methods of national credit management beginning with the years immediately following the establishment of our central banking system, and later to trace the effects of these monetary phenomena—quantitatively and qualitatively. FEDERAL RESERVE

INFLUENCE

At its establishment, the Federal Reserve system's cardinal functions were to maintain the liquidity of the credit structure, to protect money rates, to eliminate or smooth out business cycles, and to furnish credit through the rediscounting of paper growing out of commercial, industrial and agricultural activities. T h e opening of the World War soon after the establishment of the system imposed an early test of its ability to abstain from unsound activities. This test was met with complete failure, and activity in highly dangerous directions was immediately undertaken. For example, the rediscount facilities provided by the Reserve banks were used to accomplish the otherwise unattainable, huge government financing program of the war period. 1 1 Hollander, J . H., War Borrowing (Macmillan Co., 1919). " T h e actual effect of certificate borrowing upon the business life of the country as attested

INFLATION

Effect

IN

289

SECURITIES

of Public

Debt

Illustrating the expansion of government loans and credit during the war period, are the figures comparing the amounts of the interest-bearing d e b t of the U n i t e d States which are given in T a b l e 20. TABLE

20

E X P A N S I O N O F G O V E R N M E N T C R E D I T , 1917-19 • (In Billions of Dollars)

TOTAL

BONDS

March, 1917 . . . . S 1,023 • 26,349 Aug., 1919

S 1,023 17,020

DATE

SHORT-TERM OBLIGATIONS

TREASURY NOTES

CERTIFICATES OF INDEBTEDNESS

$9.247

$5,046

84,201

• Source: Annual Reports of the Comptroller of Currency, Federal Bulletins and Annual Reports of the Secretary of the Treasury. Table

21

shows

the quantities

of

United

States

Reserve

Government

securities h e l d by the banks, 1913-20. t a b l e

21

V O L U M E O F G O V E R N M E N T S E C U R I T I E S H E L D BY B A N K S • (In Billions of Dollars)

YEAR

191 3 191 4 191 5 191 6 19'7 191 8 191 9 '920

TOTAL HELD IN B A N K S

5

8 25 833 819 796 '>063 2,848 4.437 3.705

PER CENT OF T O T A L

85 4 85.I 84.4 81.9 39.2 23.8 «7-6 154

• Source: Annual Reports of the Comptroller of Currency, Federal Bulletins and Annual Reports of the Secretary of the Treasury.

Reserve

by the state of the money market has seemingly been the avoidance of strain and fluctuation to a very marked degree. But this stabilizing effect is to be imputed not to the particular borrowing device which has been employed but to the credit mechanism which statute and administrative policy have provided for use in conjunction therewith. Permissive payment by credit, exemption of government deposits from reserve requirements, rediscount facilities with the Federal Reserve banks—and not any virtue inherent in or peculiar to certificate borrowing, have saved the capital market from the dislocation which might have been anticipated in a period of war borrowing."

290

INFLATION

IN

SECURITIES

T h i s tremendous expansion of governmental borrowing and credit expansion constituted a first-rank phenomenon of inflation and fiat credit. Instead of using the printing press, the Federal Reserve system provided the mechanism by which the Treasury acquired for itself unlimited funds without restraint or the unpopularity resulting from unduly enlarged taxation. A fiat credit structure was built by means of the utilization of our central banking system. W e must remember, nevertheless, that in contrast to subsequent periods, the proceeds of this earlier war-time expansion, however unsound, were at least employed in satisfaction of the demands of industry. T h e credit was used in transforming industry from a peace-time to a war-time basis, in the sending of a large army to France and the building of a merchant marine, in the purchase of war materials and equipment, and in the financing of shipments of goods from all over the world to our Allies. In other words, the proceeds of this particular credit expansion went into industrial, and not financial, channels. Accordingly, the analysis of its results must be given an industrial direction. Postwar

Expansion

A second period of credit inflation was also supported by our central banking system. It should be remembered in the first place that, whereas the credit resulting from war-time expansion went into industry, the expansion which occurred from 1922 to 1928 was economically and industrially unnecessary. T h e credit thus released was added to an existing volume of credit already greater than legitimate commerce needed, and flowed into securities, giving direct rise to all manner of financial instead of industrial excesses. From a quantitative standpoint, whereas the comparatively necessary war-time bank expansion amounted to $5,800,000,000 in deposits and $7,000,000,000 in loans and investments, the later period witnessed a doubled expansion of $14,500,000,000 in loans and investments and $13,500,000,000 in deposits, 2 arising from a $600,000,000 increase in member bank reserves.3 T h i s expansion, occurring in the later period, arose mainly from the following causes: 2 Source: Reports of the Comptroller of the Currency. » R e s e r v e balances of all m e m b e r banks rose f r o m $1,689,000,000 in 19s», to a h i g h of $2,396,000,000 in A p r i l , 1928. Source: Federal Reserve Board Annual Report, 1929.

INFLATION

IN

SECURITIES

291

1. A great part of the world being off the gold standard, most of the newly-mined, as well as hoarded, European gold came to the United States.4 2. T h e Federal Reserve banks kept their rediscount rates artificially low and periodically engaged in heavy open-market purchases of government securities. 3. Reserve requirements of member banks, already too low in the opinion of many economists, had been further reduced by war-time "emergency" amendments to the Federal Reserve Act. An open-market policy was mildly initiated by the system when rediscounts went below a billion dollars in the depression of 1920. In 1923, open-market operations were pursued in comparatively vigorous fashion. From November 21, 1923, to September 17, 1924, holdings of government securities were increased from $73,000,000 to $618,000,000 and member banks increased their reserves by $370,000,000. In 1925 and 1926, open-market policy was relatively inactive; but in the autumn of 1927, in the desire to ease the strain on the London gold reserves and other foreign centers, and in order to stimulate our domestic trade situation, the cheap-money policy and credit expansion proceeded on a grand scale.5 If the Federal Reserve authorities were ever subject to any justifiable criticism, it is for their action at this particular time; since by further increasing the holdings of United States government securities from $253,000,000 to $627,000,000 and acceptances from $183,217,000 to $387,131,000 from June 22, 1927, to January 4, 1928, they furnished cheap money which started a long speculative orgy and placed the credit authorities in a subsequent inescapable dilemma. During 1928 and 1929, they found themselves torn between the following three conflicting motives: (1) the desire to restrain the use of credit for speculative purposes; (2) the desire not to tighten money in foreign countries and not to divest them of their gold; and (3) the desire to keep money available domestically at reasonable rates for legitimate business purposes. « Changes in gold holdings of the United States and foreign countries, 192029, were as follows: .. . . . . . . ^ . • 3 United States All Other Countries 1920 $2451,182,000 $4,754,623,000 1929 3,900,160,000 6,390478,000 Source: Federal Reserve Bulletin (1930), xvi, 171. »Source: Federal Reserve Bulletin (1927), xiii, 627, 630, 631, 691, 751.

292

INFLATION

IN

Discount

SECURITIES Changes

In March, 1928, after speculation in securities had been stimulated to a disturbing degree, the discount rate was raised from 3 % to 4 per cent, and securities were sold by the Federal Reserve banks, this action and the loss of gold forcing the banks to increase their borrowings.® Government securities were again sold and discount rates raised in April, May, June, July, and August, 1928.7 But the sale of $400,000,000 of government securities and the loss of $500,000,000 of gold did not effectively check security expansion, now that it had become established on so broad a scale. In fact, in recent years, open-market operations have had wholly unexpected effects on speculation. For example, in 1928 and 1929 Reserve sales of government securities were actually accompanied by a rapid rise in brokers' loans, while declining loans accompanied enormous Reserve purchases in the period from 1930 to 1933. Once the credit system had become infected with cheap money, it was impossible to cut down particular outlets of this credit without cutting down all credit, because it is impossible to keep different kinds of money separated in water-tight compartments. It was impossible to make money scarce for stock-market purposes, while simultaneously keeping it cheap for commercial use. Other devices, such as forbidding Reserve banks to make rediscounts to member banks for stock-market purposes, were futile. In the case of this latter method, for instance, loans and rediscounts to member banks constitute only one of several ways in which Federal Reserve credit is extended. In the autumn of 1928, when the Federal Reserve authorities were endeavoring to fight speculative activities, they made large purchases of bankers' acceptances, which were presumed to represent commercial transactions. Although the purpose of this policy was merely to support the acceptance market, the member banks sold the acceptances to the general discount market, with the result that they soon became lodged with the Federal Reserve banks, and the funds went into stock-exchange operations. 8 Likewise, restrictions on loans and discounts did not and do not prevent the utilization for stock-market purposes of Federal • Source: 1 Source: July, 1928, 8 Source: letin, Feb.

Federal Reserve Bulletin, April, 1928, pp. 244, 247. Federal Reserve Bulletins, May, 1928, p. 313; June, 1928, p. 380; p. 461; August, 1928, p. 548. "Some Sidelights on the Money Market," The Chase Economic Bul13, 1929.

INFLATION

IN

SECURITIES

293

Reserve credit arising out of open-market purchases. W h e n Reserve credit was created, there was no possible way that its employment could be directed into specific uses, once it had flowed through the commercial banks into the general credit stream. A n d the practice of member banks using Federal Reserve credit, under Section 15 of the Act, as a means of building u p their reserves to support brokers' loans, has also been admitted. 9 As Senator Glass has estimated, in his discussion of the situation, in a single six months' period in 1929, ten New York City banks were given $750,000,000 of Federal Reserve credit under the 15-day provision. T h i s money was loaned to brokers for stock-gambling purposes. 10 A f t e r the damage arising from issuance of this excess credit had once been done, attempts were simultaneously made to tighten speculative credit and to ease commercial credit. B u t these efforts proved futile; at this stage, any attempt to tighten speculative credit would have had an immediately unfavorable effect on commercial credit.

Difficulty

of Localizing

Speculative

Credit

A l t h o u g h an excessive credit supply always tends to bring about speculative activities and movements, and although security expansion seems to be the most convenient outlet therefor, these movements usually do not evidence themselves in identical fields in successive periods. T h e boom of 1919-20 did n o t take place i n securities, but in commodities and inventories. 1 1 In the next period of expansion, business men well remembered the disastrous effects of these commodity and inventory excesses, and sought earnestly to avoid repeating their previous error. In the years 1924-29, inventories were kept down to the m i n i m u m as a result of managerial prudence and other factors, such as the intensified vogue of installment selling. Misgiving and doubts over the situation were allayed by demonstrating the nonexistence of large stocks of goods. T h e fact was overlooked that speculation in securities could be just as dangerous as speculation in commodities. T h e burnt child kept away from the stove, but not from the fire. T h e cause of our amazing lack of economic prudence is to be found in the deleterious effects 9 In Hearings before the Subcommittee of the Senate Committee on Banking and Currency, Res. 71. 1 0 Quoted from radio speech of Nov. 1, 1932. 1 1 T h e maximum total of brokers' loans. iqiq-2o. was only $i.7>;o.ooo,ooo.

294

INFLATION

IN

SECURITIES

on popular psychology of the pressure of cheap money and multiple expansion of credit. Effects

of

Expansion

T h e effects of the latter great expansion—or inflation—developed an orgy of financial character manifested in the following phenomena: (1) tremendous booms on the New York stock exchange and all other security exchanges; (2) issues of new securities of all kinds, domestic and foreign, conducted on an enormous and reckless scale; (3) a great increase in the number of investment banking houses and a perversion of their character and normal functions; and the initiation on an enormous scale of all manner of financial institutions such as finance companies, investment trusts, underwriting houses, security affiliates of banks, and all kinds of promotions; (4) a craze for industrial and bank mergers and consolidations, and for the promotion of holding companies of all kinds to satisfy a hungry, speculative community; (5) a tremendous increase in brokers' loans and loans "for the account of others"; and (6) immersion of the commercial banking system in the speculative pool, with a great stimulation to the speculative movement from the banking system, followed by an ensuing demoralization of the banking position. Let us now examine, quantitatively and qualitatively, these phenomena resulting from credit inflation. Effects

of Credit

Inflation

W e may first examine quantitatively some of the measurable effects of speculative credit expansion. One of the primary, direct methods by which this credit abetted speculation was that of loans on securities made by banks. Of course, relatively decreasing need for bank credit by commercial borrowers was also a factor in increasing possible bank loans on securities, but the creation of vast excess reserves, arising from reduced reserve requirements and open-market policies, coupled with the easy superficial method of making these loans, were the main, direct cause. Figures detailing the general course of development in this particular have been fully worked out and presented in former studies. 12 Only a very brief restatement of a few outstanding facts in this connection is needed. 12 Willis, H. Parker, and Chapman, John M., The Banking Situation, University Press (1934), pp. 610-33.

Columbia

INFLATION Loans

IN on

295

SECURITIES Securities

Loans on securities have been a major banking asset only since the World War. Before 1914, the Annual Reports of the Comptroller of the Currency classified loans mainly as "demand" or "time." Beginning with 1914, statistics of state banks and trust companies, but not of national banks, distinguished loans secured by stocks and bonds from other secured loans. O n June 30, 1914, loans secured by stocks and bonds in state banks, and secured loans other than real estate loans in national banks, amounted to $1,526,319,186. During the war, the nation's enormous fiscal requirements necessitated the flotation of government bond issues, many of which bonds went into the banks as security for loans. In the postwar period, this practice extended to other bonds and stocks, of all descriptions. T h e change in the amount of security loans in all classes of banks is given in T a b l e 22. TABLE

22

S E C U R I T Y L O A N S BY CLASSES O F BANKS * 1930 PER CENT INCREASE OVER 1921

CLASS OP BANK

JUNE 30, 1921

JUNE 30, '930

JUNE 30, '933

National B a n k s . . .

$4,361,884,000 ',525,894,000 1,704,065,000

* 5.484.7I3.000 M35.529.000 4,534.946.000

82,759,876,000 371,701,000 ',55'.804,000

26

Î7>59I,843,OOO

$II,455,L88,000

84,693.48',000

5'

Trust Companies.

• Source: Annual

Reports

of the Comptroller

Growth

of Security

of the

Currency.

Loans

T h e record of the increase in security loans of reporting Federal Reserve member banks in leading cities, classified according to United States government bonds and other stocks and bonds, since 1919, is presented in T a b l e 23. T a b l e 24 shows the proportion of loans on securities made by the various classes of banks, and these classes of banks' proportion of the banking system's total loans and investments on June 30, !930T h e reporting member banks, which possessed only half of the

296

INFLATION

IN

SECURITIES

TABLE

23

SECURITY LOANS »

YEAR

LOANS SECURED B Y UNITED STATES

SECURED B Y O T H E R STOCKS

T O T A L SECURITY LOANS T O

G O V E R N M E N T BONDS

A N D BONDS

CUSTOMERS

«9>9 >920 I92I >922 1923 «924 >925 '926 192 7 192 8 192 9 193 0

1,020,359,000 908,722,000 512,520,000 290,261,000 228,365,000 194,974,000 170,107,000 144,075,000 128,253,000 106,239,000

3,300,331,000 3,173,823,000 3,165,481,000 3»774>775.°o° 3,857,662,000 4,667,760,000 5.759.678,000 5,708,092,000 6,587,067,000 7,023,487,000 8,304,000,000 7,814,000,000

4,320,690,000 4,082,545,000 3,678,001,000 4,065,036,000 4,086,027,000 4,862,734,000 5,929,785,000 5,852,167,000 6,715,320,000 7,129,726,000 8,304,000,000 7,814,000,000

• Source: "Statement of Condition, Reporting Member Banks in Leading Cities," issued by the Federal Reserve board. Published in Hearings before the Subcommittee of the Senate Committee on Banking and Currency, Res. 71, part VII, p. 1008. TABLE

24

T O T A L LOANS AND INVESTMENTS OF BANKS BY CLASSES * (In Thousands of Dollars)

SECURITY LOANS BANKS P E R CENT OF T O T A L

AMOUNT

Reporting Member Nonreporting Member Nonmember Totals • Abstracted from Annual

TOTAL LOANS AND INVESTMENTS AMOUNT

PER CENT OF T O T A L

8,442,000 1,983,000 1,030,000

74 17 9

23,099,000 12,556,000 11,643,000

SO 26 24

11,455,000

IOO

47,298,000

IOO

Reports

of the Comptroller

of the

Currency.

total resources, are thus shown as the source of advances of 74 per cent of the security loans. T h e chief motives prompting the desire to get funds from banks on the basis of security collateral, may be listed as follows: (1) to earn a profit by currently making the difference between the income paid on the security put up as collateral and the rate of accommodation charged by the lending bank (this purpose having been especially dominant in 1925, 1926 and 1927); (2) to carry

INFLATION

IN

297

SECURITIES

securities with the intention of reselling them at a higher price (prevalent to an enormous degree, 1927-29); (3) the carrying of securities by dealers pending distribution to "investors"; (4) the carrying of securities for corporate control or similar "nonvalue" reasons; (5) for commercial, industrial, or agricultural purposes; (6) for miscellaneous consumption purposes.

Brokers' Loans Tremendous increase in brokers' loans was a significant index of unwieldy expansion during the period in question. Brokers' loans, as reported by the New York Stock Exchange, increased from 2,767 million dollars on May 31, 1926, to 4,433 millions on December 31, 1927; to 6,440 millions on December 31, 1928; and to a peak of 8,549 millions on September 30, 1929. T h e extent of the rise in common-stock prices can be seen in Table 25, which gives the yearly high and low prices of combined averages of 50 stocks. TABLE

25

NEW Y O R K TIMES INDEX OF FIFTY STOCKS

High Low

W3

im

1925

1926

1927

1928

92.5 77-2

107.2 82.3

138.2 101.2

142.A 109.6

1855 »35-8

23'-5 '73-'

19*9 3"-9 164.4

T h e increase of interest in stock-exchange speculation is illustrated by the figures on volume of stock sales on the New York Stock Exchange which are given in Table 26. TABLE

26

YEARLY AVERAGE OF MONTHLY VOLUME OF STOCK SALES • (In Millions of Shares) «923 »924 192 5 192 6

19.77 23.56 37.69 37.42

'927 1928 1929 1930

48.08 76.71 93-75 67.55

1931 1932 1933 «934

48.08 35.43 54-57 26.99

* Source: Standard Statistics Co., Bulletin for 193s and supplements, Jan.,

'935T h e gross commissions resulting from this stock trading on the New York Stock Exchange in 1929 were $191,248,553, while commissions on bonds were only $7,550,000.

298

INFLATION Extent

IN

SECURITIES

of Inflation

Increased

T h e extent of the security inflation is indicated by the degree to which security prices outran business activity. It is thus of interest to contrast the above-listed stock-price averages, in which stock prices quadrupled between 1923 and 1929, with the appropriate indexes of industrial activity. T h e pertinent statistics, compiled by Professor F. C. Mills, under the auspices of the National Bureau of Economic Research, are shown in Tables 27 and 28. TABLE

27

INDEX OF CHANGES IN OUTPUT OF NONDURABLE CONSUMPTION GOODS, 1922-29 • 1923 1923 1934 1925

100 108 IIO no

• Economic

Tendencies

in the United

1926 1937 1938 1929

116 118 123 124

States, p p . 269-80.

TABLE

28

INDEX OF PHYSICAL VOLUME OF THE PRODUCTION OF FINISHED GOODS • 192 2 192 3 1934 1925 • Economic

100 130 132 '4 8 Tendencies

in the United

1926 I937 1928 '929

154 143 158 '53

States, p p . 269-80.

With respect to the movement of prices during the period, the index numbers of the prices of raw materials, semifinished and finished goods, as compiled by the United States Bureau of Labor Statistics, are shown in T a b l e 29. TABLE

2 9

INDEX OF RAW MATERIALS, SEMIFINISHED AND FINISHED GOODS YEAR

192 2 192 3 192 4 192 5 192 6 192 7 192 8 192 9

RAW

MATERIALS

100 103

101 m 104

100

«°3 101

SEMIFINISHED GOODS

FINISHED GOODS

100 119 109 106 101 95 95 94

100 102

99 104 103 9s 99 94

INFLATION

IN

SECURITIES

299

An index of productive activity in manufacturing plants in all sections of the United States, based upon the consumption of electrical energy, is shown in T a b l e 30, while the clearings index of business appears in T a b l e 31. TABLE

30

INDEX OF PRODUCTIVE ACTIVITY MANUFACTURING • 1923 1924 1925 1926

Average Average Average Average

• Electrical

104.9 89.9 105.2 113.5

1927 Average 1928 Average 1929 Average

!'5-3 >23.9 '35-8

World, McGraw-Hill Publishing Co., Inc., New York. TABLE

31

C L E A R I N G S INDEX OF BUSINESS • 1923 1924 1925 1926

Average Average Average Average

102.8 99.5 104.8 105.7

1927 Average 1928 Average 1929 (Sept.)

106.6 107.8 115.2

* Clearings Index of Business, computed by the Federal Reserve bank of New York.

These indexes and many others show that the rise in stock prices was entirely disproportionate to the expansion in "business" and had no basis in industry. L e t us point out here the even more strikingly nonconforming concomitant action of commodities during the period, as shown in T a b l e 32. TABLE

32

DUN'S C O M M O D I T Y PRICE INDEX * 1923 1924 1925 1926

Average Average Average Average

189.8 '89.3 '97-7 189.4

1927 Average 1928 Average 1929 Average

'87.5 '94-4 191.1

• Dun's Commodity Price Index, New York City.

According to this, as well as to other authoritative indexes, there was actually a net decline in commodity prices during the period. T h i s fact illustrates most effectively the generalization heretofore made that no part of the credit expansion was employed in commodity, but was confined to stock, speculation. A l l indexes bearing

300

INFLATION

IN

SECURITIES

on underlying economic and "business" factors of the particular period, show that the rise in stock prices bore no relation to logical economic phenomena. For example, the first two indexes mentioned above show rises of but 24 and 28 per cent respectively between 1923 and 1929, while there was a net rise in stock prices of not less than 304 per cent. Not only did the stock rise not reflect a business rise, but, conversely, itself imparted some stimulation to business activity, which stimulation terminated with the collapse of speculation. Another measure of the inflationary movement of the period is the great increase in corporation dividend payments, which is presented in T a b l e 33. TABLE

33

ANNUAL DIVIDEND PAYMENTS OF REPORTING CORPORATIONS » (In Millions of Dollars)

192 3 192 4 192 5 192 6

963.3 1,012.9 1,068.8 1,690.5

1927 >928 1929 1930

2,099.4 2,325.6 3.449-4 4.203.6

'93« 1932 '933 1934

3.652-8 2,419.2 1,8772 2,019.6

• Source: Standard Statistics Co., Bulletin, Base Book, Jan. 15, i g j s , and supplements to Jan. 18, 1935.

Relative Dividend

Decline

Despite the large quantitative increase in dividends, the yield of dividends decreased sharply between 1926 and 1929, owing to the great rise in stock prices. In April, 1926, the yield on ninety combined stocks was 5.30, whereas by September, 1929, it had fallen to 2.88.13 A n d there were individual issues whose price distortions were far wider than even the aforementioned averages. For instance, in 1929, the common stock of Electric Bond and Share at 180 was selling at 100 times earnings; of Columbia Gas and Electric at 130 was selling at 70 times earnings; American Foreign Power at 199 per share represented 190 times its earnings, and so on; these prices being popularly defended by the stocks' appellation of "blue chips." In order to understand fully how these distortions were possible, it is necessary to comprehend the many factors making up the psychology of the various classes of stock speculators of the time. But these interesting phenomena are outside the sphere of this monograph, " S o u r c e : Standard Statistics Co., Bulletin, Base Book, Jan. 15, 1932, and supplements to Jan. 18, 1935.

I N F L A T I O N IN SECURITIES

301

which attempts to analyze the concrete elements and agencies which initiated the credit inflation and the resulting distortions. T h e great expansion in stock prices and speculative activity, as indicated by the above-mentioned quantitative measurements, seems to have been greatly stimulated by a concurrent enormous enhancement of investment banking activity, as well as to have caused a complete change in the functions of investment bankers. Demand for New

Issues

Demand for new issues as additional vehicles of speculation was, of course, continually stimulated by general stock-market activity, and this opportunity was used to the fullest by houses of issue. Whereas in such years as 1913 and 1918 new capital issues of $1,646,000,000 and $1,344,000,000 respectively had been floated, in the period 1924-29, the total new security offerings were as shown in Table 34. TABLE

34

T O T A L NEW SECURITY OFFERINGS, 1924-34 • (In Millions of Dollars)

192 4 192 5 192 6 «927 192 8 192 9

5.097 6,133 6,684 7.714 11,849 11,410

1930 '93' '932 «933 1934

5.473 2,588 643 379 491

* As compiled by the Commercial and Financial Chronicle, and published in Jan. of each year.

These figures are exclusive of "rights," which were thought of as privileges given to stockholders to increase their stockholdings in companies in which they already held an interest, through subscriptions to additional issues. An amount of $4,205,000,000 of preferred and common stocks of seventy-two listed companies was thus subscribed for by stockholders in 1929. As a preliminary step in appraising the effect of this new financing on the commercial and economic structure, it would be well to consider the changes that were occurring in the character of the issues and in the purposes and methods of the issuing houses. Investment banking before the period under discussion was the agency by which the long-term capital, necessary for the expansion of American industry, was secured. Commercial bank credit was em-

302

INFLATION

IN

SECURITIES

ployed in financing the short-term, self-liquidating transactions of industry and agriculture; the long-term capital so necessary to the speedy industrial growth of the country was secured from those willing to assume business risks through the medium of investment bankers. Thus, our great railroads, steel plants, and motor factories were started and expanded. In addition, the great investment bankers performed constructive functions, when called upon, in refinancing corporations and in aiding in the guidance of their financial policies. T h u s prewar investment banking performed a necessary and constructive service in the building and expansion of our industrial economy and our standard of living. Perversion

of Credit

Use

But this concept underwent a complete change in the postwar decade of inflated credit. T h e economic use and purposes of credit and capital extension were perverted, security issues of the quality which had arisen from the needs of industrial development and growing concerns were succeeded by mere stockjobbing schemes and promotions of every kind, and, instead of functioning as prudent bankers, heads of "investment" houses—and even of banks—became high-pressure salesmen of stock issues and propagandists of "New E r a " financing. And, as we shall see below, this "financing" was really to a great extent a misnomer; actually the public craze for common stocks and the securities exchanges were used as a means of enabling established owners of corporations and securities to distribute their personal holdings to the lay public at fantastic prices. In the period from 1922 to 1927, investment banking houses were engaged mainly in capitalizing and recapitalizing established businesses, and in selling the resultant common-stock issues to the public as "new issues"; while in 1928 and 1929 most of their activities consisted of reselling old issues by various methods predicated on the public's misconception of the true nature of what they were purchasing. T h e activities in both of these periods represented a complete debauching of the previously outlined constructive concept of true economic investment banking. Almost no capital was furnished to industry itself or to economic industrial development. The Perversion

of Investment

Banking

This contention can be confirmed as to the earlier period, if one examines the list of common-stock issues offered by even experienced

INFLATION

IN

SECURITIES

303

and relatively conservative houses, as well as by "security affiliates" of the largest banks. In the case of the investment houses, which before the w a r had been engaged in financing new industries at their inception—largely with their own capital—and in the discounting and sale of commercial paper on a large scale, in the period under discussion they operated to enable the owners of these identical industrial businesses to sell out their enterprises to the public and otherwise to manipulate their capitalizations for their o w n profit. A pertinent example of this change in investment banking practice is to be noted in the contrast between the constructive railroad financing designed to facilitate the great pioneering of the Northwest with the contrasting promotion jugglery, in 1928-32, by railroad exploiters of their own railroad holding-company securities. Similar operations were largely engaged in by the bank security affiliates. As is well illustrated in the testimony before the Senate Committee on B a n k i n g and Currency in 1933, the affiliate of a large New York bank, in its "strong-arm salesmanship" distribution of a copper-company stock, certainly performed no conceivable service to either the individual copper company or to the copper industry itself. N o r did the functions of investment houses in underwriting "stock split-ups" and other arithmetical changes in capitalizations and in bringing about an enormous number of mergers in many fields—dictated by the opportunism of stock s p e c u l a t i o n perform any economic function.

The Investment

Trust

Illustrative

A typical example of 1928-29 financing was the formation of all manner of so-called "investment trusts" and holding companies. Over $4,000,000,000 of new securities of these promotions were sold in 1928 and 1929. 14 W h i l e the raison d'etre of British investing companies has been to afford the small investor a means of diversifying his income, the American companies were, for the most part, little else than stock-gambling pools formed in the last and highest stage of an inflated boom. T h e i r purpose was twofold: (1) to distribute stocks of "insiders" through the misleading method of using new names for the constituent stocks as an excuse to increase their already highly inflated selling prices, and (2) to make money by direct market speculation. These legitimatized syndicates were both stimulated by, as well as 1* Source: Standard Statistics Co., Bulletin, 1930-31, Base Book Issue.

304

INFLATION

IN

SECURITIES

actively stimulating, the ever-increasing speculative psychology of the public—a psychology initiated by over-easy credit, then impossible to stop. It is their effect on the security price level and on the "investment" habits of the public and their utter disregard of the intrinsic value of the securities, rather than the many abuses with respect to profits paid to their founders and managers and to many allied parasitic purchasing syndicates, distributing syndicates, and others, that is important and pertinent to our general discussion. Public utility super-holding companies furnished another device for skillful "stock-swapping" activities by influential investment bankers. As far back as 1927, Professor William Ripley had attacked the utility holding companies of that and prior periods as being "watered" and surreptitiously pyramided. In holding-company operations, and in other promotions, little or none of the money subscribed by the public went into industry. T h e proceeds of many of the new capital issues did, however, go directly to operating corporations; but, owing to the overexpansion of credit directly and indirectly available for the promotion and carrying of securities, all careful functions of scientific credit analysis were completely vitiated. Corporations were entirely independent of commercial-credit restrictions; the "decisions" as to allocation of credit were made by speculators whose only interest lay in securing personal profits through appreciation of equities. T h e demand coming from the vast nation-wide army of speculators in the period of common-stock "craze," and the insatiable demand of the gambling public for more and more stock, represented a condition of the cart being before the horse, in the sense that speculators' funds were forcing their way into commercial and industrial expansion in direct proportion to the stock-market boom, rather than in response to the legitimate demands of industry. Moreover, this new trend of financing industry through the stock market was dangerous, in that it led people to believe in new limitless and permanent sources of national capital wealth. In other words, billions of dollars of marginal stock-buying, with the aid of enormous brokers' loans, was considered the sound " n e w " way of financing industry and a means of normal expansion of plant. As a matter of reality, great overexpansion of long-term plant equipment was caused by the oversupply of credit looking for speculative profits —credit unscientifically extended, ready to withdraw at a moment's notice. As President Simmons, of the New York Stock Exchange, said

INFLATION

IN

SECURITIES

305

further: 15 " T h e problem is to make more good securities available to absorb excess supplies of capital." In addition to the above-illustrated—and prevalent—misconception of the nature of the n o n b a n k i n g credit extended, the supplanting of the banker by the stock speculator eliminated all possibility of proper scientific credit analysis. It caused ruinous and uneconomic overexpansion in many industries such as copper, chainstore, public-utility, automobile, and other types; and also in the case of foreign financing, prudent credit analysis by conservative bankers was nullified by the uncontrolled desire of the public to purchase any foreign issue with a high-rate coupon. In cases where an individual stock buyer, a group of stock buyers or investment bankers may have attempted to apply principles of scientific credit analysis to individual companies, ensuing overexpansion of entire industries, owing to general credit inflation or unscientific overinvestment by others, nullified the efforts of the relatively careful individual by weakening the entire structure. T h i s condition is exemplified by the case of foreign issues. In the earlier years of foreign lending, most of the individual loans were carefully made and could be defended on scientific investment principles. But as the credit supply increased and it became increasingly difficult to find worthy borrowers at home or abroad, the quality of the loans deteriorated progressively, with the result that in many countries the entire credit structure was ruined by the progressive overlending; and prudent individual lenders suffered along with the reckless.

Psychological

Factors

Inasmuch as the laws of credit and of speculation are not mechanical nor subject to precise mathematical formulation, but rather statements of the way in which human beings react and behave in dealing with credit, the psychological effect of the above-mentioned phenomena on the mass mind should be considered. As the speculative structure grew, considerations based on logic became increasingly to be disregarded and were displaced more or less by romantic excuses for the excesses of the period. T h u s the so-called " N e w E r a " philosophy reached its point of greatest popularity immediately before the complete collapse of the speculative structure in October, 1929is "New Aspects of American Financing, 1929," address delivered before a convention of the Indiana Bankers Association at Evansville, Ind., Sept. u , 1929.

S06

INFLATION

IN

SECURITIES

There seems to be a psychological cause for the postponement of complete liquidation of security loans. In the latter part of 1929 and in 1930, the crash was widely regarded as only a temporary recession in a permanent long-term upward movement; the community was unwilling to recognize the permanence of the depression. In the interval between October, 1929, and the end of 1 9 3 1 , while security loans remained frozen near the maximum levels, a tremendous fall in security prices was occurring, stock prices declining from 3 1 1 in September, 1929, to 88 in September, 1931, and bond prices falling from 85 to 72. i a During 1931 and early in 1932, there were frequent sharp rallies in prices, based usually on rumored or actual governmental steps to bolster values artificially by such agencies as the Reconstruction Finance Corporation. Nevertheless, the terrific deflation continued relentlessly, stocks registering a low of 34 in July, 1932. 18 T h i s date, and not the prebank suspension period as is popularly imagined, marked the depression low point. In fact, the 1933 February-March low was 46, a rise of 36 per cent having occurred in the seven-month period. T h i s was caused by the influences of a re-stimulated Federal Reserve easy-money policy, fears of currency inflation, and growing distrust of the banking and monetary system, rather than by any proportionate improvement in business activity or of intrinsic economic conditions. Renewed Creation of Credit After the bank holiday in March, 1933, stocks rose from a low of 46 to 98 in J u l y , 1933, receding to 71 in October, advancing back to a level of 98 in February, 1934, and standing at 87 in December, 1934. While the reasons for this price advance, following our suspension of the gold standard, are highly contentious, it is rather generally agreed that its foundation did not lie in intrinsic investment value, as reflected by asset position or by actual or prospective earnings. Upon the bases of 1934 prices, many stocks are selling on as fantastic a price-earning ratio basis as they did in 1929, and the average yield of a selected group of leading stocks is but 3.03 per cent. 17 Close observation of the market and its reaction to various extraneous influences shows that the main cause of the continued high level of security prices lies in the credit inflation which has existed—in the plethora of funds looking for employment, 1« New York Times average of 50 stocks and 40 bonds. Standard Statistics Co. average of 90 stocks combined.

INFLATION

IN

SECURITIES

307

combined with the apparently permanent choice of securities by bank management as a desirable form of assets, and in the recognition by the investing community of the explosive qualities of further credit expansion inherent in recent monetary legislation and governmental policy. Potential credit expansion through Federal Reserve holdings of two and a quarter billions of government securities, huge excess reserves of approximately two billions, and such legislative enactments as the so-called Thomas Amendment and the 1934 Gold Reserve Act, have created a foundation for credit expansion far greater than existed in previous inflationary periods. This thesis seems to be proved by the action of the bond market. Factors of monetary distrust and currency devaluation would ordinarily be expected to depress the price of bonds, especially government and other "high grades." Moreover, economic prospects of many industries, such as utilities and railroads, would be harmed rather than helped by inflationary factors. Yet we find that the average of government securities advanced from 101 in March, 1933, to 103 in September, 1933, and stood at 105.2 in January, 1935. 18 T h e New York Times average of 40 leading bonds rose from 60 in April, 1933, to 84 in April, 1934, standing at 83 in February, 1935; and even in the case of public utilities, an industry suffering acutely from increasing taxes, lower rates, and increased costs, a great rise occurred, as is shown by a decrease in yield from 5.18 per cent in March, 1933, to 4.28 per cent in January, 1935. 19 This remarkable record shows that the artificially idle funds seeking an outlet have been an agency strong enough to overcome economic factors of fundamental value or of instability of government finances and the unit of value. Again, the supply of credit has been the governor of the security price structure. SOME

CONCLUSIONS

1. Booms are the result of, and are carried on by, the two necessarily present factors of an uneconomic oversupply of credit, plus an active distortion of public psychology, both of which are interrelated and interacting. 2. T h e expansion occurring in the war period could not have 18 From Federal Reserve Board averages of 15 United States government issues, as quoted in the Annalist, J a n . 18, 1935. 18 Source: Standard Statistics Co. averages, contained in bulletins to Jan. 18,

'935-

308

INFLATION

IN

SECURITIES

taken place without accompanying credit inflation; but the credit expansion did not of itself cause all the industrial expansion of that particular period. On the other hand, in the subsequent twenties, the Federal Reserve system unwittingly initiated the security boom. 3. T h e existence of any central banking system or any other form of credit management in America is always a potential source of nationwide speculation, through the perversion of its legitimate functions. 4. As a result of the 1919-29 commodity, real-estate, and security booms, the soundness of the nation's financial, industrial, banking, and entire economic structures was distorted and for a time ruined. 5. Since the 1929 collapse, managed-credit inflation has been again introduced with increasing intensity, and the basis appears to exist for an expansion, surpassing anything that has heretofore preceded it.

6 INFLATION

AND

THE

BY SCHROEDER

STOCK

MARKET

BOULTON

DURING the postwar decade there were two great waves of inflation: (1) immediately following the war, interrupted by the primary postwar depression and lasting in many countries until the early or middle 1920's; and (2) during the later 1920's, coming to a climax in 1929. Government deficits characterized the earlier inflation period, private loans and private capital issues the second. In the wake of the extreme deflation of 1930-32, a new inflationary wave has appeared, bearing many features of the early postwar inflations. T h e most important extensive inflations of the first period were diose of France and Germany; the most important extensive inflations of the second and third periods have occurred in the United States. T o the latter we turn our attention in this monograph. THE

"NEW-ERA"

INFLATION,

1927-29

T h e advance in common-stock prices in the United States from 1927 to September, 1929, was different in character from the earlier advances in France and Germany. Although the American inflation had its ultimate origin in economic readjustments wrought by the war, this ends its similarity to the European inflations. T h e French and German inflations were government-deficit inflations, accompanied by currency depreciation and rising commodity prices; the United States inflation was a private-credit inflation, accompanied by government surpluses, exchange regularity and commodity price stability. T h e United States inflation was marked by presence of confidence; particularly in the years from 1927 through 1929, Americans thought and acted as though they were in a "New Era" of permanent prosperity. Similar in many respects to other American booms, the "New Era" boom was widely different in degree from any that preceded it. Its culminating phase, in which stock prices went far out of line with earnings, and yields approached the vanishing point, consumed years, rather than a few months. T o find examples of similar market rises during periods of currency stability is almost impos-

310

I N F L A T I O N AND T H E STOCK

MARKET

sible. One must go back as far as the England of the South Sea Bubble, when South Sea Company stock rose from 1281/2 in January, 1720, to 1,000 in July, and in course of a disastrous panic fell back to 135 in November. Large-scale finance capital was a new thing in the England of 1720, and the English suffered heavy losses in learning its prudent management. Likewise, in the United States, after the war, Americans had little experience to guide them in the management of a suddenly assumed creditor position. That unsound policies were carried to an extreme, that initial appearance of success led to ebullience of enthusiasm, and that the economic situation eventually got completely out of balance, does not seem strange in retrospect. SIGNIFICANCE OF

1926

T h e year 1927 is a logical point for beginning the history of the "New Era" stock market inflation, as 1926 was the last year of relative normalcy in postwar American finance. Despite unsound elements of growing importance, 1926 was a year of reasonable adjustment in comparison with succeeding years. In particular, 1926 was a year of fair adjustment between stock prices, industrial production and commodity prices. Although all had advanced over the levels of 1913, the advances were of similar proportions. If one were to give full weight to the indexes of industrial production and commodity prices, the conclusion would be reached that stocks were under- rather than over-valued. Offsetting factors, such as increased taxes on corporate incomes, indicate that in 1926 stock prices probably represented sensible valuation. In 1926 stocks were selling at price-earning ratios similar to prewar ratios; dividend yields were lower, but only moderately so. In 1927, 1928, and 1929, the increase in common-stock prices went far beyond any reasonable relationship to tangible factors. From 1926 to 1929, common-stock prices increased 93 per cent, but industrial production advanced only 8.1 per cent and commodity prices declined 4.7 per cent. "New Era" changes in common-stock prices, industrial production and commodity prices are indicated in the following table. For comparative purposes, records of a number of years both before and after the 1927-29 period are shown in Table 35. It is significant that in 1926 industrial stocks showed a much greater gain over prewar levels than railroad or public-utility stocks.

I N F L A T I O N

AND

T H E

TABLE

STOCK

M A R K E T

311

35

UNITED STATES COMMON-STOCK PRICES, INDUSTRIAL P R O D U C T I O N , AND C O M M O D I T Y P R I C E S COMMON STOCKS * YEAR

20 RAILROAD STOCKS

•9'3

1919 1920 1921 1922

9'-3 74-2

66.9 65.2 76.6 76..

2 0 PUBLICUTILITY STOCKS

60.7 46-3 39-4

40.6 54-5

5 0 INDUSTRIAL STOCKS 42-5 65-5

9° COMBINED STOCKS

67.2 67.2 6O.2

80.0

53-6

57-3 77-9 929

60.0

64.6 67.O

1035

'52-9

97-2 IOI.I

96.7

'53-2

'57-2 IOI.I

'933

39-1

73-2

27.1

84.9 81.7

52.0 73-4

96.7

95-7

1582 IOI.I

220.2

'54-4 97-6

100.0

'43-1

122.8

69.8 I38.6

89-9 I OO.O

1929 '93° >93' '932

"9-5

COMMODITIES)

100.6 98'

193.2

100.0

(782

87.1

164.5 204.0

126.4

639 70-5 89-9

COMMODITY PRICES X

72.7

'53-4 244-3

79-2 897

100.0

7'-7

61.3

"7-5

1926 1927 1928

64.8

49-7

58.4 66.3 90.5 100.0 116.8

•923 1924 '925

INDUSTRIAL PRODUCTION T (UNADJUSTED FOR LONG-TERM TREND)

I18.9

50.1 65.2

108. i 86.2 70.2 5 4 °

61.6

100.0 95-4 95-3

86.4 73-°

64.9 66.0

• Source: Standard Statistics Co., weighted for number of shares of each stock outstanding, corrected for value of rights, stock dividends, changes in par value and consolidations; annual averages of monthly high-low prices. f Source: Standard Statistics Co. J Source: United States Bureau of Labor Statistics.

T h i s situation was logical, inasmuch as, with flexible costs and prices, industrial companies were in better position than railroad or public utility companies to adjust to war-caused changes in the general price level. E C O N O M I C AND PSYCHOLOGICAL

BACKGROUND

During the "New Era" period from 1926 to 1929, unsound economic and psychological factors, which had been present in previous years, increased in importance and influence. Unsound economic factors included extreme expansion of the long-term credit structure, particularly in the fields of real estate, and municipal and foreign bonds. There was also a heavy expansion of medium-term and short-term credit, particularly for installment buying and stockmarket speculation. War-time economic forces and a changing price level altered the situation of many leading companies, in ways which

312

I N F L A T I O N AND T H E STOCK

MARKET

c o u l d not h a v e been forecast by the old methods. T h e shortage of l a b o r d u r i n g the war and the d e m a n d f o r new products, increased the rapidity of technological change. M a n y long-established companies were p l u n g e d into insolvency; at the same time, many small u n i m p o r t a n t companies suddenly acquired substantial earnings, financial strength and d o m i n a n t trade positions. W h i l e these changes in companies' positions were taking place, total corporate earnings were rapidly growing. T h i s growth stimulated search for companies giving promise of substantial increase in earnings. Earnings of all corporations, based u p o n D e p a r t m e n t of I n t e r n a l R e v e n u e statistics, from 1920 through 1929, appear in T a b l e 36. TABLE

36

NET INCOMES AND NET DEFICITS OF ALL CORPORATIONS • (In Millions of Dollars)

YEAR

1920 1921 1922 '923 1924 •925 1926 '927 1928 '929

N E T INCOMES ( A F T E R DEDUCTING N E T DEFICITS OF A L L CORPORATIONS REPORTING DEFICITS)

1 $6,190 970

5.420

7,060 6,200 8,490 8,400 7.470 9.340 9,860

NET DEFICITS OF A L L C O R P O R A T I O N S R E P O R T I N G DEFICITS

$1,980 3.840 _ 2,1 10

I,900

2,110 1,840 2,070 2,380 2,290 2,8lO

• A c c o r d i n g to the careful estimates of S. H . N e r l o v e , in A Decade porate Incomes, University of C h i c a g o Press, 1932.

of

Cor-

T h e large a n d gradually increasing deficits of corporations rep o r t i n g deficit, indicated a growing instability, and should have served as a w a r n i n g to the overenthusiastic. H o w e v e r , it was mainly the smaller corporations w h i c h reported deficits. T h e s e unsuccessful companies were not so well k n o w n to stock speculators as the larger companies. Stocks of small companies for the most part are held privately; stocks of larger companies are usually listed on a securities e x c h a n g e . W i t h their computations favored by the general price rise d u r i n g the W o r l d W a r and by the increased earnings of a large n u m b e r of p r o m i n e n t companies, most speculators came to believe that com-

INFLATION

AND T H E

STOCK M A R K E T

313

mon stocks far excelled bonds as long-term investment media. Holding this belief in a period when the older principles of stock valuation h a d lost favor, they adopted an entirely new set of ideas: 1 (1) " t h e value of a common stock depends u p o n what it can earn for the f u t u r e " ; (2) "good common stocks will prove sound a n d profitable investments"; (3) "good common stocks are those which have shown a rising trend of earnings." These beliefs abolished the f u n d a m e n t a l distinction between speculation and investment, ignored the price of a stock in determining whether it was a sound investment, and gave no weight to dividend or asset factors. T h e y reflected an emphasis u p o n good will, expected earnings, h i d d e n potentialities, and other intangibles, subject to wide variations in accordance with p o p u l a r moods. T h e y signalized capitulation to the gambling fever. INCREASE OF CAPITAL FUNDS

Unusually large increases in available capital f u n d s created a favorable investment a n d speculative background. After 1919 the national debt was continually reduced. Funds from this source, plus swollen interest and dividend payments and increased incomes from other sources, m a d e available a much larger a m o u n t for investment and speculative purposes than had ever been known in the U n i t e d States. From the end of 1919 to the end of 1926, Federal interest-bearing debt was reduced by $6,800,000,000; f r o m 1926 to 1929 it was f u r t h e r reduced by $2,800,000,000. T o t a l corporation interest a n d dividend payments, as reported by the New York Journal of Commerce, were $1,777,200,000 in 1913, $3,299,700,000 in 1922, $4,391,000,000 in 1926, a n d $8,577,600,000 at the peak, in 1930. T h e heavy surplus of investment f u n d s was not allowed to lie idle, and new corporate capital issues were offered in increasing volume. According to the Commercial and Financial Chronicle, they totaled $2,336,000,000 in 1922, $4,101,000,000 in 1925, $4,357,000,000 in 1926, $5,391,200,000 in 1927, $6,080,000,000 in 1928, a n d $8,639,000,000 in 1929. In addition, foreign lending totaled $828,400,000 in 1922, $1,316,300,000 in 1925, $1,288,500,000 in 1926, $1,577,400,000 in 1927, 1,489,300,000 in 1928, and $705,800,000 in 1929. New corporate offerings included many investment-trust securities. Sale of these was of considerable assistance in increasing stock prices, 1 Graham, Benjamin, and Dodd, David L., Security Book Co., New York, 1934, p. jog.

Analysis,

McGraw-Hill

314

INFLATION

AND THE

STOCK

MARKET

since, with the funds obtained, investment trusts often went directly into the market to purchase blocks of stock. Investment-trust offerings were estimated to reach the high total of $2,400,000,000 in the first ten months of 1929. During the "New Era," stock speculators were spurred o n by economic changes resulting from the war; by the rising level of corporate profits; by large security issues and heavy expansion in longterm, medium-term and short-term credit; and by an encouraging supply of new investment funds. T h e y were further stimulated by the adoption of new methods for valuing stocks, and by financial confidence and political stability. BROKERS'

LOANS

It is not surprising, in view of the factors involved, that in their operations "for the rise," speculators in the 1927-29 period were extremely successful. However, speculation would probably have been unable to advance far, without the assistance provided by the inflation of loans based on security collateral. American stock speculators characteristically trade on a margin, financing part of their commitments with borrowed money. T h e y thus are enabled to operate on a larger scale and, if successful, to increase their profits accordingly. U p to 1929, loans on securities grew rapidly, and at the peak it is estimated that such loans aggregated $20,100,000,000, distributed as in T a b l e 37. TABLE

37

LOANS ON SECURITIES,

1929 *

L o a n s by Banks Loans by " O t h e r s " (Corporations, Individuals, Investment Trusts, etc.) to N e w York Stock E x c h a n g e M e m b e r s N e w York Stock E x c h a n g e M e m b e r Borrowings f r o m Private Banks, Brokers, a n d Foreign L e n d i n g Agencies

$14,700,000,000

T o t a l Security Loans O f Which Loans to N e w York Stock E x c h a n g e M e m b e r s T o t a l e d . .

$20,100,000,000 8,500,000,000

• Beckhart, B e n j a m i n H a g g o t t , The New versity Press, 1932), III, 78.

York Money

There are numerous valid reasons for Many bank customers borrow thus for mercial business, although surveys have times a surprisingly large percentage of

Market

3,900,000,000 1,500,000,000

(Columbia Uni-

borrowing on securities. financing ordinary comindicated that at certain bank debtors have bor-

INFLATION

AND T H E STOCK MARKET

315

rowed on securities merely for the purpose of carrying such securities. Loans made to brokers are unquestionably for the purpose of financing ownership of securities. Changes in the a m o u n t of such loans have shown a strong positive correlation with changes in stock prices. It is natural for brokers' loans to parallel changes in stock prices, inasmuch as the d e m a n d for brokers' loans arises from the necessity of financing transactions already consummated in the market. At whatever interest rate may be found necessary, f u n d s are always forthcoming in sufficient quantity to meet the d e m a n d for them, since shortage might precipitate a crisis in which the safety of previously extended loans would be endangered. Although in the 1927-29 period interest rates at times rose to extreme heights, this did little to d a m p e n speculation. Interest rates were always moderate in comparison with the rates of gain expected from stock-price changes. T a b l e 38, listing stock prices, brokers' loans, a n d call-loan rates, shows that although there was a close relation between brokers' loans and stock prices, there was little relation between stock prices and call-loan rates. BANKERS' POLICY DURING THE

BOOM

Strenuous b a n k i n g efforts to halt the increase in brokers' loans were made in the latter years of the boom. In 1927, an increase in speculative borrowings had been directly stimulated by Federal Reserve policy. D u r i n g the latter half of the year, in the face of gold loss a n d business recession, the Reserve banks adopted an inflationary policy, reducing rediscount rates to 31/2 per cent and rapidly e x p a n d i n g their holdings of government securities. It was hoped that the increased reserves thus made available to member banks would go into commercial loans and stimulate business. O n the contrary, business loans declined slightly d u r i n g the year, while security loans and bank investments in securities increased. Financed by sharp credit increases, the stock market forged ahead so strongly that the Reserve authorities became alarmed, a n d in 1928 and 1929 numerous attempts were made to discourage speculative borrowings. Rediscount rates were raised early in 1928, and by July a 5 per cent rate was in effect in seven of the twelve Reserve banks. T h i s move failed to be effective, and early in 1929 the Federal Reserve Board adopted the experimental policy of exercising "moral suasion" to induce banks to lessen their loans for

316

I N F L A T I O N A N D T H E STOCK M A R K E T TABLE STOCK

PRICES, BROKERS' LOANS AND CALL-LOAN

BROKERS' STOCK PRICES STANDARD YEAR

STATISTICS COMBINED STOCKS

Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.

1928

Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.

¡929

Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.

LOANS,

NEW YORK

CITY

REPORTING MEMBER

BANKS

RATES

CALL-LOAN ON N E W STOCK

RATES YORK

EXCHANGE

COMPANY 90

1926 '9*7

38

AMOUNT (OOO.OOO OMITTED)

INDEX NUMBER

I OO.O

$2,710

IOO.O

104.4 106.8 108.2 110.6 114.1

2,778 2,773 2,816 2,866

102-5 IO2.3

"5-7 118.6 124.7 130.2

2,933 3."5 3,096 3,'Si 3,261

129-3 130.4 '33-6

3,392 3,44» 3,621

136.4

3,802

'33-4 141.0

3,784 3,762 4,062

"49-3 '53-5 146.3 147.0 »55-9 160.5 1639 172-3 «75-6 .87.9 188.6 188.9 189.3 191.6 196.1 212.2

4,4*4 4,355 4,232 4,238 4,417 4,701 5,102 5,'55 5,408 5,555 5,679 5,477 5.491 5,383 5,84> 6,069

224-5 232.7 188.2

6,54° 6,498

'55-9 161.9

4,023 3,39'

'°3-9 105.8 108.2 »4-9 114.2 117.4 120.3 125.2 127.0 '33-6 140.3 '39-6 1388 149-9 162.9 160.7 156.2 156.4 163.0 '73-5 188.3 190.2

HIGH

6%

3%

5 5 4 yi 5 4 yi 5 4 yi 4 4 yi

4 3K 3JÎ 4 4 4 3K 3K 3H

yi òV,

4

4

5X 4K 5 6

6yi

8 10 8

9 10 10 12

199-6 205.0 209.6 202.1 202.6 198.6

12 10 20 16

215-5 223.9

'5 12 10 10 6 6

24'-3 239-8 148.5 125.1

LOW

>5 10

3yi 3X

3'A 4 4 yi 4 yi 4 yi 5 yi 5 4 yi 6 6 6 6 6 6 6 6 6 6 6 6 6 5 4 X 4X

INFLATION

AND T H E STOCK MARKET

317

stock-exchange purposes. T h i s attempt also failed, and in August, 1929, the Reserve bank raised its rediscount rate to 6 per cent. Fears of i n j u r i n g business had all along prevented more stringent action, and when the rediscount rate was raised to 6 per cent, the acceptance buying rate was reduced. T o lower rediscounts, large amounts of acceptances were sold to the New York bank, so that this step of the Reserve authorities also proved fruitless, and the market continued its advance. It collapsed two months later, after liquidation h a d been impelled by a definite business recession and by publication of disquieting foreign and domestic news reports. T o understand the failure of the Federal Reserve system to restrict brokers' loans, it is necessary to know the source of these loans. T h r e e principal classes of lenders participated in the brokers' loan market: (1) New York banks; (2) out-of-town banks; and (3) "others," represented by corporations, individuals, investment trusts, etc. At every point in the attempt to reduce speculative credit, the Reserve banks suffered defeat through increases in loans by " o t h e r " lenders, who were independent of banking control; or by out-oftown banks, who were less directly subject than New York banks to banking control. Loans by New York City reporting member banks "for own account" showed no net increase from January, 1926, to the peak of the boom in 1929; for the period from January, 1927, to September, 1929, the increase was only slightly in excess of $100,000,000. O n the other hand, loans by "others" increased from $741,000,000 in January, 1927, to $3,802,000,000 in October, 1929; and loans by out-of-town banks increased from $1,104,000,000 in January, 1927, to $1,850,000,000 in September, 1929. From J a n u a r y 4 to July 25, 1928, when New York reporting member banks reduced their loans to brokers by $687,000,000, "other" lenders increased their loans by $896,000,000, and out-of-town banks increased theirs by $166,000,000. T a b l e 39 indicates the changes in the composition of brokers' loans, by quarterly periods, from 1927 through 1929. T h e growth in loans by "others" was due to attractive rates and the heavy excess of current assets enjoyed by many corporations on account of large earnings, careful inventory policies, and f r e q u e n t stock issues. Brokers' loans by "others" were made illegal d u r i n g the depression, and will probably never again be the dangerous factor they were in 1927, 1928 and 1929. T h e "New E r a " stock boom was thus a result of unusual postwar economic and psychological influences, and was facilitated by a

318

I N F L A T I O N

A N D

T H E

TABLE

S T O C K

M A R K E T

39

BROKERS' LOANS MONTHLY AVERAGES OF WEEKLY FIGURES (In Millions of Dollars) LOANS B Y NEW Y O R K CITY REPORTING MEMBER BANKS

'9 S7

s

Jan April July Oct

933 929 i »032

LOANS B Y _ OUT-OF-TOWN BANKS

Si,104 1,13' 1,187

i

i,301

Jan April July Oct

i .34« i .>93

1,470 1,617

929 933

>.559 1,720

Jan April July Oct

1 »173

1,801

934 1 ,•98

1.649 1,651

1928

1929

'930

Jan

LOANS BY „ „ OTHERS

8

TOTAL LOANS

74' 806

«2,778 2,866

877 963

3,096 3.392

989

3,802 4,062 2,232 4,701

',245 '.744 2,048 2.434 2,893

1 »257

>.639

2,992 3,802

844

863

1,645

5,408 5.477 5,841 6,498 3,35'

heavy expansion of credit for speculative purposes. In principle it w o u l d have been possible for current stock prices to reach considerable heights o n the basis of strictly cash transactions. However, those w h o buy for cash d o not ordinarily plan to resell quickly, b u t desire safety a n d a fair rate of income. Cash buyers d o not contribute largely to the class which trades for quick profit f r o m speculative rises. Cash investors alone w o u l d not have caused the large turnover a n d rapid price increases of 1927-29; it was the speculators w h o drove stocks upward. THE

CHARACTER

OF SPECULATIVE

INTEREST

T h e character of the speculative " b u l l interest" is indicated by the type of security w h i c h enjoyed the greatest favor. In general, stocks in industries such as aircraft and radio, whose future could be p a i n t e d in glowing, if general, terms, were given most attention. T h i s attention was divorced from the sober consideration of tang i b l e factors. T a b l e 40 gives the annual price range of the ten stock groups showing the greatest percentage increase after 1926; for purposes of comparison, annual earnings of the leading corporations

i 5$ o o

tri í 3 ci o o.

z £ 5 S w

» u z s

Ipi

I— Qi T*- CTj — Tf o O io c i n s iCTieoœ r- r^to ûMMiiooio'ûn

co O g

S

g>

Ö •o S 3

e S _3

u M H < o^ w J«

5'5

21 146

4,186 190 1,271

',539 5"

2,522 1,462 249

Total Investments

2,091

309

2,400

2,945

United States Securities Other Securities June, 1933 Total Loans and Investments

1,112

116

979

«93

1,228 1,172

',577

3,'72

7,138

1,288

8,426

Total Loans

3,429

677

All Other Loans Loans on Securities Real-Estate Loans Miscellaneous Loans Total Investments United States Securities Other Securities

10,148 3,"9'

2,031

4,439

9,784

1,267

3,863

8,494

7,874

24,794

4,106

4.484

4,276

12,866

260 312 29

1,317 2,"5

77

489

2,007 1,142 '.055

5,048

186

'.724 '»447 1,'3'

7'

4,704 2,372 74'

3,709

611

4,320

4,010

3.598

11,928

2,55«

385

2,936 «,384

2,482 1,528

1.469 2,129

6,887

«>057

1,803 '57 412

1,158

226

1,368

181

• Source: Member Bank Call Reports of the Federal Reserve

5,92i

5.041

Board.

In 1929 a dominant proportion of the portfolio was in all other loans and loans on securities. Country banks held their greatest percentage of loans of the secured category in 1933. Over this period, these banks and banks in the other reserve cities held the largest proportion of real estate in relation to total loans. Realestate loans were practically a negligible percentage of central reserve cities' loans, although this relation tended to increase in 1933Besides these changes, which were in the loan part of member

338

INFLATION

AND

BANK

PORTFOLIOS

bank portfolios, the figures for the entire portfolios show a new element injecting itself into this balance-sheet situation after 1929. T h i s had to do with the increase in investment holdings between December, 1929, and J u n e , 1933, in all groups except the country banks. T h i s trend, counter to the declining volume of loans held in the portfolios, leads us now to a discussion of its causes, which are indicated in the behavior of investments. TABLE

47

CHANGES IN T H E C O M P O S I T I O N O F LOANS O F ALL M E M B E R BANKS • (In Percentages of Total Loans) NEW YORK CITY

DATE

October, igsg All Other Loans Loans on Securities Real-Estate Loans Other Real Estate On Farm Land Miscellaneous Loans September, 1330 All Other Loans Loans on Securities Real-Estate Loans Other Real Estate On Farm Land Miscellaneous Loans June, 1933 All Other Loans Loans on Securities Real-Estate Loans Other Real Estate On Farm Land Miscellaneous Loans • Source: Member Bank -(-Less than 0.001.

CENTRAL RESERVE CITIES CHICAGO COMBINED

OTHER COUNTRY RESERVE BANKS CITIES

ENTIRE SYSTEM

%

%

%

%

%

%

40 45 3 3

39 54 î î

46 2

40

t

12

t

6

t

12

42 38 16 '5 î 4

53 29 16 13 3 2

45 37 12 10 2 6

3« 55 2 2

31 58 î î

3' 56 2

36 39 18 16 2 7

52 28 18 15 3 2

39 4' 12

38

33 25 22 3 4

47 26 25 21 4 2

39 37 18 16 2 6

Reserve

Board.

Î

T

12

10

31 53 4 4

38 46 4 4

12

12

t

t

Call Reports

Investments

I

I

î 11 32 52

4 4

î

12 of the Federal

of All Member

11

i 8

Banks

T h u s far, we have related the evolution of the portfolios as a whole through loans, and given investments, which constituted generally the smaller part of the portfolios, only passing notice. T h e reason for this is that until about the close of 1929, the portfolios of

INFLATION

AND BANK P O R T F O L I O S

339

m e m b e r banks were largely dominated by loans. W e have already seen indirectly that, in relation to the entire portfolio in all group holdings, government a n d other securities together, as late as the close of 1930, constituted generally less t h a n 30 per cent, except i n the country banks where a b o u t 35 per cent of the portfolio was devoted to investments. Of these percentages we find, through 1930, the greater p r o p o r t i o n held largely in other securities, in all except the New York group. After this date, the percentage holding of government securities increased in all groups to a marked degree, while o t h e r securities increased at a much more gradual pace. Following 1929, all investments increased, for the system, to a peak of $12,266,000,000 in December, 1932. However, the peak of $4,765,000,000 for country banks, which held chiefly other securities, came in J u n e , 1928. T h e peak of $3,789,000,000 for New York banks, which held more government securities than other securities, did not come until December, 1932; while in Chicago the peak was $611,000,000 in J u n e , 1933. O t h e r reserve cities held principally other securities, to a peak of $4,187,000,000 occurring in June, 1931. O t h e r securities were held by the system in the greatest quantity, $6,886,000,000, in March, 1931, and for the other reserve cities in J u n e , 1931, when $2,125,000,000 were held. T h e decline in the holdings of other securities in country banks started after J u n e , 1928, as noted; in Chicago, after December, 1930; a n d in New York, after September, 1931. Contrasted with these dates, government securities were held in the greatest quantities in all groups, in 1933, with the exception of New York, where December, 1932, marked the peak. T h u s the period of d o m i n a n c e for other securities generally was before the close of 1931. After this time and u p to 1933, government securities h a d their greatest prominence in the investment portion of the portfolios. Investments did n o t increase very rapidly u n t i l after 1930 (see T a b l e 44). T o w a r d t h e end of 1929, both government and other securities were liquidated as member banks generally p u t their portfolios in better shape toward the end of the period of speculation. A f t e r 1929, holdings of government securities, in relation to total investments, increased rapidly. A d o m i n a n t part of the investment portfolio of the central and other reserve cities (see T a b l e 48), of 68 p e r cent a n d 62 p e r cent respectively, was so comprised in June, 1933. O n this same date, 58 per cent was so held for the system

340

INFLATION AND BANK

PORTFOLIOS

and 41 per cent for country banks. This represented an increase from October, 1929, to June, 1933, for central reserve cities of 14 per cent; for other reserve cities, of 13 per cent; for the system of 17 per cent; and for country banks of 11 per cent. The largest proTABLE 48

DISTRIBUTION OF INVESTMENTS AMONG ALL MEMBER BANKS » (In Percentages of Total Investments) NEW YORK CITY

DATE

March,

1926

United States Securities Other Securities June,

1918

United States Securities Other Securities October,

192$

United States Securities Other Securities September,

1931

United States Securities Other Securities December,

1932

United States Securities Other Securities June,

1933

United States Securities Other Securities October,

OTHER COUNTRY RESERVE BANKS CITIES

ENTIRE SYSTEM

%

%

%

%

%

%

55 45

23 77

5° 5°

42 58

43 57

44 56

50 50

37 63

48

52

42 58

31 69

62

55 45

47 53

53 47

45 55

28

72

61

55 45

49 51

46

54

49 51

30

4' 59

61

39

60 40

60 40

49 51

31

46 54

69 3'

55 45

67

33

57 43

36 64

53 47

69

63

68

62

37

32

38

4' 59

58 42

57 43

65

63 37

42 58

57 43

1922

United States Securities Other Securities December,

CENTRAL RESERVE CITIES CHICAGO COMBINED

1933

United States Securities Other Securities • Source: Member

3« 66

34

Bank Call Reports

35

of the Federal

Reserve

70

69

38 39

Board.

portions of investment funds devoted to government securities appeared after 1931. The percentages so held in 1932 and 1933 reflect the increasing amount of government financing, and show the tendency for member banks to absorb an ever-increasing share of it. On the other hand, the proportion of funds devoted to other securities tends to become less in practically all groups, up to June, 1933Country banks held the greatest proportion of investments until

I N F L A T I O N AND BANK P O R T F O L I O S

341

the end of 1932 (Table 49), after which this position was taken by the central reserve and other reserve cities, respectively. Other reserve cities and central reserve cities held more of the proportion of government securities after 1929. The largest holding was 40 per cent in other reserve cities, in March, 1931, and 43 per cent in central reserve cities in December, 1932. The percentage of the volume of other securities remained relatively stable in other reserve cities, at about 30 per cent. In the central reserve cities, there was an increased percentage of the other-securities volume after 1930. From an average of about 18 per cent held up to 1930, the percentage in 1933 was 28 per cent. Thus with the increasing volume of funds flowing into investTABLE 49 DISTRIBUTION

O F INVESTMENTS AMONG V A R I O U S GROUPS MEMBER BANKS »

OF

(In Percentages of the Holdings of All Member Banks)

DATE

March, 1922 United States Securities Other Securities April, 1926 United States Securities Other Securities June, 1928 United States Securities Other Securities October, 1929 United States Securities Other Securities September, 1931 United States Securities Other Securities December, 1932 United States Securities Other Securities June, 1933 United States Securities Other Securities October, 1933 United States Securities Other Securities

NEW YORK CITY

CENTRAL RESERVE OTHER COUNTRY ENTIRE CHICAGO CITIES RESERVE BANKS SYSTEM COMCITIES BINED

%

%

%

%

%

%

23 15

2 4

25 19

28 31

47 5°

IOO IOO

22 15

4 3

26 18

37 3°

37 52

IOO IOO

26 •4

5 3

31 •7

38 3°

31 53

IOO IOO

24 14

4 3

28 17

38 27

34 56

IOO IOO

33 18

5 3

38 21

36 3i

26 48

IOO IOO

40 21

3 3

43 24

34 30

23 46

IOO IOO

37 23

6 5

43 28

36 3°

21 42

IOO IOO

34 23

4 5

38 28

38 30

24 42

IOO IOO

• Source: Bank Call Reports of the Federal Reserve

Board.

342

INFLATION

A N D BANK

PORTFOLIOS

ments toward the close of the period, there was a tendency for these f u n d s to be assembled largely in the other and central reserve cities. T h i s may be a t t r i b u t e d to the increased h o l d i n g of all types of securities after December, 1930. T h e declining importance of country banks after J u n e , 1928, was d u e to their reduced holding of domestic securities, w i t h o u t a n offsetting increase in governm e n t securities to prevent a decline in investments as a whole. A f t e r 1932, the rapid rise to temporary dominance of the central reserve cities was d u e to their large holding of government securities, despite a decrease, to a less degree after 1930, in other securities. In addition, it is to be observed that there was more stability in the investment holdings of the other reserve cities. Changes in Portfolio of All Member Banks,

1922-32

Summary 1. U p to 1929, the d e m a n d for commercial loans tended to hold in abeyance the flow of f u n d s into investments. Although investments increased somewhat from 1922 to 1928, this growth was largely d u e to domestic securities and only to a slight degree to government securities. T h e reduction in investment holdings came in the latter part of 1928 and lasted until the early part of 1930. After this date, holdings of government securities increased. 2. T h e increase in loans u p to 1929 arose from loans on securities created, as a result of low money rates, by the increased capital issues of both domestic and foreign securities. After 1929, business loans were first to contract, while loans on securities declined after the middle of 1930. Real-estate loans, which were mostly held by other reserve cities and country banks, were liquidated after 1930 in the former, and in 1929 in the latter, group. 3. Investments, although liquidated in the latter part of 1928, h a d recovered their original volume and started to advance by the end of 1930. In the period following, which lasted to the end of 1932, the rapid increase in investment holdings may be attributed to the absorption by m e m b e r banks of a large part of the public debt. After 1929, there h a d been a decrease in both domestic and foreign security flotation. T h e decline in holdings of other securities came generally in the early p a r t of 1931. 4. Relatively the increase in holdings of government securities after 1929 was roost marked in the central reserve cities. T h e rela-

INFLATION

AND BANK PORTFOLIOS

343

tive amount held in other reserve banks remained on about the same level over the period to 1931. On the other hand, country banks tended to hold a declining proportion of government securities over the period to the latter part of 1931. 5. By far the largest actual volume of both investment items was held in country banks. However, a comparison of percentages of loans and investments, as individual parts of the total portfolios, showed that relatively the largest part of investments was in other securities. Only late in 1931 was the declining proportion of loans offset by increased proportions of government and other securities. 6. In the central reserve cities, generally more than half the investment portfolio was in government securities. T h i s proportion increased rapidly after 1930. T h e other reserve cities held more than half their investments in other securities, and only after 1931 shifted their major holdings to government securities. Country banks, from ig22 to 1930, held government securities in decreasing proportion to other securities. T h i s situation was reversed by 1933. T h e absolute figures tended to show these same results. 7. T h e tendency of the Federal Reserve to consider the qualitative nature of loans, was indicated by their detailed figures for four classes of loans first published in 1929. Relatively, of the four classes of loans, business loans were more important in all but the central reserve cities, where nearly half the loans were on securities. Real-estate loans occupied an increasing proportion of the loans, in both other reserve cities and country banks, after 1929. They increased slightly in central reserve cities, where they were never very significant. 8. Urban real-estate loans were held largely in other reserve and country groups, where the proportion, in relation to total loans, tended to increase up to the end of 1932. Farm-land loans were of most importance in country banks, and of somewhat less significance in other reserve cities. T h e proportion held increased in 1933, in both cases. T h o s e loans were negligible in the central reserve cities. Urban real-estate loans had some significance, though it was slight, in this group. T h e actual volume of all real-estate loans declined after the early part of 1931. T h i s was true in the case of other real estate, while in the case of farm land loans the decline was from early in 1930.

8 INFLATION BY V .

AND D.

PUBLIC

WORKS

1

KAZAKEVICH

WITH the advent of the depression, the attention of the American public was focused on a number of economic issues that had hardly ever come up for discussion, even in academic circles, until a very few years previously. Foremost among such issues was the notion that in order to preserve the existing social framework, a system of planning and control had to be instituted. It was asserted that the existing economic structure, based on profits as a motivating force for private and competitive enterprise, could be resuscitated through deliberate planning and control, or by introducing two elements, the successful operation of which required a negation of the principles of profits, competition and private ownership. It was further asserted that these two mutually exclusive systems could be operated simultaneously and that the community could reap the advantages of both, at the same time avoiding the difficulties inherent in each when applied separately. T h e ramifications of such a notion are wide and far-reaching, but here we are concerned only with one of the by-products of this type of reasoning—the public-works program and its inflationary effects upon the financial mechanism. Efforts to "control" the depression through attempts to influence the course of commodity prices and business by monetary and banking means, did achieve some results on the side of supply. Many existing relationships were preserved. Some success was had in pegging values, at least for the time being, on a level resembling that of the pre-depression years. However, on the side of demand, planning through the use of monetary means met with complete failure. Therefore, in order to prevent the demand for goods from diminishing further and prices from continuing their decline, it was 1 In 1931 the author was research assistant at the National Bureau of Economic Research, engaged in a study of public works; in 1934 he made further inquiries in connection with the preparation of a report to the National Planning Board on the same subject. Although liberal use has been made of the knowledge acquired in those studies, this chapter is an independent piece of investigation and neither the above institutions nor any individuals that are or were connected with them are to be held responsible for the opinions expressed, or the conclusions drawn, by the author.

INFLATION

AND P U B L I C W O R K S

345

deemed appropriate to revive, or reflate, purchasing power through the use of an expanded program of public construction. While the efforts to peg prices and business through monetary means resulted in further freezing of bank assets, it was expected that public works would not only make use of the existing bank credit, but also stimulate other industries to do likewise, thereby setting the national economy again in motion on a scale similar to that prevailing before the depression. Such an undertaking had to be financed through the existing banking mechanism, so that fundamentally the problem of reflation remained the same, irrespective of the side from which one attacked it. But since few people seem to have a clear realization of this fact, it is pertinent to deal with the issue of inflation and public works from the angle of the construction program itself, rather than to follow the conventional path and start from the financial point of view. It is the contention of the author that in so far as the "priming of the pump" through monetary means failed to attain its ends, the public works program also could not, and did not, achieve the results desired or expected. T h e strictly financial measures attempted resulted in a banking inflation. Public works only aggravated the same phenomenon, as the effect of inflationary measures is identical, no matter through what channel they are advanced. But, as the public works notion itself passed through various stages during the course of the depression, we must trace the process from the beginning, in order to substantiate the conclusion so reached. T o such an analysis we now turn. T H R E E BASIC IDEAS

T h e desirability of a large program of public construction was voiced by President Hoover shortly after the stock-market collapse of 1929, and since that time the scheme has been advocated by individuals of all conceivable shades of belief and affiliation, becoming one of the most persistent issues of the depression years, with existing political parties favoring public works for a variety of conflicting motives, which very often had little bearing on the questions at issue. Such an attitude on the part of the public led to the rather unique experience of the years 1930-32, when the publicworks experiment was attempted under the Hoover administration, abandoned as a failure, and then from 1932 to 1934 repeated all over again under the "New Deal" of President Roosevelt; with

546

INFLATION AND PUBLIC

WORKS

the result that by the autumn of 1934, the Democratic administration found itself in approximately the same position with respect to public works that had been reached by President Hoover in the summer of 1932. In order to survey the events of these years, we must first establish exactly the reasons for which public works were wanted. In the majority of cases the reasons given for public works only restate this question in a different form without coming closer to a real answer. But, in spite of the fact that it is often difficult to obtain anything very definite—even from professional advocates of public works—one still can classify most of the public-works notions into three groups, each representing a fairly distinct idea as to what is expected from a program of public construction. Broadly speaking, one of the following three ideas or a combination of them is usually present: First, that public works are a way of providing relief to the unemployed; second, that public construction serves as a balance wheel for industry; and third, that it is a device to reflate both prices and business back to a certain level. According to the first concept, a construction program is desirable because it provides direct employment. T h e balance-wheel-of-industry theory asserts that through the use of public works, one can arrest the decline in prices and economic activity, and thereby prevent depression from reaching the proverbial bottom. Finally, reflationists, having despaired of halting the process of decline, want public works in order to engineer a rise in prices and business activity, to some predetermined level considered normal. One of these three ideas, or more often a mixture of all of them, has appeared during the depression years under countless labels. It is, therefore, neither feasible nor necessary to trace here the entire history of the movement, nor to show how practically the entire public was converted to the idea. It is the intention only to examine the implications of the views set forth by public-works advocates and to demonstrate, in so far as existing data permit, what actually did take place as a result of the attempts to apply one or all of these notions in practice. THE

R E L I E F T H E O R Y OF PUBLIC W O R K S

Long before the present depression, it had been considered wise to keep u p the morale of the unemployed through providing an occupation instead of allowing them to depend on charity. Saint

I N F L A T I O N AND P U B L I C W O R K S

347

Simon, one of the so-called Utopian socialists, proposed at the time of the French Revolution, the creation of a special bank to finance public projects; and the second French Republic employed thousands of people in the famous national workshop of Paris. In the United States, also, work was provided for the "worthy poor" during times of stress; in New York City this was done in the depression of 1 8 5 7 - 1 8 5 8 by Mayor Fernando Wood, and social agencies in various cities attempted all through the eighties and 'nineties to substitute some occupation for charity. However, the question that interests us is not the antiquity of this method, but whether under modern conditions public works can directly absorb a sufficient number of unemployed to outbalance the effects of an industrial depression. In a primarily agricultural community, with a relatively small city population, the number of people affected by a slowing down of business could probably be materially reduced through direct employment on government projects. Artisans, craftsmen and employees of mercantile establishments, form at such a time a comparatively small percentage of the total population and could easily be provided for; similar conditions still prevail in a great many parts of the world, as for instance, in the Balkans and certain South American republics. But, when one deals with highly industrialized communities, with millions of people completely detached from the land and selling their labor to industries owned and administered by entrepreneurs or corporations, the problem assumes an entirely different aspect. TABLE

50

T H E DECLINE OF INCOME AND E M P L O Y M E N T D U R I N G T H E DEPRESSION •

OCCUPATION

INCOME P A I D OUT

(In Millions of Dollars)

'9*9 Manufacturing Construction All Occupations

18,157 3,135

81,136

m" 8,373

864 48,894

N U M B E R OF PEOPLE ENGAGED

(In Thousands)

1929

I932

10,023

6,257 673 34,'S1

«,528 44.225

• Source: Kuznets, Simon, National Income, 1929-1932, Bulletin 49, National Bureau of Economic Research, Inc., New York (June 7, 1934).

348

INFLATION

AND PUBLIC

WORKS

As one can observe from T a b l e 50, the income paid out in manufacturing industries declined during the depression by about ten billion dollars, while the income paid out in the construction industry amounted to only about three billion dollars prior to the depression. T h e decline in employment for the country as a whole equaled over ten million, and in manufacturing alone the loss of employment was placed at nearly four million, while the construction industry employed in 1929 only one and a half million people. It must also be remembered that before 1929, only about one-third of all construction consisted of public works. 2 But even if the entire construction industry were to become public, as well as to continue on its pre-depression level, it is apparent from the data presented in T a b l e 50, that an industrial depression brings about a shrinkage in income and employment that cannot be made up either by public works or by the entire construction industry, even if we were to assume that these particular branches of the national economy could be made immune from the effects of the depression. Public works, even if they were made to embrace all of construction, would reemploy directly only a comparatively insignificant portion of the population deprived of employment by the depression, and the direct relief provided through such a program would be negligible, while the cost would run into many billions of dollars. THE

BALANCE-WHEEL-OF-INDUSTRY

IDEA

During the last two years of the administration of President Hoover, it was alleged by members of the national government that through retarding public-works expenditures in times of prosperity and accelerating them with the appearance of a depression, it would be possible to "even out" the business cycle in the construction industry, which, in turn, would act as a balance wheel for all industry, eliminate the violent fluctuations of the entire economic system, and enable the curve of business to continue on a higher level than that which would otherwise have been the bottom of the depression, up to the time of the natural advent of recovery. 3 2 Wolman, Leo, Planning and Control of Public Works, National Bureau of Economic Research, Inc., New York, 1930. a T h i s idea was advanced in the minority report of the British Commission on the Poor Laws, 1909, and in the Wainwright Commission in New York, 1 9 1 1 . T h e emergency public-works law of Pennsylvania, passed in 1917, incorporated the same idea for the first time in a legislative act, but the law was repealed in 1923 as unworkable. Similar bills were passed in certain other states, and

INFLATION

AND PUBLIC WORKS

349

If we assume for the moment that it is feasible to retard and accelerate, at will, innumerable activities spread out among the different departments of the Federal and state governments, and more than thirty thousand various local, self-governing bodies, making up what is known as public works, one would still have to prove the correctness of two basic assumptions underlying the balance-wheel-of-industry theory. In the first place, it is taken for granted that there exist certain "prosperity reserves" built up or stored during the fat years, which can be converted into purchasing power in lean years. Secondly, it is also taken for granted that while only a limited amount needs to be spent on public works, such expenditures stimulate a great deal of other activity, so that the net result exceeds—by how many times has never been agreed—the effect of the initial investment. Relative to the first contention, one must point out that the major feature of an industrial depression is the slowing down of all economic activity, resulting in a drastic shrinkage of both national wealth and income, which affects all wealth no matter when accumulated. 4 Most of the activities of present-day industrial society are highly interdependent, and the social framework does not provide any economic reservoir in which large quantities of purchasing power could be stored intact over a period of years and released to the community at an appropriate moment. This point was clearly elucidated by John Stuart Mill in the first edition of his Principles of Political Economy, appearing in 1848; and since then the greater complexity of capitalist society renders any such undertaking even more difficult. T h e only reserves that could be easily drawn upon, aside from the possibilities of increased taxation or confiscation of various proposals of a kindred nature were made in Congress during the postwar depression. A recommendation to the same effect was made by the President's Conference on Unemployment in September, 1921; and early in 1923. Mr. Hoover, then Secretary of Commerce, voiced a similar thought in a letter to the President. In February, 1931, the so-called Wagner bill became law, and a Federal Employment Stabilization Board was set up to "watch the movement of business activity and report to the President if a state of depression exists or is likely to arise in the next six months in the United States or in a substantial part thereof." 4 On national income, see Senate Document No. 124, 73d Congress, 2d Session, or Bulletin 49 of the National Bureau of Economic Research, both by Simon Kuznets. T h e effect of the depression on national wealth is analyzed by Robert R . Doane in The Measurement of American Wealth (1933). Although most of the information furnished by Mr. Doane needs further checking, the general trend indicated by his analyses is probably correct.

350

I N F L A T I O N AND P U B L I C

WORKS

existing wealth, would be the savings of the community at the time or immediately preceding the financing of an expanded publicworks program, excluding those already sunk in the fixed capital of the country through investment channels during the terminated period of prosperity. Just because no such prosperity reserves did or could exist, the construction program of the Hoover administration was financed through the sale of government obligations, largely to commercial banks. REPERCUSSIONS OF P U B L I C

CONSTRUCTION

T h e second contention, namely that public-works expenditures create other activity, set in motion the wheels of industry, and thereby generate purchasing power throughout the community, also seems to have very little foundation in fact. Before the war the English statistician Bowley advanced the idea that out of every 100 units of money spent on construction, 35 go directly to labor, and that out of the remainder, spent for materials, a similar percentage also goes to labor, thus creating secondary employment. In recent years, the most outstanding advocate of this thesis is undoubtedly Mr. Keynes, who asserts that primary expenditures and employment lead to secondary employment, and that in order to obtain the net result we must sum the whole series of repercussions, the second to the first, the third to the second and so on, apparently ad infinitum. 5 This argument is presented without any attempt at factual verification, although the importance of such a contention, if true, would certainly warrant testing on the basis of existing experience. Although Mr. Keynes and other English economists still adhere to the idea that prosperity could be restored through a perpetum mobile of repercussions bearing the same ratio to each other as the first to the second, the English government abandoned the experiment, the Chairman of the Board of Trade stating at the London Economic Conference, that it was too costly a method to create employment and that the results achieved (presumably of the sum total of repercussions) did not warrant the expenditures. 8 0 Keynes, J . M., The Means to Prosperity, Harcourt, Brace and Co., New York, 19338 On J u l y 13, »933, Walter Runciman, President of the Board of Trade of Great Britain, said at the plenary meeting of the economic commission of the Work Economic Conference: " W e have in recent years devoted £100,000,000 to schemes of this kind. T h e result has been on the average that for 1,000,000 in

I N F L A T I O N AND PUBLIC WORKS

351

In the United States an attempt was made to verify this theory through the use of the data of the Census of Manufactures of 1929. T h e Federal Employment Stabilization Board found that out of every dollar spent on public works, about 33.5 per cent go directly into labor, thus bearing out the first part of the prewar estimate of Bowley. It was also shown that some eighteen different types of material form the bulk of supplies used for public works, and that the industries providing these materials are located in very definite regions of the country. It was found unwise to attempt to estimate the "secondary" employment or the extent of repercussions, as they would vary widely with the time, place, and type of project. Apparently it is difficult to rely upon any "automatic and even" spread of the effect of an expenditure, as the problem contains so many unknown and fluctuating factors that, with the existing statistical data, it is impossible to venture an intelligent guess. T h e complete results of this investigation never were made public, and the Federal Employment Stabilization Board discontinued this type of analysis with the advent of the "New Deal." In the first months of its existence, the Public Works Administration, created in the summer of 1933, did compile data on the number of men employed directly on governmental construction projects and an estimate of secondary employment derived along the line suggested by Mr. Keynes, through the application of a "multiplier" to the first figure. T h i s practice was soon discontinued, in all probability on account of the fact that data began to come in from the relief authorities pointing out clearly that the expected secondary reemployment was largely imaginary. 7 In addition to the lack of any real information on the subject, the notion that public building can indirectly affect employment in sections of the country not producing construction materials or, where such production forms only a minor part of all industry does not stand scrutiny; and the existence of surplus stocks of goods which may be used for construction with a minimum of reemploysterling expended we have employed 2,000 men directly and 2,000 indirectly. You will observe this method of dealing with the problem is expensive. In our view it is unduly expensive and an experiment we are not going to repeat. We terminate our schemes for dealing with unemployment by capital expenditure on public works and we shall not reopen them no matter what is done elsewhere." (As reported in the New York Times, July 14, 1933.) 7 Comprehensive statistics on the scope of the relief problem in the United States were compiled for the first time by the Federal Emergency Relief Administration. T h e reports of this organization began to appear in the 9pring of 1934.

352

INFLATION

AND PUBLIC

WORKS

ment is also not taken into account. Last, but not least, no allowance is made for the different degrees of mechanization of plants. Materials may be produced in highly mechanized plants, operating with a skeleton force and below capacity. Such establishments can increase production to quite a noticeable degree without employing anything like the number of additional workers that is generally expected. An even spread of purchasing power, due to public works, presupposed a degree of fluidity in economic organization that does not exist in actual life, and a perfect geographic distribution of production facilities and opportunities for employment which are not to be found, at least in the United States. PRACTICAL

DIFFICULTIES

After having thus examined the two basic assumptions underlying the balance-wheel-of-industry theory of public works, it is appropriate to return to the plan itself, and to indicate briefly why it is impracticable, even if one were to take the theoretical base as correct—which it is not, as has just been demonstrated. Under the existing system of local government, it is impossible to retard or to accelerate expenditures with any degree of preliminary advance planning or control. American municipalities and counties are administered by elective officials, who are under constant pressure from their voters and who do not plan, as a rule, for a period of time covering a complete business cycle, but for one year, or at best, until the next election. In good times the electorate demands various public improvements; in bad times the difficulties of raising funds through local efforts are practically unsurmountable. With the advent of a depression, the two main sources of income available to cities—taxation of real estate and borrowing—are drastically curtailed. T h e value of real property declines, as well as the income from it, and it becomes difficult to collect the usual amount in taxes, owing to delinquencies. T h e depression affects the capital market and it becomes more difficult for cities to borrow, especially with the decline of municipal credit and the necessity of not exceeding the constitutional limitations on municipal debt, which are a percentage of the total real-estate valuation. A great number of local governments borrowed up to their constitutional limits in prosperity; with the decline of real-estate values, they found themselves, having exceeded their legal debt limit, unable to borrow at all. At the time when large public construction should

I N F L A T I O N AND PUBLIC WORKS

353

begin, according to the balance-wheel-of-industry theory, most local bodies find themselves unable to meet past commitments and sometimes even current expenditures. A belated recognition of this fact is found in the law facilitating municipal bankruptcies, passed in the spring of 1934. Even if the cities should conduct their financial affairs on some different plane, the retardation and acceleration of public works would require the existence of carefully prepared architectural plans, so that projects could be started without notice. Such preparation would necessitate a considerable outlay of money without knowledge as to when the project to be undertaken would materialize. Municipal ordinances require competitive bidding for contracts and advance notice of such bids. Sites have to be acquired through condemnation proceedings, which often involve the city in litigation. Finally, the project may be held up by various personal and political disagreements among officials, as to the exact location of the building, the type of architecture, the color of stone to be used, etc. T h e r e are no exact figures showing how long, on the average, it takes to get a project under way; it has been estimated that under ideal conditions it takes not less than six or eight months before building can actually be begun. In the majority of cases, it probably takes much longer, so that a public-works program is likely to get under way exactly at the time when the city government is beginning to feel the financial stringency of the depression. In order, therefore, to accelerate construction projects, one must first of all prepare architectural plans and count on a frictionless working of the local governmental machinery. Secondly, there has to be a continuity of policy in local government over the entire period of the business cycle, involving a most unpopular course of action, both in prosperity and depression. All local plans must also in some way be coordinated on a national scale, so that retardation and acceleration may proceed simultaneously. Even a surface survey of the practices prevailing in the thirty-odd thousand incorporated bodies responsible for public construction, indicates that under the present system of local self-government, no such degree of planning for future policies throughout the country and, especially, no such defying of the immediate desires of voters, is in the realm of practical possibilities. In order to obtain real planning of municipal and county projects all over the country, one would have to have effective central control amounting probably to an abolition of

354

INFLATION AND PUBLIC

WORKS

democracy in local government, to which most advocates of public works would be more than reluctant to agree, even in theory. ABANDONMENT OF THE IDEA

Thus, the balance-wheel-of-industry theory of public works breaks down on both the theoretical and the practical sides. In theory it is based on the unwarranted assumptions that there exists a way of carrying liquid surplus funds from a period of prosperity into a depression, and that money spent on construction creates repercussions that spread purchasing power throughout the community. O n the factual end, it ignores the existing organization of society, which does not lend itself to an even and automatic spread of economic influences, as well as the fact that the existing political organization of local government in the United States makes coordination of efforts and long-range planning quite out of the question. In discussing construction statistics, some of these points will be further elaborated. Here it is only necessary to indicate that the Hoover administration, which sponsored the balance-wheel theory, had apparently come to a realization of its unworkability by the summer of 1932. During the congressional discussion in connection with the balancing of the Federal budget, and further appropriation for public works, President Hoover issued a public statement virtually reversing the three-year-old attitude of his administration on the publicworks question—a stand to which, as Secretary of Commerce, he subscribed as far back as 1921.8 President Hoover declared that he was opposed to any further extension of nonself-liquidating public works—the vast majority of public projects being of that nature— as the degree of employment provided by such projects had proved to be very scanty, and as the further extension of such activity would have a detrimental effect on the budget and the integrity of the financial structure. T h e enlarged expenditures on Federal construction did not halt the drastic decline in city and state projects, had no effect on private construction, and did not produce any repercussions in industry at large. According to President Hoover, the depression had gone too far to permit an attempt to keep the curve of business activity on a certain level through Federal construction expenditure, without impairing the financial structure 8 President Hoover's letter to President Parker of the American Society of Civil Engineers, New York Times, May «3, 193a.

I N F L A T I O N AND P U B L I C W O R K S

355

through inflation, and other methods to combat the depression had to be sought. Admittedly, the balance-wheel-of-industry theory failed to produce the desired results, and President Hoover was commended by a conservative publication for having "blazed one right path through the public works muddle." T h e entire issue seemed to have been closed, and it would have been difficult to suspect at that time that the same experiment was going to be repeated in 1933 and 1934 as if no previous attempts in that direction had ever been made. P U B L I C W O R K S AS A R E F L A T I O N A R Y

DEVICE

With the change of administration in March, 1933, the idea of a public-works program was revived—this time as a part of a much larger scheme. Already, during the summer and fall of 1932, various groups had begun to agitate for drastic changes in the prevailing monetary and banking set-up, with public construction figuring as one of the means of achieving inflationary expansion. Thus the public-works notion that was propagandized for nearly three years by the preceding administration and finally abandoned as unworkable, was incorporated in the "New Deal" as an original device which the repudiated "old order" had presumably refused to apply. T h e nature of "New Deal" economics and of the idea of reflation are reviewed elsewhere; here we are concerned only with the place that is occupied by an expanded program of public works in the framework of these schemes. T h e prevailing economic thinking of the years 1933 and 1934 can probably be summarized in the following fashion: First, that it is impossible on social grounds to allow the depression to strike bottom; second, that the deflationary process has progressed too far and that it is no longer practicable to attempt, as did Mr. Hoover, to peg the curve of business activity; third, that natural recovery may not come for several years, and that, in any event, the population is unwilling to wait for it any longer; fourth, that in view of all this, the recovery process must be started through governmental reflationary measures, which are to continue until a predetermined normal has been reached. This trend of thought was already crystallized, even before March, 1933, and it was openly discussed in so-called "brain-trust" circles that, with the advent of the new administration, a reorganization of industry would be undertaken, so as to increase the purchasing power of the workers, and that parallel to it, heavy industry would

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be stimulated through an expanded program of public construction. In the summer of 1933, the first part of this scheme took shape in the National Industrial Recovery Act, and the administrative machinery set up under that law; the second part of the scheme resulted in new appropriations for construction purposes, and the setting up of the Public Works Administration. THE

ROOSEVELT

PROGRAM

In order to analyze this second effort at developing a large publicworks program, it is best to list its main points as contrasted with the balance-wheel-of-industry theory tried and discarded by President Hoover: 1. This time public works were to stimulate primarily "heavy industry," consumers' demand being accelerated by means of the N R A organization. 2. As long as private industry was unable or, as it was said, unwilling, to start revival, the Federal government must step in and create a demand for producers' goods through a public-works program. 3. It was again asserted that an expenditure of construction creates economic repercussions which spread both purchasing power and employment to an amount exceeding by two or two and onehalf times the original investment. 4. T h e idea that past "prosperity reserves" could be directed into construction was abandoned; the renewed program was to be financed through the advance "tapping" of future prosperity. 5. It was realized that the mere building up of available credit, as was done in the spring of 1932 by the Federal Reserve system through the purchase of over a billion dollars of government bonds, does not in itself create an effective demand for credit. Federal public works, plus their repercussions, were expected to furnish this demand. 6. T h e banking system was again to expand credit to meet this new demand, and thus create a business turnover that would bring the country back to a state of normality. 7. T h e scheme could be made to pay for itself in the end, because, it was asserted, taxes from the prosperity thus brought about would be sufficient, and could be collected rapidly enough, to amortize the expenditure in the course of the next upswing of the cycle.

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357

8. Finally, the belief that there had been planning of public works was also discarded, the attempts to persuade various local bodies to go ahead on their own responsibility discontinued, and most of the burden placed on the central authorities. O n e can see from this enumeration that in many respects the Roosevelt program followed the pattern set by the previous administration with the distinctions that future "prosperity reserves" were to be used instead of those of the past; that the object now was to bring about prosperity instead of preventing further deflation, and that a more centralized control was substituted for the idea of cooperative efforts of various authorities. T h e notion of using future reserves cannot be substantiated any more effectively than that of relying on past "prosperity reserves," although an attempt to apply the latter idea changes the financial aspect of the problem to a very considerable degree. O n e can at least attempt to mobilize past savings by trying to sell bonds to the public, while future savings can be " t a p p e d " only through an artificial expansion of credit in the present. T h e "money" needed for public works is thus raised exclusively through the sales of evidences of government indebtedness to the banks, the assets of which begin to consist more and more of government deficit. If the assets of a commercial bank are made up of obligations that are not liquidated in the ordinary course of business, while the liabilities are of a demand nature, then such a bank is eventually bound to reach a point at which it is unable to meet claims presented. If the entire banking system is to participate in the diverting of its commercial assets into the financing of construction, a general freezing of the system will be the result, and the banks can no longer respond automatically to the behavior of the business world, as the resources which they command are curtailed while the demand liabilities increase. Under such circumstances, unrestricted redemption in specie, especially abroad, becomes impossible, as the demands of the uncontrolled business world are liable to conflict with the planning of public-works authorities. Both cannot have access to the same bank assets; therefore, a large scale public-construction program, financed through the diversion of bank credit, is hardly compatible with an international automatic gold standard. 8 T o 9 Arthur D. Gayer states: " A policy of controlled public works, unless adopted internationally, is therefore at bottom inconsistent with the underlying principles of a freely automatic international standard based on gold, though not

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put the same thought in different words, the use of existing bank assets in anticipation of future savings, for public construction, necessitates the adoption of a form of elastic currency (not based on commercial assets), or what is known as "managed money." Although, as indicated, some public-works advocates realize the implications of this course of action, they do not seem to provide any tangible solution indicating exactly how money is to be managed; by whom, for whose benefit, and especially, how such a scheme in banking is to be superimposed on a democratic-profit economy in industry and trade, which the protagonists of planned money presumably do not propose to relinquish, even in thought. A

DELIBERATELY

UNBALANCED

BUDGET

Public works, financed on such a basis, are expected to be amortized out of taxation during the forthcoming period of prosperity. Taxes are collected on the basis of the income of the past years, and if the large expenditures incurred for construction during a depression are to be paid off, one has to presuppose that several years of prosperity are to follow. If that takes place, then the experience of the postwar decade—when more than one-half of the war debt was paid off—could be repeated, other things being equal. T h e success or failure of such a scheme depends on whether it is possible deliberately to unbalance the budget during a depression and make good the deficit during the next upswing of the cycle, or have the budget balanced not over a period of twelve months, but over an indefinite number of years that include a complete cycle. In this connection, one would have to know the following factors: First, that such an attempt at budgetary management is not going to change the course of the cycle in such a fashion that we should be dealing with something entirely different from a presupposed "normal" cycle; and, secondly, whether it is possible to carry through such a long-range plan in public finance in a world of miscellaneous economic forces which are beyond the control of the government—just as in the case of "planned money" the issue comes down to the question, whether the control of one vital phase of an uncontrolled economic world is feasible or can be effective. Whatever the solution may be, the attempt to finance a large necessarily with a modified gold standard operated under central bank cooperation," Report of the Columbia University Commission on Economic Reconstruction (Columbia University Press, 1934), p. 165.

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construction program through deliberately unbalancing the budget, substituting government deficit for commercial assets in banks and thus diverting f u n d s from behind d e m a n d liabilities into fixed capital, would distort the kind of financial structure that has so far existed in the United States. T h e protagonists of the use of public works as a balance wheel for industry reversed their position in 1932, exactly for the reasons that it was impossible to carry the experiment any f u r t h e r if one wanted to cut down the deficit a n d not jeopardize the continuation of the existing financial system—that is, without recourse to inflation. T h e financial aspect of the renewed public-works program of 1933-34 presupposes the nonobservance of the old budgetary and b a n k i n g rules of democratic capitalism, without substituting in their place any other set of rules based on a different organization of society. Public-works advocates do not contemplate the abolition of the existing profit system; in fact, the scheme is expected to rejuvenate the existing order; but at the same time, if one proposes to operate along lines directly contrary to those established in the type of society that it is sought to cure, the possible effect of such financial policy cannot be any other than an inflation of the existing structure. T H E LARGER

"PLAN"

In addition to a purely inflationary method of financing, the public-works program of 1933-34 has another aspect not present in so decisive a form in the previous attempt of 1930-32. It was admitted from the start by the framers of the " N e w D e a l " that even a complete success of the National Industrial Recovery Act would not affect the basic industries of the country to the extent desired. Industry and business reorganized u n d e r the N R A administration could conceivably employ a larger n u m b e r of people and may even relinquish an increased share of the national income to labor, but an enlarged output of producers' goods would hardly be expected. T h e problem that remained to be solved was how to revive the demand for goods not consumed directly—the goods manufactured by the heavy industries of the country—the field in which the depression brought about a great shrinkage of activity. After the unsuccessful campaign for credit expansion waged by the Federal Reserve system in the spring of 1932, it was recognized in most quarters that the mere availability of credit did n o t mean that such credit would be used. As long as industry was either

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u n a b l e or u n w i l l i n g to e x p a n d , t h e g o v e r n m e n t decided to perf o r m , f o r t h e t i m e being, some of t h e f u n c t i o n s of industry, a n d c r e a t e a d e m a n d f o r p r o d u c e r s ' goods t h r o u g h p u b l i c works. I n this c o n n e c t i o n we may o n c e m o r e refer to the figures pres e n t e d in T a b l e 50 in c o n n e c t i o n w i t h the discussion of t h e " r e l i e f " t h e o r y of p u b l i c works, s h o w i n g t h e e x t e n t of t h e i n d u s t r i a l d e c l i n e caused by the depression, a n d t h e q u e s t i o n w h e t h e r p u b l i c cons t r u c t i o n can fill t h e gap. A l t h o u g h u n d e r t h e " N e w D e a l " over t h r e e billion dollars were a p p r o p r i a t e d for p u b l i c works, it is estim a t e d t h a t only b e t w e e n two a n d two a n d a half billions were actually s p e n t o n c o n s t r u c t i o n f r o m the m i d d l e of 1933 to t h e e n d of 1934. W h e n F e d e r a l c o n s t r u c t i o n activities were in f u l l swing (spring a n d s u m m e r of 1934) it was officially alleged t h a t a b o u t half a m i l l i o n m e n were directly e m p l o y e d a n d a " h y p o t h e t i c a l , " o r secondary, e m p l o y m e n t of over a m i l l i o n was a t t r i b u t e d to t h e influence of the p r o g r a m . T h e s e figures, if correct, i n d i c a t e t h a t p u b l i c works may, to a certain e x t e n t , take u p the slack in t h e cons t r u c t i o n i n d u s t r y , g o v e r n m e n t b u i l d i n g t a k i n g t h e place of p r i v a t e c o n s t r u c t i o n , b u t t h a t the scheme is grossly i n a d e q u a t e to fill t h e g a p m a d e by t h e depression in industry. T h e only way o n e can j u s t i f y the a p p l i c a t i o n of t h e public-works r e m e d y is by a s s u m i n g o n c e more, as was d o n e in the first a t t e m p t of 1930-32, t h a t a given e x p e n d i t u r e sets in m o t i o n a c h a i n of economic repercussions w h i c h spreads t h r o u g h o u t all o t h e r i n d u s t r y . T h e r e does n o t seem to b e a n y m o r e reason to expect such repercussions to t a k e p l a c e in 1935 t h a n t h e r e was in 1931 a n d 1932. I n a d d i t i o n , t h e g r o w t h i n the n u m b e r s of i n d i v i d u a l s placed on relief rolls d u r i n g t h e m o n t h s f o l l o w i n g D e c e m b e r , 1933, w h e n e x p e n d i t u r e s for p u b l i c construct i o n were m o u n t i n g rapidly, indicates the exact opposite. 1 0 F A I L U R E OF T H E S E C O N D

ATTEMPT

T h u s , t h e reflation theory of p u b l i c works fails to fulfill its m a i n objectives—create a d e m a n d f o r p r o d u c e r s ' goods a n d thereby p u s h 10 In April, 1934, the number of families on relief increased sharply, with nearly 17 million individuals dependent on the government, according to the report of Donald Richberg, on Sept. 2, 1934. On Oct. 25, 1934, Ogden Mills stated that " b y J a n u a r y , it is officially estimated that 20 million people will be recipients of relief." Both the members of the administration and critics seemed to be in agreement relative to the fact that the unemployment and relief question was likely to reach a new peak in the winter of 1934-35, a n d 'n fact proved to be the case. T h e discussion of the problem has practically in all in-

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t h e business curve up—just as t h e a p p l i c a t i o n of t h e balance-wheelof-industry idea d i d n o t p r e v e n t t h a t c u r v e f r o m declining. I t is difficult to see h o w p u b l i c works c o u l d b e e x p a n d e d a n y f u r t h e r t h a n now, a n d even w e r e t h e g o v e r n m e n t to take over t h e e n t i r e c o n s t r u c t i o n industry, t h e o u t l a y w o u l d n o t be large e n o u g h , as o n e can observe f r o m t h e figures in T a b l e 50, to t a k e t h e place of the d e m a n d for p r o d u c e r s ' goods t h a t existed p r i o r to t h e depression. I n o r d e r to s t i m u l a t e effectively the d e m a n d for such goods, t h e g o v e r n m e n t w o u l d h a v e to become a larger user of p r o d u c e r s ' goods, o r e n t e r i n t o i n d u s t r y a n d business to a degree t h a t w o u l d e n a b l e it to o u t - b a l a n c e the decline in p r i v a t e enterprise. Such a course of action w o u l d create a collectivized, or socialized, sector in t h e economic s t r u c t u r e , o p e r a t i n g in direct c o m p e t i t i o n w i t h p r i v a t e e n t e r p r i s e . As it is difficult to conceive t h a t industrialists w o u l d resign, o r give u p voluntarily, t h e i r c o n t r o l of wealth, this f u r t h e r step is n o t likely to occur w i t h o u t violent social changes, s o m e t h i n g t h a t the a d h e r e n t s of the reflation theory of p u b l i c works w o u l d p r o b a b l y b e t h e last to advocate or sponsor. T h e second public-works e x p e r i m e n t , t h a t of 1933-34, was expected t o r u n c o n c u r r e n t l y w i t h t h e s p r e a d of consumers' d e m a n d , t h r o u g h t h e N R A . T h e N R A was b e g u n in the s u m m e r of 1933; b u t b e f o r e the year was over, t h e g o v e r n m e n t was forced to divert p u b l i c a t t e n t i o n to m o n e t a r y m a n i p u l a t i o n s a n d to i n t r o d u c e the most extensive relief scheme—the Civil W o r k s Administration—ever yet a t t e m p t e d , o w i n g t o t h e lack of e x p e c t e d results f r o m t h e array of t h e o t h e r "recovery" measures. A t the same time, publicworks e x p e n d i t u r e s b e g a n to increase only in the l a t e fall of 1933, a n d it was officially a n n o u n c e d t h a t w h e n the public-works p r o g r a m s h o u l d get u n d e r way in the s p r i n g of 1934, considerable reemploym e n t w o u l d take place. 1 1 As already i n d i c a t e d , such r e e m p l o y m e n t stances centered around the data prepared by the Federal Emergency Relief Administration. 11 T h e F. W. Dodge Corporation, beginning Jan., 1933, compiled comprehensive figures concerning public-works contracts contemplated and awarded for thirty-seven states. These data show that expenditures for contemplated public works began to rise in May, 1933, reached over half a billion dollars in Sept. and declined below the May level in Jan., 1934. Contracts actually awarded from May to Aug., 1933. were below the corresponding months of 1932 and rose only toward the end of the year. According to this set of statistics, public-works contracts awarded for the entire year 1933 equaled 500 million dollars, while the figure for 1932 is 5 1 5 million dollars, or slightly above that of the year when the largest public-works program was initiated.

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d i d n o t materialize, b u t h e r e these events are m e n t i o n e d to i n d i c a t e t h a t the original idea of t h e " N e w D e a l " of o p e r a t i n g t h e N R A a n d t h e P W A parallel to each o t h e r , o n e s t i m u l a t i n g c o n s u m e r s ' d e m a n d , t h e o t h e r t h a t of producers, also failed to a t t a i n t h e h o p e d f o r results. A c t u a l c o n s t r u c t i o n c o u l d n o t b e b e g u n p r i o r to at least eight m o n t h s a f t e r t h e projects were contemplated—as c o u l d h a v e been j u d g e d f r o m t h e e x p e r i e n c e of 1930-32, already r e f e r r e d to—and t h e c o n s t r u c t i o n p r o g r a m got u n d e r way only a f t e r t h e forces set in m o t i o n by the N R A h a d s p e n t themselves. T h u s t h e second a t t e m p t at a n e x p a n d e d public-works scheme failed to bec o m e p a r t of a larger p l a n as originally conceived, a n d h a d to s t a n d o n its o w n merits, as was t h e case w i t h t h e previous H o o v e r plan. T h e results of t h e second e x p e r i m e n t have been very similar to those of t h e first. T h e expected repercussions in i n d u s t r y d i d n o t occur, a n d t h e p r o b l e m of relieving u n e m p l o y m e n t r e m a i n e d just as pressing, if n o t m o r e so. I n t h e late s p r i n g of 1934, t h e suggestions of a t h i r d public-works p r o g r a m a d v a n c e d in Congress were n o t e n c o u r a g e d by the a d m i n i s t r a t i o n . Before Congress a d j o u r n e d in t h e s u m m e r of 1934, t h e P r e s i d e n t asked a n d received w i d e powers to use f u n d s f o r relief; t h e P u b l i c W o r k s A d m i n i s t r a t i o n c o n t i n u e d t h e e x p e n d i t u r e s of its r e m a i n i n g resources w h i c h , acc o r d i n g to Secretary Ickes, h a d already all b e e n allotted by F e b r u ary, 1934, w h i l e projects a m o u n t i n g to over t h r e e billion dollars s u b m i t t e d a f t e r t h a t d a t e r e m a i n e d in abeyance. 1 2 T h e a d m i n i s t r a t i o n d i d n o t issue, in the s u m m e r of 1934, a n y s t a t e m e n t reversing its p o s i t i o n o n t h e e n t i r e m a t t e r , as d i d President H o o v e r in t h e s u m m e r of 1932, b u t t h e insistence of the g o v e r n m e n t only o n a p p r o p r i a t i o n s f o r relief purposes, i n d i c a t e d t h a t the u n f e a s i b i l i t y of c o n t r o l l i n g e c o n o m i c activity t h r o u g h p u b l i c works h a d once m o r e b e e n realized, this t i m e w i t h o u t a p u b l i c s t a t e m e n t to t h a t effect; a n d t h a t , just as in 1932, o t h e r m e t h o d s w o u l d b e s o u g h t to c o m b a t existing ills. A l t h o u g h t h e d e m a n d s for a t h i r d a t t e m p t in t h e same d i r e c t i o n c o n t i n u e d , 1 3 the public-works p r o g r a m of 12 New York Times, Feb. 1 1 , 1934. ' » J . M. Keynes stated that he was "quite confident," if the emergency expenditures were continued on a $4oo,ooo,ooo-a-month basis, "that a strong business revival would set in by the autumn." Article, New York Times, June 10, 1934. In the late fall of 1934, Secretary Ickes made more than one public statement to the effect that another and much larger program of governmental construction should be initiated.

I N F L A T I O N AND PUBLIC WORKS

363

1935 appears to be intended mainly as a substitute for direct unemployment relief, thus signifying a reverting to the "relief theory" of public construction, already discussed, and shown to be quite inapplicable in a modern industrial state. A F T E R M A T H OF THE

EXPERIMENT

However, the question of the net result of the second experiment is not as yet settled. It has been financed through the sale of government obligations to banks, just as the first attempt, but on a larger scale, and it has not brought about recovery. T h e net result can be evaluated when we know whether it has, or has not, retarded the advent of a revival. If banks place an excessively large portion of their assets in government obligations, there is bound to come a point at which they may find it difficult to meet the demands for credit from the business world. A revival of business will necessitate the "unfreezing" of the banks, or the shifting of the burden of carrying the Federal debt to the public. Whether a banking system inflated with bonds can do that easily or in a sufficiently short time is an open question. If the inflation of the banks shall have progressed far enough, it is entirely feasible that the real advent of recovery will encounter a formidable obstacle in impending banking difficulties, rooted in the unsuccessful efforts to "cash in" on the savings of the future, through diverting the assets of commercial banks into fixed capital expenditure. In this connection it is appropriate to raise the question, whether under different circumstances the experiment could have been successful and what those circumstances should have been. During the depression years, there developed a certain amount of capital too timid to enter productive activity, so long as business uncertainty prevailed. If such funds were applied to some productive endeavor, the advent of recovery may have been accelerated. A large public-works program financed by such funds, with most of the spending concentrated inside the span of a few months or a year, could probably have some stimulating effect. Such a reapplication of idle funds would be effective only over a short period of time, because capital rarely remains idle for long and the idea of the scheme would be to use only the funds that would not have found application elsewhere. A public-works program stretched out over a period of years absorbs a decreasing proportion of funds otherwise unemployed, with the result that after some time the net eco-

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n o m i c effect w o u l d be zero, as all the money spent would be diverted f r o m o t h e r purposes. 1 4 T h e obstacles to such a p l a n are twofold. First, the difficulty of any advance p l a n n i n g owing to the institutional framework of local self-government, already dealt with; second, the difficulty of d e t e r m i n i n g the e x t e n t a n d whereabouts of " t i m i d " capital. T h e r e does not seem to be any way, u n d e r a democratic form of society, of effectively coercing such f u n d s to go in a given direction. O n e probably could attract idle capital by high returns, but even t h a t is problematical, as these f u n d s are economically idle for the very reason that the owners prefer to take a lower r e t u r n in order not to tie u p their wealth for any length of time in any definite undertaking. A

POSSIBLE ALTERNATIVE

A n o t h e r m e t h o d of rendering public works more effective would consist in changing the n a t u r e of the projects u n d e r t a k e n . It has already been demonstrated that public construction cannot be substituted to a sufficient degree for the decline in the d e m a n d for producers' goods. If the a m o u n t spent should be directed toward u r b a n residential projects or what is known as "slum clearance," the ensuing r e b u i l d i n g of most of the large cities would assume the proportions of a new industry with a much more extensive dem a n d for producers' goods in sight. In spite of its social significance, such a course would probably be most disastrous to existing realestate values. U r b a n real-estate debt is held to a very large degree by savings banks a n d insurance companies, a n d a mortgage crisis w o u l d i m p a i r their solvency. Such a program might necessitate a m u c h larger outlay t h a n all the public-works expenditures of the last five years combined. A genuine rehousing program for the u r b a n p o p u l a t i o n is of d o u b t f u l validity f r o m the point of view of pecuniary profits; it implies a real redistribution of wealth, a n d therefore meets with the opposition of those who would have to foot the bill. Apparently for the above reasons, the public-works authorities scrupulously avoided the so-called slum-clearance question. Presid e n t Hoover voiced his disapproval at a conference called by sponsors of exactly such a plan. 1 5 In the spring of 1934, Secretary Ickes " T h i s idea is advanced by Professor A. G. Pigou, in The Theory of Unemployment, Macmillan and Co. (London, 1933). I ' T h e opening speech of Mr. Hoover at the President's conferencc on Home Building and Home Ownership, Dec. 2, 1931.

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stated that the rebuilding of city dwellings was not a part of the public-works program. T h e so-called Housing Bill was also sponsored by groups interested in slum clearance, but, as enacted in the summer of 1934, the new law had practically no bearing on the problem. This way of rendering public works more effective appears never to have been seriously considered by the government, as it would involve a deliberate reshuffling of the social and economic relationships of the various classes in society. EXISTING D A T A

ON P U B L I C

WORKS

It has probably been already noticed by the reader that the usual procedure in such discussions has not been followed in this particular instance, since thus far we have had scarcely any recourse to statistical information concerning public works. Such a method of presentation has been quite deliberate, as it is most important first to review the underlying ideas and because the question of data is, in this case, a problem in itself. One cannot discuss the factual information available on public works without starting with construction statistics in general. T h e first and greatest difficulty encountered lies in the definition of the term "construction," or in the distinction between new building and maintenance. In such fields as railroads, public utilities, and industrial buildings, the total figures of annual construction may vary by hundreds of millions of dollars, depending on whether one classifies certain expenditures as "new construction" or "operating expenses" of already existing plants. T h e second difficulty consists in the absence of reliable and complete basic data, covering all the construction activities in the United States. Up to a few years ago, there were no estimates of total construction, so that it was impossible to determine the size of the construction industry, even approximately. Owing to these obstacles, the estimates of total construction made in recent years vary considerably, as one may observe from Table 51, and none of them can be regarded as final. We observe from T a b l e 51 that during the postwar prosperity period, total annual construction exceeded ten billion dollars, that a very drastic shrinkage took place during the depression, and that in 1933 construction diminished to one-third of its former volume. It was the objective of both the first and the second public-works experiments to stimulate that total back to normal. In order to

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51

C O M P A R I S O N OF T O T A L C O N S T R U C T I O N E S T I M A T E S • 1929 = 100 NATIONAL B U R E A U OP ECONOMIC RESEARCH

«919 1920 1921 1922 •923 '924 1925 1926 '927 1928 1929 «93° >93" »932 >933

70.9 76.7 92.6 92.5 97.6 99.7 103.4 82.9 38.0 36.5

ENGINEERING NEWS RECORD

34- 1 32.6 33-4 47.2 56.6 60.0 78.8 85.6 92-5 102.0 100.0 77-7 57-1 27.4 23-5

FEDERAL RESERVE BOARD

VOLUME f

(In Millions of Dollars) 8,638 10,200 9.224 11.033 '3.315 13.308 14.032 14.343 14.876 15.919 14.381 11,921 8,920 5.458 5.253

53-8 53-8 47-9 07-5 71.8 80.3 104.3 110.3 110.3 "5-4 100.0 78.6 53-8 23-9 21.4

• Source: Kuznets, Simon, Durable Goods and Capital 52, National Bureau of Economic Research (Nov., 1934). f National Bureau estimate.

Formation,

Bulletin

appraise the results statistically, it is necessary to separate public construction from private. T h e nature of the available data is such that only rather rough estimates can be obtained. Prior to the depression, public works comprised approximately one-third of total construction; during the depression they rose to an amount equal to about one-half of the total. 16 So that, while total construction declined drastically as seen from Table 52, public works fell off less rapidly and, as a result, comprised a greater shaie of the diminished total. While in the years 1927, 1928, and 1929, the total annual expenditures for public works stood at about three billion dollars, by 1932 they had declined to about two billions, and there is ample ground to believe that in 1933 they fell off further to about one billion and a quarter. Such a decline in the amount spent on public works, while this type of expenditure was encouraged and stimulated for over five years, can be explained The first estimate of total expenditure on public works appeared in Planning and Control of Public Works, by Leo Wolman (National Bureau of Economic Research, 1930). More recent estimates were made by Corrington Gill and are presented in Table 52.

Oí

o

c o

3

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m to W eô

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u «j u S | H - «j « js o -g JS "O — u " « u m rt M O s Jj u s " • „ » ¡ k o «¡ -c o -C S H 'S " Ü n c O ~ •» 9 r? « rs c 60 ,¡¿ > 2 o c — r 2 ä - | g: ^ il ° 2 « u o - s c oo 2 2 3 « » 73

-_ -V " s o aG

§ a «

s

s

1 1 i -S M •S í - 2 - g t, « j o o •S z X u | 23 £ ¿ C -O ^ 3-3 15-1 '5-5

0.6 0.4

14.1 13.6

o-5 0.6

18.1

1.0

'2-5 11.2 I 1.9

0.6 0.4 0.6

.6.5 20.6

1.4

"5-3

'•7

30.I 24.O 24.I 20-7

23-1

0.8

2O.4

22.9 24.7 24.2

°-5

19« 17-5

27-3

'•3 '•9 1.0

30.0 31.2

0.7 0.6

16.5

2-7 1.2 0-9 1.0

i-9

14.6

18.5

I.I 0.7 I.O 0.7 O.7 0.7

°-5

2.0

16.9

'5-4

16.5

'3-4 13-7 13-5 10.8

11.7 11.2

"•9 15-3 15 b

I.I 0.9 '•5 I.O I.O 0.9 0.7 I.O 0.7 0.8

i-4 '•5

151

13.2 I4.I 13.0

'4-5

14.0

'4-9

16.4

145

15.0 17.0 18.9

1.2 I.O I.I 0.7 I.O

1.2 '•3

I.I I.O I.I 1.6

i-7

Total foodstuffs imported, by value, as compared with total wheat imports by volume, are next considered. In this case the theory does not seem to hold so well, since the value of the imports shows a downward trend after depreciation took place, while the quantity of wheat imported shows, if anything, a slight increase. T h i s is shown in Table 56. T h e most logical explanation of this phenomenon seems to be that, although the values quoted are in pounds, the foreign currencies which were dealt in were also depreciated to the same extent as the British pound, since most of the foodstuffs consumed come from within the Empire, or from the Scandinavian countries, which form part of the "Sterling bloc," consisting of countries that tie up their currencies with that of Great Britain. It is therefore apparent that, under such conditions, the theory will not work, it being valid only when the country with the depreciated currency is dealing with one still on the gold standard, or at least with a greatly dissimilar currency. In the first case cited, it was possible to apply the theory, since much of the raw cotton imported comes from the United States, and the pound and the dollar are very dissimilar. T h e case of the value of exports, as compared with their quantity, is more involved than the comparison of the value and quantity of imports. With exports, the trend in value depends on the

382

INFLATION

AND F O R E I G N TABLE

T O T A L

56

FOODSTUFFS,

WHEAT, WEIGHT:

TRADE

VALUE

IMPORTS, MILLIONS

POUNDS

(In Millions Cwt.)

1929

1930

I93I

*932

¡933

VALUE WEIGHT VALUE WEIGHT VALUE WEIGHT VALUE WEIGHT VALUE WEIGHT

Jan. Feb. March April May June

July

Aug. Sept. Oct. Nov. Dec.

49.I

405 42.1 42-7 44-2

39-6 42.2 45-7 45-' 4»-5 46.8

9-2 7-1 9-5 9-7 9-7 7-7 8.2 9-7 12.2 11.9 9.8 Ö.5

42-9 37-3 40.0 36-7 39-6 37-7 39-2 37-2 36.7 44.1 40.6 44.4

7-0

5-b 8.2

36.2

30.0

«•3 7.2 q.6 8.1 11.i 9-8

32.6 32-5 33-3 33-4 35' Si-8 33- 6 40.8

139

39-7

5-8

10.4

38.6

7-3 5-1 9 .b 8.2 7-7 8.6 12 11.8 16.2 •4-5 «1-3 7.6

315 33-6 30-9 27-5 29-9 31-4 29-3 28.2 30.6 35-i 34-4 32.1

5-' «•5 10 9-3 8.8 9-7 10 9-2 8-3 10.5 8.4 7-7

27.2 25.2 29.2

26.4 30.0 27-3 26.3 27.0 29.8 32-3 32.0 30.2

8.1 7.6 11.8

10.4 10.1

8.8 8.4 8.2 10.6 IO.I

10.i 8.2

point of view taken, or in other words, on whether the value of the exports is quoted in terms of domestic or foreign currency. In terms of outside currency, the value of the exports would naturally decrease, owing to depreciation in the exchange market; but in terms of the domestic currency, the value would remain at practically the same level as before depreciation, and would fluctuate only as the quantity of exports fluctuated. Applying this idea to the figures presented, the value of exports showed a fairly horizontal trend after depreciation, as did the representative commodities, iron and steel, and cotton piece goods. T h e value of exports showed a fairly horizontal trend after depreciation, as shown in Table 57, as did the representative commodities, iron and steel, and cotton piece goods. A third angle of approach to the problem of the relation between the exchange rate and the price level, is through the application of the purchasing power parity theory of Cassel, since, Great Britain being off the gold standard, the actual worth of the currency is difficult to determine. According to this theory, the worth of the currency is established by the relative values of the two price levels of the respective countries, or in other words, the worth of one in terms of the other. T h e parity between the United States and Great Britain was compared (Tables 58 and 59) with the exchange rate

AND

| STEEL

IRON

i 2S o u H

STEEL

VALUE STEEL

AND

IRON

COT-

TON STEEL TON

COT-

AND

IRON

r^oo

C i t o »-;

r ^ c o in i n t o to

c o t o r ~ t o

O O O O O O O O O O O O

non m e o « r^co ano o ai o c o a e io f N c o t o o i

R * . o o

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r-*

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B W H N M H H H H

« » o r-co o o q > « « e n i ^ t q 4«« c i t o á i c ó ó i c ó c iu S ci ^ r ^ f ^ c o c o e o c o e o c o c o e o «

STEEL

AND

IRON

oioo

c ó • « * « ió -¿to « to c ic i ^ ci c i M W W W M M M W t t M W M

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r ^

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VALUE

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1 ?

t n t o

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VALUE

»«< ?

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SO ?

Si

in c o c o

oóóóóóóooooó

ci«indeó«cicó 4 * t oc i c i ««CIMH«flflnM«H

AND

IRON

VALUE

i

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« c o m^^-coto o a i c oc o ^ • c o c o c O ^ c o c o c o c o c o c o c o

óóóóóóóóoóóó o>

a n o ~ ^ tn ~ c o to a c o c * « inn c o t o c o r ^ C Oe o C OC OC OM C O C O C * C I MM

c ó

9 '•'i0!0? ^ r^. r^. c ó c ó c ó d c iÓc o

X

—

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a >3 < S

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a

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g-u o u «OZQ

384

I N F L A T I O N AND FOREIGN

TRADE

as a percentage of par, in order to show whether the price level of the two countries actually determined the exchange, as would be inferred from theory, or whether the reverse was true. From a study of the figures, it would seem that at first the price level moved, followed by the exchange rate, while later the exchange rate seems to have moved, with no apparent relation to the price level. During 1932, the price level seemed to move first, according to the theory, b u t after that time, the exchange rate seemed to be affected by other factors than the price level, and moved far above the old gold par. TABLE

58

FOREIGN EXCHANGE RATE, UNITED STATES AND GREAT BRITAIN (Percentage of Par)

*925 Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.

98-3 98.1

1926 100 100

99-7

100 100 100 100.2 100 100

99-7 99-5 99-7 99-7

99-7 99-7 99-7 99-7

98.3 98.7

100 100 100

1927

1928

*929

99-7 99-7 99-7

100.4 100.2 100.4 100.4 100.4 100.4 100

99-7 99-7 99-7 99-7 99-7 99-7 99-7 99-7 99-7

100 100 100 100 100 100 100.2 100.2 100.4

99-7 99-7 99-7 99-7 99-7

TABLE

100.2 100.4 100.4

¡93° 100.2 100 100 100 100 100 100.2 100.2 100 100 100 100

'93' 99-7

100 100 100 100 100 100 100

93-2 80

76-5 693

'932

'933

7°-5

69..

74-9 77-4 75-7 75" 73

70.5

71.i

71.6

71 -3 699

67.4 67.4

70-3 73-6

80.8

85.1 95-6 9'-5 95-8 96

'05

105

59

PRICE LEVEL OF GREAT BRITAIN EXPRESSED AS PERCENTAGES OF THE UNITED STATES PRICE LEVEL

Jan Feb March April May June July Aug Sept Oct Nov Dec

1931

1932

1933

82.1

82.9

92.8 93.7

96.9 97.7

86.3

92.3

84.0 85.2

93.6 92.2

95.6 94.9

90.6 89.4

92.3 87.6

84.8

92.1

85.8

91.1

95- 2

86.9 86.1 83.6 87.5 89.5

90.0

92.6 93.3

93.4

86.8

I N F L A T I O N AND FOREIGN TRADE

385

It therefore seems that the price level, under present-day conditions, does not have the great effect on the exchange rate, that the purchasing power parity theory postulates. If anything, the relation existing between the two would seem to be reciprocal, since the exchange rate affects the price level to a great extent, in Great Britain at least, by its effect on imports and exports, while the price level may affect the exchange rate in that it reflects the general level of business activity, and thus the demand and supply of exchange. The relation existing between the foreign buyer and the domestic producer is one which must also be taken into consideration. Under a depreciated currency system, the foreign buyer is given an undue advantage over the domestic producer, owing to the fact that goods are cheap in terms of foreign currency, and that the country with the depreciated currency is consequently a good place in which to buy. In this way, foreign trade is relatively stimulated. This advantage, which is unfair to the country with the depreciated currency, must be paid for by someone, and that someone is the domestic consumer who uses imported goods. Clearly, by relatively the same amount as the foreign buyer profits from the depreciation, the importer loses, since he must pay more for his imports. This increased rate is passed on to the consumer through an increase in the general price level, so that he is the one to pay the cost of depreciation. Exchange and Inflation In the foreign exchange field, the problem must be considered in an international sense, and any interrelationships thought of as existing between countries, or between individuals and their government, rather than as being between individuals. By considering the problem in this light, it is possible to define inflation in the exchanges as a redistribution of the purchasing power of one currency in terms of another, and anything tending to bring this about is inflationary. A condition of equilibrium must be assumed to be the normal condition between two countries, so that the discussion may have a starting point. The gold standard may also be assumed to be in operation. By the term equilibrium is meant that the two countries have trade relations that are reciprocal, and that the exchanges do not move outside the gold points. Under such conditions, the price levels of the two countries have a definite relation

386

INFLATION

AND FOREIGN

TRADE

one to the other, not necessarily as the purchasing power parity theory states it, but nevertheless a distinct relationship, through the exchange rates. We now turn to a discussion of the actual happenings in the sterling exchange field, as these relate to exchange movements. T o relate theory accurately to happenings, is never easy, since in actual practice there are many cross currents at work at the same time, so that it often happens that no one theory may be applied and found to work. Inflation in the field of foreign exchange is defined as a redistribution of purchasing power between two countries, or a disturbance of the existing price relationships, and yet it is not easy to prove that this has taken place. In fact, it is possible only to show that inflation has not in any sense of the word taken place. In considering the first proposition, that the abandonment of the gold standard means inflation in the exchanges, the position of Great Britain in relation to the rest of the world must be considered. Great Britain's trade is confined largely to the Empire or to countries closely affiliated with the Empire in one way or another. These countries form the previously mentioned sterling bloc, and are those whose currencies are tied to that of Great Britain. Therefore, when the gold standard was abandoned by Great Britain, these countries also abandoned gold, with the result that there was practically no change in the price relationships existing among these countries. Of course there is the relation with the United States, but observation of the price levels of the United States and Great Britain shows that, after the abandonment of gold, the two price levels drew much closer together, and seemed to fluctuate in fairly close correlation. After the United States abandoned gold, the two seemed to continue along much the same lines as formerly, although the time is as yet too short to draw any definite conclusions. With the United States off gold, there were very few countries in the world left with the gold standard, and British trade with them is thus comparatively small. It does not seem, then, in actual practice, that the abandonment of the gold standard by Great Britain caused any inflation in the field of sterling exchange, since price relationships were not disturbed greatly thereby, if at all.

INFLATION C.

AND F O R E I G N T R A D E DOLLAR

BY D .

J.

387

EXCHANGE LEAHY

Contemporary American experience with the manipulation of the exchange rate by fixing the price of gold has failed, u p to the present time, to produce any result other than a small rise in the commodity price level. T h e plan has been to buy gold at a figure higher t h a n the world price and thus forcibly to depreciate the exchange rate, which, it has been supposed, would raise the price level. There is, of course, another theory involved here, but to investigate it would take us too far afield from the scope of the present discussion. T h e result expected may take place under either of two circumstances: (1) if speculative activity raises prices, with no actual basis in trade; (2) if the United States actually convinces those dealing in foreign exchange that the dollar is overvalued, whereupon there would be an actual inflation, resulting in a wholesale export of capital, or an internal investment in commodities, raising their prices. Clearly, an alteration must be effected in the equation of exchange, specifically, that is, in the conditions of supply and demand. T o make this demand more effective than it has been throughout the past four years, an artificial purchasing power must be placed in the hands of potential consumers whereby the relative position of supply would raise the price level. T h i s alteration would be nothing less than inflation in its most vivid colors. W h a t we are attempting to do is to divorce our own price level from that of the world, which it has usually followed with no alteration in the conditions of trade. If we expect to do so by the medium of the exchange rate, we must allow the rate to become effective; that is to say, the rate must have been of some significance to others than speculators; it must alter the conditions of international trade. As we may generalize the case, the external price level influences the domestic price level only so far as the country is dependent upon world trade. T o suppose that domestic prices will shoot upward with changes in the exchange rate, with no changes in domestic demand, with no increase of purchasing power, money, credit or production, is to suppose a relationship which has no actual basis in trade. Whatever correlation is visible is present by virtue of the movements of export and import goods in the price

388

INFLATION

AND F O R E I G N

TRADE

index, which have some dependence on the exchange rate, as conditions of trade. 6 Aftalion, writing on the French experience in the postwar period, has much the same experience to report. 7 We hasten to add that France is much more dependent on foreign sources of material supply than is the United States. 8 We may summarize the discussion at this point: there are, roughly speaking, three classes of goods from our particular point of view: (i) purely domestic goods, (2) export goods, and (3) import goods. We hold that variations in the depreciation of the exchange rate have no direct effect on prices of goods internally produced and consumed, for, as has been shown, conditions of marketing, production, distribution and consumption are affected to so minute a degree by foreign trade activities that the foreign exchange depreciation has, as such, little influence on their price levels. As for export goods, depreciation has one significant aspect: falling exchange makes foreign purchasing cheaper, if the price level remains the same. But if this brings about an increased foreign demand for these goods, then the price level may rise, ironing out the differential. Thus the price rise will come about here only if there is an increased demand exerted in the export market. T h e prices of import goods, on the other hand, tend to fluctuate with the exchange rate, particularly if the country is dependent on foreign sources to such an extent that rises in prices will not effectively alter the volume of demand, for such commodities as tin, for instance, which, as seen above, maintained a close relationship with exchange depreciation. « Cf. Standard Trade and Sec. Service, Dec. 26, 1933, Special Survey, " T h e case for the managed dollar." 1 "Durant les années 1920 à 1924 les variations combinées du change et des prixor extérieurs, les variations du pouvoir d'achat extérieur du franc ont commandé aux variations des prix en France. . . . Elle apparaît surtout dans le fait que les variations des prix, en hausse ou en baisse, très intenses et a peu près égales à celles de cette dernières courbes quand il s'agit de marchandises dépendent directement du marché internationale, des produits d'importation se manifestent a peu près parallèles mais beaucoup moins intenses quand il s'agit de produits domestiques moins dépendent du marché internationale." Aftalion, Monnaie, prix et change, pp. 52-53. s " L e mouvement s'est révélé dirigé du dehors au dedans. Parti du change ou des prix-or extérieurs, il a entraîné les prix des produits d'importation et avec une intensité moindre les prix des autres produits, puis avec une intensité plus diminuée encore et avec certains retards, la circulation monétaire, laquelle a dû s'ajuster au niveau des prix." Aftalion, Monnaie, prix et change, p. 53.

INFLATION

AND

FOREIGN

TABLE

TRADE

389

60

CHANGES IN W H O L E S A L E C O M M O D I T Y P R I C E S , 1932 AND 1933 • NOV., 1932

NOV., 1933

CHANGE

I. All Commodities

639

71.1

+

2. Domestic Goods: ( i ) Eggs, Fresh, per Dozen, New York Firsts (2) Milk, Fluid, per 100 Lbs., New York (3) Brick and Tile (4) House-Furnishing Goods

86.7 66.3 75-4 73-7

3- Export Goods: (1) Cotton, Middling, per Lb., New York (2) Iron and Steel (3) Fuel Oil, Refined, Penn., per Gallon (4) Wheat, Short Patents, Kansas C i t y . .

723 78.4 84.7 81.0 Average

-14.4 + 12.1 +9-3 + 7-3 +3-8

35-3 79-4 52.1 42.1

57-2 8.-5 64.4 74-4 Average

+21.9 +2.1 + «2.3 +32-3 + I7-I

24.1 35-6

25-7 82.4

+ 1.6 +46.8

45-' 7-2

40.4 17-5 Average

-4-7 + 10.3 + 14.0

4- Import Goods: (1) Silk, Raw, Canton Extra, a Crack, per Lb., New York (2) Tin, Pig, per Lb., New York (3) Coffee, Brazil, per Lb., New York, Rio No. 7 (4) Rubber, Crude, per Lb., New Y o r k . .

7-2

Source: Monthly Labor Review, U. S. Bureau Labor Statistics, 1932-34. • Brazilian exchange, milreis, Oct., 1933, 70 per cent par; Japanese exchange, yen, Oct., 1933, 55.3 per cent par; Straits Settlements dollar, recovered from 38.0026; Nov., 1932, to 60.0625 ' n Nov., 1933, par, 60.08; Chinese exchange, yuan, Nov., 1932, 20.5937; N o v - '933- 3 2 -9°3°; P a r 32-69-

W e can recognize a distinct rise in each of the various price levels, but for the greater part we cannot suppose that the influence of exchange depreciation has had more than a slight effect. During the past year, 1933, there were various price-lifting influences at work, namely, the activities of the N R A , which had the effect of raising costs, thus forcing up prices; the influence of the AAA, which has been giving a bounty to agricultural producers for acreage reduction by a processor's tax; third, the wholesale destruction activities of the government during the summer of 1933, which acted to cut the existing stock of agricultural goods. On the other hand, foreign trade approximates the extremely low level of its fall throughout the depression period; it has enjoyed moderate upturn, to be sure, but not enough effectively to diminish supplies. T h e s e activities seem to have had a varying effect on the classes of goods selected as domestic. Export goods had a varying rise,

390

INFLATION

AND FOREIGN

TRADE

more discernible than domestic goods' prices. T h e rise in import goods, particularly tin, is noticeable because of the heavy depreciation of some of the eastern exchanges. In October, 1933, the Japanese yen was selling at 55.3 per cent of par—this, considering the fact that our own dollar was selling at about 37 per cent below par of the franc. Many of the oriental exchanges have, moreover, regained par, by reason of our own depreciation. It would seem that the influence of trade in maintaining and restoring equilibrium between world price levels has been diminished. International competition in commodities has been restricted to a large extent by tariffs, quotas and exchange restrictions. Present

Exchange

Position

Throughout the latter half of 1933, the government of the United States was following a policy of conscious depreciation of the exchange. This was adopted in order to stimulate a rise of the domestic price level. We have shown the relationship between exchange and prices, particularly noting the effect of a depreciated exchange upon import and export prices, and the lack of it on domestic prices. A glance at Table 61 will show some relevant facts regarding the present exchange position of the United States, with France, and England, a paper country, whose exchange has been selling above par ever since our gold policy was announced and put into effect. This policy has advanced all exchanges against the dollar, as was to be expected. This policy has had the effect of somewhat weakening confidence in our monetary system abroad, and to a lesser degree at home. T h e credit of the national government has been called into question on several occasions, with a substantial weakening of government bonds, which has elicited on these occasions government support by active purchases. T h e severest test of its credit, however, was to be expected upon the announcement of the President to Congress of the very large deficit to be incurred within the "recovery period." From present indications, however, this test seems also to have been its proof, since ultimate stabilization must be effected before the government can either (1) declare the gold in excess of rate of conversion in the Federal Reserve banks to be confiscated; or (2) finance its recovery program by the sale of bonds to investors.

INFLATION

AND

FOREIGN

TRADE

391

TABLE 6 I E X C H A N G E

POSITION,

UNITED

STATES,

ENGLAND

A N D

FRANCE

•

(1926=100)

ENGLAND 705-? ' J J J

WHOLESALE PRICES

UNITED STATES WHOLESALE PRICES

DOLLARS POUND

FRANCE

PER CENT OF P A R

WHOLESALE PRICES

IN

FRANCS

EXCHANGE PER CENT __ „ . „ OF P A R

Jan Feb March.... April May June

61.2 60.6 60.6 61.7 63.6 63.8

61.0 59.8 60.2 60.4 62.7 65.0

69.1 70.3 70.5 73.5 80.8 85.0

59.2 58.2 55.8 55.7 55.1 58.0

100.4 99.9 99.6 95.6 85.4 81.6

July Aug Sept Oct Nov

64.2 63.8 63.4

68.9 69.5 70.8 71.2

95.5 92.5 95.9 91.8 105.8

57.7 57.2 57.2 57.2

71.8 72.9 67.9 67.4 62.5

* Source:

Standard

Statistics

Bulletin,

Base

Book.

T h e exchanges seem to have i n t e r p r e t e d the message in this way, since o n t h a t day they suffered only a f r a c t i o n a l weakness, r e m a i n i n g a b o u t 63 p e r cent of par. T h u s t h e b u d g e t position a n d governm e n t credit a r e of i m p o r t a n c e to f o r e i g n exchanges, because they i n d i c a t e to a large e x t e n t t h e possibility of inflation. H o w e v e r , it seems o n t h e w h o l e as if the exchanges w o u l d r e t u r n to a s o m e w h a t b e t t e r technical position if the U n i t e d States s h o u l d w i t h d r a w f r o m t h e gold m a r k e t a n d s h o u l d n o t a t t e m p t to d e p r e c i a t e t h e dollar. T a b l e 61 shows t h a t t h e price levels of E n g l a n d a n d t h e U n i t e d States are i n h a r m o n y , so that, w i t h the p o s i t i o n of t h e b a l a n c e of p a y m e n t s considered, we s h o u l d logically expect sterling to sell a t b e t w e e n $4.60 a n d $4.89. F r e n c h a n d A m e r i c a n price levels are n o t in so close h a r m o n y as are t h e l a t t e r a n d the British levels; b u t t h e r e l a t i o n s h i p is close e n o u g h f o r us to realize t h a t the depreciat i o n of the d o l l a r in gold is m u c h greater t h a n if left to find its own level. A t any rate, t h e t i m e seems r i p e f o r these t h r e e c o u n t r i e s to c o m e to some sort of a g r e e m e n t r e g a r d i n g stabilization of t h e currencies. Inflation and Depreciation of Exchange L e t us n o w e x a m i n e t h e r e l a t i o n s h i p b e t w e e n inflation a n d dep r e c i a t i o n of t h e exchanges. D e p r e c i a t i o n is o n e aspect of inflation, b u t it is n o t invariably connected w i t h t h e latter. T h e y are related,

392

I N F L A T I O N AND F O R E I G N

TRADE

b u t n o t always co-agents. N o g a r o , p a r t i c u l a r l y , expresses the viewp o i n t of the writer: " E x t e r n a l d e p r e c i a t i o n , w h i c h the theory of t h e e x c h a n g e s a t t e m p t s to e x p l a i n , a n d internal d e p r e c i a t i o n are t w o p h e n o m e n a w h i c h m a y be related a n d m a y even affect each o t h e r . . . ; b u t at the present t i m e they are essentially

distinct

p h e n o m e n a ; f o r they present themselves a n d are m e a s u r e d by the o b s e r v a t i o n of d i f f e r e n t sets of facts—rates of e x c h a n g e , o n the one h a n d , average

fluctuations

of i n t e r n a l prices o n the other. 9

I t is precisely o n this p o i n t of m o n e t a r y theory

that w e find

m u c h disagreement. It is the p o i n t w h i c h logically connects

the

q u a n t i t y theorists a n d G u s t a v Cassel; but, as N o g a r o p o i n t s out, there is certainly n o precise or i m m e d i a t e r e l a t i o n s h i p b e t w e e n int e r n a l a n d external p u r c h a s i n g p o w e r . T h e three phases of economic theory—foreign trade, the balance of payments, a n d i n t e r n a t i o n a l price levels—are closely b o u n d u p together. L o g i c a l l y , w e s h o u l d look

to changes i n f o r e i g n

trade

m o v e m e n t s to e x p l a i n changes in the other two p h e n o m e n a , w h i c h o w e their i n c e p t i o n as current p r o b l e m s largely to the f o r m e r . W e m u s t not neglect the fact, h o w e v e r , that i n t e r n a t i o n a l debts a n d m o v e m e n t s of capital h a v e arisen in this a n d the last c e n t u r y to c o m p l i c a t e o u r p r o b l e m . I n t e r n a t i o n a l debts h a v e g i v e n rise to the " D u a l " b a l a n c e of payments, the o l d simple b a l a n c e of the movem e n t s of goods a n d g o l d h a v i n g b e e n a u g m e n t e d by o t h e r items in the statement. T h u s the classical theorists w o u l d h a v e it that d i s e q u i l i b r i u m in the b a l a n c e of trade leads to an increase in currency, a n d then to a rise i n prices. If this is a correct statement of their position, then w e s h o u l d logically reach the q u a n t i t y theory of m o n e y , that the v o l u m e of currency in each country varies w i t h the p r i c e level, a n d influences its m o v e m e n t s . T h u s the theory f u r t h e r leads to the ass u m p t i o n that any e x p a n s i o n of t h e currency or of t h e credit of a c o u n t r y , w i t h o u t a l i k e e x p a n s i o n i n other countries, w o u l d lead to d i s e q u i l i b r i u m in the b a l a n c e of payments, w i t h a rise in the p r i c e level. A n d this likewise w o u l d f o l l o w any l i k e i n f l a t i o n a r y p o l i c y , w h e r e the v o l u m e of credit a n d currency, t o g e t h e r w i t h the p r i c e level, are i n v o l v e d . D u r i n g the period 1925-33, w e h a d a fairly g o o d b a l a n c e b e t w e e n e x p o r t s a n d imports, w h i l e prices c o n t i n u e d to fall. A t this same time, credit a n d currency e x p a n d e d a n d con» Nogaro, Bertrand, Modern don, 1927, p. 128.

Monetary

Systems, P. S. K i n g 8c Son, Ltd., Lon-

INFLATION

AND F O R E I G N

TRADE

393

tracted without relation to the price level or to the balance of payments. A large volume of gold was shipped here from Europe, but this did not affect the price level, even though credit expanded. As a matter of fact, we maintained the balance of payments, as well as the stability of the exchange, by virtue of the huge volume of foreign loans throughout the last decade, and the consequent withdrawal of further loans led to a breakdown of the exchanges. T h e foreign balance has not been allowed to become self-correcting, as it should in theory; the increase of gold, of course, might lead to an increase of credit, depending upon the demand for it. But there is no reason to expect a rise in the price level proceeding from an increase of credit. If we divorce the problem of foreign debts from that of the balance of payments, light may be thrown upon the latter. Where foreign exchange dealings are carried on solely to finance physical trade, then imports will normally balance exports, because the rate of exchange will adjust the demand for it. Gold can flow to settle differences, but only to a relatively insignificant extent. Thus trading will keep the prices of a substantially large part of international and semidomestic goods in line. Thus we shift our emphasis, in explaining the similarity of world price levels, away from gold flows and consequent expansion of credit. It is more nearly correct to say that price levels are kept in harmony by flows of goods, rather than by gold; by trading, rather than by banking. Inflation and depreciation are two separate phenomena, as we have said, but one does not accurately show the extent and duration of the other. Purchasing power is usually measured internally by the movements of the price level; depreciation can be accurately shown by the course of the exchange. Inflation, as we have seen, involves a redistribution of purchasing power; therefore, it is inaccurate to say that this is measured by changes in the price level; the correct procedure is to measure the amount of individual consumers' expenditures and outlays, and show how they have been individually affected. For want of this statistical material, however, we resort to the common practice of calculating price changes, which leads to the common error of identifying and substituting one for the other. Price change is an incidental factor of inflation, as we have already shown. However, it is a very important factor in measuring the effects of depreciation, because it is through the medium of comparative costs and prices of trading countries that

394

INFLATION

AND

FOREIGN

TRADE

d e p r e c i a t i o n is effected, or—in r a r e cases—itself causes inflation. Conscious of t h e t a u t n e s s of t h e r e l a t i o n s h i p a m o n g t h e t h r e e p h e n o m e n a , e x c h a n g e , prices a n d inflation, it is difficult to d r a w a nice d i s t i n c t i o n b e t w e e n inflation a n d d e p r e c i a t i o n . W e have to a c e r t a i n e x t e n t a n t i c i p a t e d o u r p r e s e n t p r o b l e m earlier, by s h o w i n g t h e r e l a t i o n b e t w e e n exchanges a n d i n t e r n a l prices, a n d c o n c l u d i n g t h a t v a r i a t i o n s i n rates of e x c h a n g e h a d a v a r y i n g effect u p o n prices, d e p e n d i n g u p o n the c h a r a c t e r a n d v o l u m e of i n t e r n a t i o n a l trade. W e a r e c o n c e r n e d h e r e w i t h d e p r e c i a t i o n r a t h e r t h a n inflation, w h i l e conscious of t h e fact t h a t inflation may proceed w h i l e a country is o n t h e g o l d s t a n d a r d , a n d t h a t d e p r e c i a t i o n may o f t e n result w i t h o u t a n y i n t e r n a l inflation. H o w e v e r , we must limit ourselves h e r e to i n f l a t i o n w h i c h may occur w h e n t h e c o u n t r y is on an inconv e r t i b l e p a p e r basis. As a f a c t o r in d e p r e c i a t i o n , t h e v o l u m e of m o n e y in circulation is of s e c o n d a r y i m p o r t a n c e . It w o u l d be m o r e logical to seek the causes of t h e issuance of t h e fiat money, w h i c h usually arise o u t of b u d g e t a r y difficulties. T h e n t h e r a p i d increase of prices, partly caused by t h e d e p r e c i a t i o n of t h e exchanges, a n d partly by inflation itself, by its e x t r e m e fluctuations necessitates an increase of m o n e y to f i n a n c e t h e real v o l u m e of transactions. Credit a n d m o n e y , in fiat f o r m , m a y b e t h e i n s t r u m e n t s of r e d i s t r i b u t i o n of p u r c h a s i n g power, b u t d o n o t act as causative factors to t h e exclusion of o t h e r i n f l a t i o n a r y processes. It seems illogical to assume t h a t the v o l u m e of m o n e y a n d credit in circulation, m u l t i p l i e d by t h e i r velocity, fixes t h e price level. It seems m u c h m o r e likely t h a t the v o l u m e of t r a d e a n d prices d e t e r m i n e s t h e a m o u n t of m o n e y a n d credit, w h i c h l a t t e r a d j u s t themselves to t h e needs of trade. T h r o u g h o u t the p e r i o d u n d e r review, 1925-33, w h i l e prices were falling, t h e v o l u m e of credit a n d m o n e y in circulation varied w i t h n o r e l a t i o n e i t h e r to p r o d u c t i o n o r t h e price level. T h e r e f o r e , it is i n a c c u r a t e to suppose t h a t the v o l u m e of m o n e y a n d c r e d i t in c i r c u l a t i o n , t o g e t h e r w i t h the price level, is indicative of the v o l u m e a n d e x t e n t of inflation, as we have seen. T h e y are merely phases of i n f l a t i o n a r y policy; b u t for o u r purposes here, t h e t h r e e statistical measures a r e of c o m p e l l i n g i m p o r t a n c e w h e n cons i d e r i n g d e p r e c i a t i o n of the e x t e r n a l p u r c h a s i n g power of t h e currency, because they show in a c o m p a r a t i v e way deviations f r o m a previous e q u i l i b r i u m w i t h a n o t h e r c o u n t r y . T h u s , we h a v e examined t h e i r r e l a t i o n s h i p in t h r e e specific cases, viz., (1) t h e effect of

INFLATION

AND F O R E I G N

TRADE

395

expansion of the price level upon exchange; (a) the effect of an expansion of the currency and of credit upon the exchange rate when under a gold standard; and (3) the effect of depreciation upon the price level. In all these cases we have assumed that the volume of currency and credit is of subsidiary importance in influencing the price level, which is itself more or less indicative of the activity of trade. This being the case, the volume of currency is important in those cases where the price-specie flow analysis is used to explain variations of credit and trade between countries in maintaining the balance of payments. T h e volume of gold and its movements are of course important in determining the reserve position of a nation in maintaining the gold standard. Thus the importance of currency and credit, as a measure of inflation, varies among individual writers, according to their own interpretation of the quantity theory. D. BY

A.

STABILIZATION A.

BEAUJEAN

Stabilization is one of the most pressing problems facing the world today. T h a t the world needs a stabilized form of currency as a means of exchange is quite apparent, for without such a means, international trade cannot go on, and all the countries of the world will suffer. T h e British government recognizes this fact, for at the Imperial Economic Conference, held in Ottawa in 1932, the following resolution was passed: T h e conference recognizes that the ultimate aim of monetary policy should be the restoration of a satisfactory international standard. Such a standard should so function as not merely to maintain stable exchange rates between all countries, but also to ensure the smooth and efficient working of the machinery of international trade and finance. 10 So at that time, before the United States was off gold, and before the London Conference, the British wished to reestablish an international medium ef exchange, realizing its importance to foreign trade. At present, the situation is even more pressing, for with the present disrupted conditions, foreign trade is rapidly dwindling, and most countries are showing an alarming tendency to withdraw 10 Report of the Imperial Economic Conference, 1932, p. 23. T h e author is indebted to Dr. Marcus Nadler, of the Institute of International Finance, New York, for details concerning contemporary British Exchange conditions.

396

INFLATION

AND

FOREIGN

TRADE

w i t h i n themselves a n d f o r m economically self-sufficient n a t i o n s . T h i s c a n n o t b u t b e h a r m f u l to all nations, since t h e r e will b e n o i n t e r n a t i o n a l t r a d e , a n d each c o u n t r y ' s industries will suffer accordingly. At t h e L o n d o n E c o n o m i c C o n f e r e n c e of 1933, the British were w i l l i n g to stabilize. It only r e m a i n e d to find t h e r i g h t figure at w h i c h to v a l u e t h e p o u n d . O w i n g , however, to t h e ideas of Presid e n t Roosevelt, whose reasons a n d policies have never been m a d e q u i t e clear, n o stabilization a g r e e m e n t was reached, a n d t h e conference failed, o w i n g e n t i r e l y to the d e t e r m i n a t i o n on the p a r t of t h e U n i t e d States d e l e g a t i o n not to stabilize at any figure. A t the time of t h e c o n f e r e n c e , t h e British m i g h t easily h a v e b e e n w i l l i n g to stabilize a t $4.50 to t h e p o u n d , b u t a f t e r the conference, they developed a w a i t i n g policy, w h i c h they h a v e p u r s u e d ever since, in o r d e r to observe t h e c o n s e q u e n c e s of t h e " N e w D e a l " in t h e U n i t e d States. In p a r t i c u l a r , G r e a t B r i t a i n is interested in the o u t c o m e of the policy of t h e U n i t e d States w i t h regard to the tariff q u e s t i o n , the w a r debts, a n d t h e N R A . She is interested in the way these v a r i o u s so-called recovery steps m a y affect the costs of A m e r i c a n p r o d u c e r s , a n d to see if it b e possible f o r British p r o d u c e r s to undersell, a n d t h u s secure some of t h e m a r k e t s of the U n i t e d States. W i t h all of these t h i n g s in m i n d , G r e a t B r i t a i n is not ready to stabilize, a n d will p r o b a b l y n o t be ready f o r some time to come. She is p r o b a b l y at a loss to u n d e r s t a n d , as are m a n y people in this c o u n t r y , just w h a t policy t h e U n i t e d States is p u r s u i n g ; w h a t she m e a n s by speaki n g of t h e gold s t a n d a r d as a "1934 m o d e l , " w h e n n o c u r r e n c y is r e d e e m a b l e in gold; o r w h a t the p o i n t was in d e v a l u i n g t h e d o l l a r to $0.59, w i t h o u t m a k i n g it r e d e e m a b l e in a n y t h i n g in p a r t i c u l a r . Such n a t i o n a l i s t i c policies as the U n i t e d States has been f o l l o w i n g certainly d o n o t lead to g o o d i n t e r n a t i o n a l feeling, a n d t h e British will p r o b a b l y be w i l l i n g to d o as we d o a n d "let things slide," since they are safely i n t r e n c h e d w i t h i n t h e E m p i r e , a n d are at p r e s e n t not particularly worried. British c o n d i t i o n s of t h e g r o u p h e r e considered at p r e s e n t a r e largely a t a standstill i n t e r n a l l y . T h e price level is at a low p o i n t , b u t it seems to r e m a i n fairly stable. T h e r e is n o inflation i n t e r n a l l y , except in t h e b o n d m a r k e t , as is also t r u e in the U n i t e d States, a n d c u r r e n c y has n o t b e e n o v e r e x p a n d e d . O w i n g to this stability w i t h i n the c o u n t r y , a n d also to the fact that the dollar lost its gold back-

INFLATION

AND FOREIGN

TRADE

397

ing, sterling has regained its former position as i n t e r n a t i o n a l currency, which it lost f o r a time when the gold s t a n d a r d was aband o n e d in England. T h e price level showed a slight u p t u r n at the e n d of 1933, b u t the time is as yet too short to decide w h e t h e r this is a p e r m a n e n t i m p r o v e m e n t or merely a m i n o r fluctuation. I n the field of exchange, the rates are allowed to follow the flow of trade, a n d n o a t t e m p t is m a d e to regulate them in their larger movements. In actual practice, inflation has not taken place in the sterling exchange field. T h e r e was no great d i s t u r b a n c e of the price relationships between Great Britain a n d the rest of the world, since most of the countries with which it trades are n o t only off gold, b u t belong to the sterling bloc a n d tie u p their currencies to the p o u n d sterling. T h e i r economic affairs in general are also influenced by British action. As to other ways to inflation, they d o n o t exist, since there is n o exchange control, a n d t h e p o u n d has not been devalued. T h e British will n o t stabilize at present, even t h o u g h they realize the value of stabilization to world trade. T h e y are t r o u b l e d by the indecisive m o n e t a r y policy of the U n i t e d States. T h e y are also interested in the o u t c o m e of the tariff policy of the U n i t e d States, its war-debt policy, a n d the results of the N a t i o n a l Recovery Act.

10 INFLATION

AND THE

STRUCTURE

OF

PRODUCTION BY E . F .

SCHUMACHER

INFLATION, though viewed as a monetary phenomenon, regularly sets forces to work that are calculated to influence every part of the economic system. W e can distinguish three different groups of price phenomena: (1) inflation as it affects the external value of the currency and thereby the balance of payments of a country; (2) inflation as it affects the internal v a l u e of the currency and thereby the different classes of income within a country; and (3) inflation as it affects the price structure within a country, i.e., relative prices, and the structure of production. 1 W e intend to confine o u r analysis to changes in the capital structure of production. A n d these changes, as we shall attempt to show, may occur independently of any movements in the value of money. W e can immediately list a n u m b e r of important questions: (1) H o w does the monetary factor affect the m u t u a l balance between the different stages of production? (2) C a n the accumulation of capital be influenced " f r o m the side of m o n e y " ? and (3) W h a t is the connection between these p h e n o m e n a a n d the phenomenon of the business cycle? T h e concept of the "structure of p r o d u c t i o n " is fairly clear and unequivocal. Inflation, however, is a term that has been defined innumerable times and in i n n u m e r a b l e different ways. T h a t inflation should be defined differently according as one discusses the repercussions of changes in the absolute price level or of changes in relative prices, is not surprising and may be unavoidable. T h o s e who are interested in the two other groups of problems which we have mentioned above, which are concerned with the value of money, must logically identify inflation with a rising price level. F o r our purposes, the price level and the v a l u e of money are incidental. 2 W e are concerned with relative prices, a n d h a v e to define inflation (and 1 This expression is taken from Hayek, Prices and Production

(London, 1931),

P- 352 Concerning the value of money and the measurability of changes in its value, see G. Haberler, Der Sinn der Indexzahlen (Tubingen, 1927), pp. 70 ft.

INFLATION

AND

PRODUCTION

399

its counterpart, deflation) in such a way as to cover all cases where the price structure is affected by a purely monetary factor. T o arrive at this definition in a systematic manner, we start from the concept of neutral money. " T h e problem," in the words of Professor Hayek, "is . . . to explain . . . how and when money influences the relative values and under what condition it leaves them undisturbed, or, to use a happy phrase of Wicksell, when money remains neutral relatively to goods." 3 W e cannot here present a complete theory of neutral money, which is a field of great difficulty and complexity that has recently attracted considerable attention. 4 W e must be satisfied to present the general line of the argument in its simplest form. T h e basic concept of economic theory is the concept of equilibrium. It signifies, in its most general meaning, a condition in which total supply and total demand are equal. It is the starting point for all economic analysis. W h e n equilibrium is disturbed, what are the natural forces, if any, that tend to get the economy into balance again? T h i s is the question that all so-called economic laws attempt to answer. Money is neutral as long as its total volume in active circulation is kept constant, i.e., its total volume, adjusted for hoards. O u r definition of inflation follows logically from our concept of neutrality: any increase in the volume of money in active circulation constitutes "pure d e m a n d " which we term inflation; any decrease in the volume of money in active circulation constitutes "pure supply" which we term deflation. T h e problem is now quite clear and unambiguous: H o w does inflation, i.e., any considerable increase in the amount of money in active circulation, affect the capital structure of production? Under what conditions docs it lead to capital creation, under what conditions to capital wastage? H o w is the balance between the different stages of production affected, and what is the relation of all this to the problem of the business cycle? Capital is created by the employment of original factors of proPrices and Production, p. 27. * Recent discussions of this subject may be found in J. G. Koopmans, " Z u m Problem des 'Neutralen' Geldes," in Beiträge zur Geldtheorie, herausgegeben von H a y e k , 1933; Dr. Walter Egle, "Das neutrale Geld," in Untersuchungen zur theoretischen Nationalökonomie (Jena, 1933), Heft 10; Alexander Mahr, "Neutrales oder wertstabiles Geld?" in Weltwirtschaftliches Archiv, 38.IM. (1933, II); Hayek, Prices and Production, Chap. IV. 8

400

INFLATION

AND

PRODUCTION

duction in the creation of capital goods. These factors of production are not normally available for such purpose. T h e y have to be made available, that is, they have to be taken out of the production of immediate consumption goods and employed in the production of goods which will yield consumption goods only at a more or less distant future. All modern theories of capital accumulation agree up to this point. 5 W e can distinguish two schools of thought with regard to the procedure of capital accumulation, i.e., two theories of development: they have in common the rather obvious idea that capital can be created only by the employment of original factors of production (land and labor) in higher stages of production (i.e., further removed from consumption), but they differ in the method they describe for effecting the shift of these factors of production from the production of consumption goods to the production of goods which cannot be consumed but can only be used for further production. T o state the difference between these two schools in a familiar formula: T h e one believes that for the accumulation of capital we depend upon voluntary saving; the other attributes all large accumulations to forced saving, 6 i.e., inflation. As a matter of fact, they say, this process of accumulation through voluntary saving is much too slow to bring the development we have seen in history. Men always tend to consume as much as they can. What they have saved during their working lives, they consume when they are old. T h e tremendous accumulations of capital of this capitalistic age cannot possibly have been made voluntarily. T h e r e would be no unbridgeable gulf between these two schools of thought, had not the "voluntary-saving school" set out to prove that all those accumulations of capital, which are made possible through forced saving, are not really capital in its economic sense, 5 T h e classical school did not give a correct analysis of the process of capital accumulation. Adam Smith gave rise to a great deal of confusion with his famous sentence: "Parsimony not industry is the immediate cause for the increase of capital" ( W e a l t h of Nations, Vol. II, Chap. III). T h e same idea was accepted by Mill (Principles of Political Economy, ed. by Ashley, Book III. Chap. X I I , Sec. 3). T h e Socialist theorists took the opposite view and attributed everything to labor, as against saving: Rodbertus, Lassalle, Marx (Das Kapital, I). On this point, cf. von Bohm-Bawerk, Positive Theorie des Kapitales, Bd. I, 2. Buch. 4. Abschnitt. 4. ed.: pp. 136 ff.; Spiethoff, Lehre vom Kapital, pp. 32 ff. • Concerning the history of this concept, cf. Hayek, " A Note on the Development of the doctrine of 'Forced Saving,'" Quarterly Journal of Economics (U. S. A.), Nov., 1932.

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but "old iron," 7 and turn out to be such as soon as the process of cumulative forced saving is stopped; at that moment, they argue, a depression is bound to set in and the economic function of depression is to eliminate these cinders of boomish over-enthusiasm and to get back to a structure of production, or an intensity of capitalization, which the volume of current voluntary saving can support. This, or a similar opinion, seems to be held by members of the Swedish and Austrian school of economists and by some German authors, all of whom base their arguments primarily upon the theories of Böhm-Bawerk and of his pupil, Knut Wicksell, 8 whose contributions have had so marked an influence on contemporary thought. So we have two violently opposed ideas: one is that development is entirely due to the investment of voluntary savings, and that attempts to accelerate the process through forced saving are bound to lead to cyclical movements in which depression will undo what the boom appeared to have achieved. The other is that the process of accumulation through voluntary saving is too slow to be relied upon; development is due to forced saving; such development will lead to booms and depressions, but the depression, far from undoing the achievements of the period of expansion, will merely 7 T h i s expression in Erich Schiff, " K a p i t a l b i l d u n g und Kapitalaufzehrung im K o n j u n k t u r v e r l a u f , " Beiträge zur Konjunkturforschung, No. 4 (Wien, 1933), C h a p . II, See. 7. 8 W e cannot give a complete list of the works of the authors we have in mind. W e should like particularly to mention Böhm-Bawerk's Positive Theorie des Kapitales, the first volume of which is available in an English translation; and K n u t Wicksell's Geldzins und Güterpreise (1898), an English translation of which is now being prepared in Cambridge, England. Also L. v. Mins, Theorie des Geldes und der Umlaufsmittel, 191»; Hayek, The Paradox of Saving Economics, 1931. T h e outstanding modern exponent of this school is Friedrich Hayek (Geldtheorie und Konjunkturtheorie, Vienna, 1929, also translated into English as Monetary Theory and the Trade Cycle; Prices and Production (London, 1931). Articles: "Das intertemporale Gleichgewichtssystem der Preise und die Bewegungen des Geldwertes," and " K a p i t a l a u f z e h r u n g , " in Weltwirtschaftliches Archiv, Bd. 28, July, 1928, and July, 193s, respectively). T h e r e are also Erich Schiff (op. cit.), Richard Strigl, with two articles: " D i e Produktion unter dem Einflüsse einer Kreditexpansion," in Schriften des Vereins für Sozialpolitik B a n d 173, T e i l 2, 1928; and " L o h n f o n d s u n d Geldkapital," in Zeitschrift für Nationalökonomie, Wien, Bd. V, H e f t 1 (1934), pp. 18-41. Also Adolf Lampe: Zur Theorie des Sparprozesses und der Kreditschöpfung, Jena, 1926; Akerman in his extremely interesting book, Realkapital und Kapitalzins. Also Machlup, Haberler, Halm, Robbins and others; in Sweden, G . Myrdal, "Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse," in Beiträge zur Geldtheorie, ed. by Hayek, 1933; and Erik L i n d a h l . In Holland J. G . Koopmans, " Z u m Problem des neutralen Geldes," in Beiträge zur Geldtheorie, ed. by H a y e k , 1933.

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overcome the friction (Reibungswiderstànde) that any rapid development is bound to cause.9 T h e two theories are not, as such, incompatible, as indeed Schumpeter does not deny the possibility of capital accumulation through voluntary savings. In all these problems—static and dynamic—we are constantly confronted with technological questions (which we can take into account only in the form of "assumptions"), namely, questions that are indicated and circumscribed by the concepts of "specific" and "nonspecific" goods.10 A dynamic theory cannot "assume away" frictions, because they are its very content. A static theory can do so, and must do so. T h e difference between specific and nonspecific goods gains in importance with the degree to which a theory becomes more dynamic. T h e main assertion of the voluntary-saving school, which constitutes the point of incompatibility, is that there cannot be any secular accumulations of capital through forced savings. Depression inevitably liquidates the capital so created during a boom. For our analysis we have to turn to the theory of Bohm-Bawerk, which forms the basis upon which all other theories have been built. There are two points in this theory to which we shall pay particular attention: one concerns the concept of the "subsistence fund," and the other concerns the place of durable goods, particularly machinery, in Bôhm-Bawerk's theory. T h e central feature of Bôhm-Bawerk's monumental treatise Kapital und Kapitalzins, which "is in fact not only a complete theory of distribution but also a theory of the whole economic process," 11 is the treatment of the element of time. T h e passing of time in itself is an important factor in economic life. Certain technological facts in our processes of production make it possible to increase the pro» As adherents of this school, we name above all Joseph Schumpeter in his Theorie der wirtschaftlichen Entwicklung, 2d ed., Miinchen, 1926; Léon Walras. Etudes d'économie politique appliquée, 1898, pp. 348-56; also Keynes (Treatise on Money, and a pamphlet: The Means to Prosperity, 1933); Robertson, perhaps, in his Banking Policy and the Price Level, London, 1926; also Erich Egner, "Zur Lehre vom Zwangssparen," in Zeitschrift fiir die gesamte Staatswissenschaft, Band 84 (1928), pp. 529-60; Albert Hahn, Volkswirtschaftliche Theorie des Bankkredites, 2d ed., 1926; W. G. L. Taylor, The Credit System; and many others, including Eucken and Ohlin. Cf. Hayek, Prices and Production, p. 67. Hayek ascribes the term to von Wieser, Social Economics, translated by A. F. Hinrichs (New York, 1927), Book I, Chap. X V . 11 Cf. Schumpeter, in the Encyclopedia of the Social Sciences, article on "Bohm-Bawerk."

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ductivity of a given outlay of original factors of production by making the process of production more lengthy—more "roundabout." This fact alone—Bohm-Bawerk gives two additional "reasons"— causes immediately available goods to be valued higher than goods which will become available only at a more or less distant future time. The difference between the valuation of immediate consumption goods and future goods is determined by the marginal productivity of the roundabout processes of production. 12 This is shown in the following way: Any producer who realizes that by making his processes more roundabout—or, which is the same thing, by increasing the capital intensity of production—he can increase the productivity of his plant, will wish to do so. He will compare the interest he has to pay for capital with the increase in productivity that he may expect. Since the supply of capital is limited, whereas the scope of capital employment is unlimited, not all producers will be able to obtain what they want. The principle of selection is the familiar one which is explained by the marginal utility theory: The marginal producer, who is at the margin of doubt whether or not his anticipated gain will exceed the cost of borrowing, will be the "last" to find accommodation. Bohm-Bawerk has evolved the concept of the subsistence fund. The subsistence fund is made up of the total of all "intermediate products" (capital), plus the total of all consumption goods. Its function is to support the community during the time that elapses between the beginning of employment of original factors of production and the ultimate output of consumable products (i.e., the average period of production). We now come to a confusing point in Bohm-Bawerk's argument. Writing about the market for the means of subsistence, he asks: "What is the price at which consumable present goods [genussreife Gegenwartsgiiter] are exchanged against future goods [Zukunftsgiiier] on this market?" His answer is that this will depend upon the volume and intensity of supply and demand. "The volume of supply [of what? obviously: of present goods] is represented by the total of wealth—excluding land—that has been accumulated in the economy." 13 This "total of wealth," the subsistence fund, includes 12

Cf. Bohm-Bawerk, Positive Theorie, 4th ed., p. 456. is There are two more small items which have to be excluded: the wealth which is needed by its owners, who are either "living on their capital," or producing on own account goods which never reach the market. Positive Theorie, pp. 401 ff.

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all capital and all consumption goods. It is to form the "supply" on a market, "where consumable present goods are exchanged for future goods." How can the largest part of the subsistence f u n d , which is made up of "intermediate products," i.e., capital, be a part of the supply of consumption goods? Bohm-Bawerk is really talking about two different "funds," one large subsistence fund, which so to say bears on the future ( " s t a f f e l weise") and combines capital and consumption goods; and one small subsistence fund, which is effective in the present and contains ready consumption goods and nothing else. When Bohm-Bawerk talks about the subsistence f u n d as determining the length of the period of production, however, it is the larger variety of the two which he has in mind. What does his theory state there? In a static, synchronized system of production, there is a constant, even flow of goods through the different stages of production; intermediate products regularly turn out finished articles after the passing of a certain period of time, and after the employment on them of some further original factors of production. There is in principle no difficulty in deciding which of two such systems has the greater amount of capital, and there is no difficulty in demonstrating that, normally, the one with the larger capital equipment will enjoy greater productivity. In static theory, all these comparisons can be made, as Bohm-Bawerk has shown, through the medium of numerical examples, by expressing capital in terms of a certain amount of money. But are we not confronted with a much more complicated problem in dynamic theory? First of all, the "average length of the period of production" and the "amount of capital per head of the working population" are synonymous terms in static theory, as Bohm-Bawerk has shown at great length. 14 But at the moment that the system is thrown out of equilibrium, through the investment, for instance, of a relatively too large amount in the highest stages of production, then the "amount of capital per head of the working population" is the same as it would be if these funds had been invested in the lower stages where they belong—yet the "length of the period of production" is increased. Professor Hayek says that "any change in the amount of capital per head of working population is equivalent to a change in the average length of the round1« Positive Theorie, Band II, Excurs V, pp. 93-iao.

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about process of production." 15 T h i s statement is true, surely, if we have in mind two different points of equilibrium, or if we compare two systems, both of which are in equilibrium—but it is certainly not true of the period of change. On the contrary, we could say that all problems of dynamic theory arise at the moment when a change in the amount of capital per head is not accompanied by a change in the period of production, or vice versa, because that means that the different stages of production have been thrown out of their mutual balance. Our second point of difficulty is closely related to the first: what is the size of the subsistence fund? How can we add up machines, raw materials, half-finished articles? T h e only common denominator which would allow us to arrive at a total would be their value. T h e value of intermediate products is determined by the anticipated value of the articles they produce. If the structure of production is unevenly developed, so that, for instance, certain intermediate products will never ripen into consumption goods, is not the value of this capital exactly the same as the value of a capital stock (in equilibrium) without those intermediate products, even though the physical size of the latter is naturally larger? Bohm-Bawerk has constantly refused to accept a "value concept of capital" 18 and, owing to the purely static character of his theory, his "physical concept" proved absolutely sufficient. In dynamic theory, this method of approach breaks down, because of the lack of a common denominator for capital goods, which would not, in the end, be a reflection of their value. And if we should try to measure or compare their value, we find ourselves unable to take into account any factors of disequilibrium. We must conclude that the concept of the "size of the subsistence fund" is a static concept of no value for dynamic analysis. But this is not all: even if we can conceive of the subsistence fund as having a certain size, and even if we accept for a moment the concept that the average length of the period of production and the amount of capital per head are synonymous expressions, that is to say, even in static analysis—what does it mean that the subsistence fund determines the length of the period of production? 16

Hayek: " T h e Pure Theory of Money" of J . M. Keynes, Part II, Feb., 1932, p. 4s. 18 Cf. his polemic against Fisher and Clark, Positive Theorie, Abschnitt 3; also Vol. II, Excurs V.

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T h e subsistence fund consists of capital, plus consumption goods; it is said to determine "the amount of capital per head." Naturally, when the subsistence fund increases through an increase of capital, the amount of capital—ceteris paribus—increases as well, though not mathematically in the same proportion. In the last analysis, this celebrated "law" of Bôhm-Bawerk's states nothing but that the stock of consumption goods, this being the "ultimate stage of production," must be in some relation to the other stages. We cannot help feeling that this is not a statement of very great importance. O u r conclusion is: (1) that the statement that the subsistence f u n d (defined as capital, plus consumption goods) determines the length of the period of production, is, though formally correct in static conditions, of no applicability in dynamic theory; and (2) that the statement that the subsistence f u n d (defined as a f u n d of consumption goods) determines the length of the period of production, has never been made by Bôhm-Bawerk, and is, for reasons which will be apparent from our discussion, incorrect. We now turn to the second point, to which we promised to pay special attention, namely, the place of durable goods in BôhmBawerk's theory. T h i s may throw some light upon the relation that exists between the stock of consumption goods (subsistence f u n d in its narrower sense) and the average length of the period of production. Bôhm-Bawerk conceives of all capital as "intermediate products," which sooner or later become ripe for consumption. In his system there is no distinction between durable and nondurable, or between fixed and circulating capital. Machinery passes into consumers' goods as it renders its services in furthering the production of consumption goods, or of other intermediate products. T h i s is an artificiality in Bôhm-Bawerk's theory, which makes his theoretical constructions to some extent clumsy and all-too-complicated. When we look, at any moment, at the different agents of production (land, labor, capital), we find them of all degrees of durability. Certain goods—like circulating capital—disappear in the productive process as fast as they have come; others—like land—are eternal. Most of the agents of production that man can provide will go under, sooner or later. Yet there are some, which, for all intents and purposes, can be considered of unlimited durability. Certain undertakings of man—and not so very few—will, once they have

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been carried out, be a factor of wealth for generations. T h e y will live on as ameliorations of land, as facilitation of traffic, as protection against flood, etc., without needing maintenance or amortization. T h e s e goods cannot be called "intermediate goods" any more than land itself; they must, for the purposes of theory, either be added to land, or be treated as a "third original factor of production," in addition to land and labor; and the income that flows from them is called "quasi-rent." T h e point which we wish to establish, however, does not depend on whether or not they may be considered "intermediate goods," 17 but is that there can be manmade capital goods which are just as independent as land of any "subsistence f u n d " and the like. Now, natura non facet saltum; there must be capital goods which are almost like land, that is, goods which need but a extremely small current rate of amortization, and we could say that there must be goods whose amortization quota is anything from zero to a percentage of more than 100, in cases where the life of the particular kind of goods is shorter than the period of comparison. If the durability of all production goods (capital) were infinitely greater than unity, in other words, unlimited, then capital would be on a par with land—its existence would involve no liability to the community, the cost of its maintenance would equal zero. In other words, once the creation of capital had been effected through saving and investment, the rate of saving and reinvestment could then decline to zero without prejudicing the maintenance of the capital structure. If the durability of all production goods were exactly equal to unity, then obviously a capital extension which was created through an increase in the rate of saving and investment, could be maintained only if the rate of saving and reinvestment was maintained at equal magnitude. O r in other words, maintenance of capital would involve a liability on the community exactly equal to the expenditure originally incurred for the production of capital. It is only in this case, it seems to us, that Professor Hayek's theory fully applies. Obviously both these cases are unreal: T h e r e are goods, as we have seen, of each description, and there is a continuous gradation 1 7 Concerning this question, cf. Bohm-Bawerk, Positive Theorie, I, 66; Knut Wicksell, Uber Wert, ¡Capital und Rente, p. 79 f.; and Hayek, Prices and Production, p. 37, n. g.

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of goods of every degree of durability, filling the space between the two extremes which we have mentioned. T h e point is this, that the community benefits from "stored-up" labor which it inherits in the form of durable capital. It draws some kind of quasi rent. 18 W h a t conclusions can we draw from all this? (1) Capital whose durability is equal to unity, represents a continuous charge on the subsistence fund (defined as a fund of consumption goods)—provided that the community is interested in the maintenance of its capital— which is equal to the charge made during the time of its original production; (2) to the extent that the durability of capital is greater than unity, the strain on the subsistence fund will be relaxed, as soon as the production of the particular instrument is completed. 1 9 A n exactly parallel set of circumstances applies to consumption goods. If I increase my rate of earnings for a short time in order to acquire a certain kind of consumption goods that will serve me a lifetime, I shall, once I have bought it, have permanently improved my standard of life, even though I allow my earnings to fall back to their previous level. O n the other hand, if I increase my earnings in order to increase my consumption of food (nondurable goods), my standard of life will decline as soon as my earnings—ceteris paribus— decline again. W e have now laid the foundation for an answer to the crucial question of whether secular accumulation of capital through forced saving is possible. T h e r e is no fixed relation between the rate of saving, i.e., the subsistence fund, and the length of the period of production, because, as w e can generally observe, the overwhelming majority of capital goods has a durability considerably greater than unity. In the long run, to be sure, the structure of production is T h e reader who has followed our arguments thus far will not misunderstand the use of the term quasi rent in this context. Particularly he will realize that this quasi rent exists, no matter whether the lengthening of the roundabout process of production in Bohm-Bawerk's sense does result in increased productivity or not. A n d he will not impute to us a "productivity theory of interest" which has so justly been buried. T h i s discussion is not concerned with a theory of the rate of interest. Cf. Marshall, Principles, 8th ed., pp. 74, 412, 420-26. 18 Messrs. Hansen and T o u t ("Annual Survey of Business Cycle T h e o r y : Investment and Saving in Business Cycle T h e o r y , " in Econometrica, April, 1933, pp. 119-47) raise a similar objection to Professor Hayek's theories, p. 135: "Suppose new investment fell to zero but that existing capital was being fully replaced, then the process of production, being neither shortened nor lengthened, would just be maintained. It follows that there could be a violent fall in the rate of investment before any shrinkage in the structure of production occurred."

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cannot be maintained without amortization of capital; and the total of all amortization quotas—which have to come out of the subsistence fund—naturally grows with the growth of capital. Yet the quantitative relationship between those two items is so remote, and the elasticity of the amortization quotas in a large modern corporation is so great, as to justify the statement that in the short run and for all purposes of our analysis those two factors may be considered as mutually independent. If we consider the relative rate of saving—relative to the total amount of income—rather than the absolute rate which we have been considering up to now, we find that in all probability it is unnecessary for the relative rate to rise with increasing capitalization, even in the long run. T h e increased productivity of the "lengthier" process of production, from which the industrialist benefits, can be expected to increase his total income faster than the additional amortization quota increases the volume of saving which he must reinvest. T h e rate of saving necessary for the production of capital being generally greater than the rate of saving necessary for replacement, there is no reason why the difference between the two should not be made u p by forced saving. So that every time the rate of voluntary saving increases, the capital stock of the country could be increased by forced saving to such an extent that the increment of voluntary saving is just absorbed by the increment in amortization. Instead of saying that an even rate of saving is the ideal thing, we would maintain that, in order to take care of modern requirements, the rate of (voluntary plus forced) saving has to be uneven and "jerky"—if only for the reason that some capital investments have to be made in such tremendously big units, or not at all, as to require extremely great sudden outlays. 20 A n o t h e r reason is given by Robertson: 21 " T h e application over a wide field of territory or of industry of any invention, such as the railway, electric power, or the Diesel engine, will raise for a more or less prolonged period the intensity of the desire for the constructional implements and materials involved, only to lower it again when the field in question has reached a condition of temporary saturation." T h e construction of large amounts of capital destroyed in wars or natural disasters cannot possibly take place except through the medium of 2 0 T h i s is, by the way, a typically dynamic problem. T h e infinitesimal method is not applicable. Robertson, D. H., Banking Policy and the Price Level (London, 1926), p. 11.

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forced saving, and the fact that these capital goods can be fitted into the productive system can hardly be denied. So far our argument has been carried on under the acceptance of one of Bóhm-Bawerk's fundamental theses, namely, that in conditions of equilibrium, every additional investment of capital means a lengthening of the structure of production. T h a t this thesis does not apply to conditions of disequilibrium, we have already shown. We have now to add one further point to our argument, concerning the introduction of inventions which "shorten" the average length of the period of production. There is, as Bóhm-Bawerk has shown, an increasing tendency for inventions to shorten rather than further to extend the roundabout process, as the average length of the process of production increases. 22 Such "shortening" inventions, it is held, will never accumulate in an economy; their appearance will always immediately be followed by their full utilization. T h e r e may be some friction to be overcome, but that greatest obstacle to innovations, capital shortage, will not exist. 23 This view, being an indisputable corollary to the thesis, reiterated by Professor Hayek, that "any change in the amount of capital per head of working population is equivalent to a change in the average length of the roundabout process of production," is based upon certain assumptions, not clearly brought out by Bóhm-Bawerk or Professor Hayek, which we shall try to make clear here. Our contention, to state it briefly, is that there is at all times of technical development a strong demand for capital in order to put through inventions which shorten the period of production; so that once capital has been provided for such purposes, the burden on the subsistence fund will be smaller than it was under the old method. In the case of unspecific goods, which can be used in the new processes as well as in the old, no problem exists. When a way is found to achieve the same result with a smaller outlay of "intermediate goods," the entrepreneur will not hesitate to eliminate the capital that he does not need, and devote it to other purposes. T h e demand for new capital may well originate from methods that shorten the process of production. Summing up, we find that forced saving will facilitate the secular accumulation of capital which has one or more of the following characteristics: (1) high durability; (2) an unspecific nature; (3) for inventions that shorten 22 Bóhm-Bawerk, Positive Theorie, Vol. II, Excurs II. 28 Bóhm-Bawerk, Positive Theorie, II, 8.

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the process of production; (4) for inventions that lengthen the process of production, if the increase in productivity is such that the subsistence f u n d is augmented simultaneously with the demand for means of subsistence arising from the amortization quota. T o the extent that one or more of these conditions is fulfilled, the fact that the capital has been accumulated through the medium of forced saving will not make impossible the fitting of it into the economic system. T o the extent that these conditions are not fulfilled, capital will lose sometimes all, sometimes only part of its value, which may, in the course of time, result in its physical deterioration. Inflation in the form of producers' credits, i.e., forced saving, is a very powerful agent for the accumulation of capital, and that means for the development of an economy. Actually, there is no difficulty, or impossibility—as Professor Hayek wants us to believe that there is—in maintaining the capital structure after a "forced" expansion has taken place. In practice, there are bound to be misdirections which may lead to a general crisis. W e now come to a short sketch of our last problem: the problem of cyclical movements. W e consider monetary d i s e q u i l i b r i u m forced saving—the main cause of the business cycle. A policy of neutral money (which so far has not been sufficiently formulated to be a practical possibility) would do away with these regular fluctuations of business activity; it would, of course, not avert all crises, which may result from wars, mistaken public policies, human errors, and other external disturbances. But this policy would, at the same time, sacrifice all development that is due to forced saving. It remains to be seen if the cure would not be worse than the disease. " P u r e demand" for producers' goods raises the price of producers' goods relatively to the price of consumers' goods. O w i n g to the peculiar working of the rate of interest, the price of producers' goods in the higher stages of production rises relatively to the price of producers' goods in the lower stages. Once the entrepreneurs have invested their borrowed funds by paying them out to workmen (and owners of land) whom they employ in the higher stages of production, these funds are disbursed by their recipients in the market for means of subsistence, in return for immediate consumption goods. T h e price of consumption goods then rises until the relation between the price of consumption goods and production

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goods is about what it was before the beginning of the process. ( T h e general price level, of course, has risen.) T h e process could end here, if the rise in the price of consumption goods had not increased the value of producers' goods, thereby stimulating new borrowing on the part of entrepreneurs. T h e activity in the higher stages of production will be further increased; and it is sustained by the relative price advantage of those goods over the goods in the lower stages, i.e., particularly consumption goods. New borrowings on the part of entrepreneurs maintain this price advantage; it is maintained as long as the borrowing keeps on. At the same time, the greater activity in the higher stages necessitates the withdrawal of more and more factors of production from the lower stages. Now, unless the new capital is rapidly put to work and unless its productivity is such as to prevent a sharp rise in the cost of living, there will appear an acute shortage of consumption goods. We do not think it must necessarily appear—as the theorists whom we are quoting maintain; if the new processes are rapidly completed and if their productivity is such as to increase the subsistence f u n d sufficiently, we believe that a crisis could be averted by slowing down the rate of expansion and providing capital only for the completion, not for the inauguration, of new investments. But when credit is plentiful and cheap, this credit will be used for the financing of all sorts of new processes, losses of the kind described above will be huge, and at one time or another a shortage of consumption goods will make it impossible for entrepreneurs, even with the help of an ever-increasing rate of forced saving, to keep the factors of production employed in the higher stages. At this point the crisis sets in.2* When the stream of additional funds ceases flowing into the higher stages of production, the goods in these stages lose their relative price advantage over the goods in the lower stages. T h e demand for investment goods declines, and the machinery for the production of investment goods lose in value. T h e disproportionate development in the structure of production, which had not been apparent owing to the steady existence of pure demand for investment goods, now becomes the all-important factor. Yet there is another phenomenon, secondary in its causal connection, but of ever24 W e do not attempt to define precisely the moment or the immediate cause of the outbreak of the crisis. A n interesting attempt in that direction has been made by Viktor Bloch, " D i e zeitliche Determinierung des K o n j u n k t u r b r u c h e s , " Zeilschrift für Nationalökonomie (Wien, 1934), B a n d V, Heft 2, pp. 197-215.

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increasing importance as the crisis develops, namely, deflation. Owing to the peculiar structure of our credit system, contraction is the almost inevitable corollary to expansion. This is due to what Professor Schumpeter has called the "self-deflating" power of credit. 25 Not only does the stream of forced savings cease to flow; the whole system is suddenly reversed and there follows a similar movement of "forced splashing," 26 which turns the price advantage of the higher stages of production into a price disadvantage, as compared with consumption goods. A condition of pure demand is converted into a condition of pure supply. T h e greater the credit expansion, the more violent is the subsequent deflation bound to be. At the moment the crisis sets in, we are faced with a highly complicated disequilibrium. T h e initial disequilibrium of the monetary factor, forced saving, has not found its own corrective, but has led to a general disequilibrium of the whole economy. We are now faced again with monetary disequilibrium: deflation. But there is, at the same time (1) a large body of capital that was fully profitable only as long as the products of the higher stages of production enjoyed a relative price advantage over the products of the lower stages; (2) a number of businesses that have become obsolete during the period of expansion, but have managed to survive for a time owing to their large reserves, solid foundation, etc.; (3) a smaller number of capital undertakings which have not been completed and cannot be completed because the rise in the rate of interest (which we have seen to be the "trigger" of the crisis) makes them unprofitable. T h e function of depression must be to eliminate, or to restore the profitability, of businesses falling under groups (2) and (3), and to purge those of group (1) of those investments whose quasi rent is too small to enable them to weather the fall in their value. In all cases enumerated heretofore—high durability, unspecific nature of the instrument, the shortening of processes, the lengthening of processes of highly increased productivity—the buffer of the quasi rent will be strong enough to withstand the fall in profitability. Whether or not the inevitable capital losses can be taken by the persons who happen to own the capital, is a question of the financial structure of the firm in question. T h e r e may have to be changes in owner28 Schumpeter, "Das Kapital im wirtschaftlichen Kreislauf und in der wirtschaftlichen Entwicklung," in Kapital und Kapitalismus, ed. by Harms (Berlin, '93'). PP2« Cf. Robertson, Banking Policy and the Price Level.

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ship, reorganizations, etc.; often it will be necessary to scale down the rate of interest; but only seldom will reduced rentability lead to a physical deterioration of the capital. Can deflation be counteracted or stopped without creating new maladjustments? A part of the phenomenon is of noneconomic character—namely, hoarding by individuals—and must be combated as much as possible by measures outside the realm of economics. Hoarding, or extinction of credit on the part of banks, however, is a factor which we have seen to be inherent in our credit system. Monetary equilibrium in such cases can be maintained only by the "creating" and the spending of money by the government. Actions of the central bank are of no avail, because it is the duty of the banker to liquidate loans that have become bad risks. T h e motive of his action is not the wish to improve his reserve ratios, but to maintain his solvency. T h e mere provision of excess reserves does not free him from the obligation to avoid capital losses in the form of bad loans. Since not all factors of production are employed, and since prolonged unemployment has now increased the mobility of labor and possibly its willingness to accept lower wages, we should expect a stimulation of demand for capital goods to increase production and prices in the higher stages without at the same time reducing activity in the lower stages, i.e., particularly in the consumption goods industries. T h e price of the factors of production, consequently, would not have to rise, as they would if all factors of production were already normally employed. But their income will increase nevertheless, because their number has increased. T h e i r demand for consumption goods, therefore, will also increase. T h e consumption goods industries will be able to meet this demand by taking on more men, whom, for a certain time, they will also be able to hire without having to offer higher wages. Yet it is obvious that when the higher stages of production, as well as the lower stages, draw on the "industrial reserve army" and increase the demand for consumption goods of their workmen, the prices of consumption goods are likely to rise faster than the price of the output of the higher stages of production. So the cost of the factors of production which the higher stages employ, is bound to rise sooner or later. W e see again that inflation is a potent factor for stimulating the entire system of production. But it does so only so long as it is

I N F L A T I O N AND P R O D U C T I O N

415

going on. Once it is stopped, we may be left with maladjustments greater than those that induced us to try that course. Yet we see that the situation is different from the one we have discussed when we started from a position of equilibrium: the cumulative effect sets in only when the prices of the factors of production are allowed to rise. Unless that happens, inflation will bring temporary relief only, and will neither further distort the price structure nor adjust it. It is easily seen that inflation for the purpose of stimulating consumption can result only in complete deterioration of capital. T h e price level of consumption goods will rise even further, relative to the price level of producers' goods. So the liquidation of the higher stages of production will proceed hurriedly. From our analysis, it seems that there is no fundamental objection to a policy of mild inflation in the form of producers' credits, if the money so created is employed in certain ways, of which we enumerate the most important only: (1) if "shortening" inventions are utilized. This is the most potent factor. A number of severe depressions in the past were stopped by the appearance of one great shortening invention of the widest economic importance, exercising a demand for huge sums of capital which were supplied by forced saving; (2) if capital of high durability is created (durability as defined above); (3) if capital is supplied for the completion of investments which had been interrupted by the outbreak of the crisis. In all cases it seems advisable that the government should take care that the funds are used for putting through a few projects with utmost speed and energy, rather than that they are spread over a great number of projects which, for some time to come, constitute a considerable burden on the funds of the community. It must be emphasized again that this discussion is not intended as an advocacy of a policy of inflation today. Its only purpose is to work out some theoretical possibilities in an extremely complicated situation, and to throw some light upon a few highly important problems which are generally attacked rather with moral and political, than with economic, arguments. T h e author is fully aware that he has not given a solution for the problem of inflation, even in its strictly economic implications. He has intentionally neglected a great number of noneconomic factors (psychological, political, legislative, etc.) which would, of course, deserve the closest

416

I N F L A T I O N AND

PRODUCTION

attention before any conclusions of pure theory could be utilized for practical life. A great deal of further theoretical work has to be done before we can claim to understand the effects of inflationmore particularly its effects when introduced into the situation of general disequilibrium of a depression period.

11 P R I C E BY

ERIK

T . THE

R E F L A T I O N H.

KJELLSTROM

CONCEPT

DURING recent years the leaders in the political and economic life of the world have apparently been divided into two schools of thought regarding the means by which economic recovery should be achieved. T h i s divergence of opinions was clearly evident during the discussions in Geneva, when the Preparatory Commission of Experts met to draft an annotated agenda for the World Monetary and Economic Conference in London. Calling "attention to the gravity of the situation with which the world is confronted," 1 this group of experts "reflected two distinct views" on the "difficult problem of commodity prices, in its relation to monetary restoration and economic recovery in general." 2 O n e view held that a substantial rise in commodity prices is an indispensable preliminary and conditioning factor in economic recovery and that it must occur before the world's currencies can be re-established on an internationally stable basis. T h e other was that rising prices are an indication of, rather than a preliminary to, economic recovery, and that neither can be brought about without foreign exchange stability. 8 T h e nongold-standard countries, under the leadership of Great Britain, urged that "price recovery must precede economic recovery," while the gold-standard countries, headed by France, insisted that the way to speedy and secure recovery could not be found without first having attained stable conditions in the foreign exchange markets. T h e nongold-standard countries consequently advocated a policy of reflation as a preferable course of action, pointing out that the only possible alternative to a rise in commodity prices would be a further reduction of costs, mainly through a scaling down of wages, salaries, and debt charges. T h e y felt that while by this Draft Annotated Agenda, Part I, p. l. Pasvolsky, Leo, Current Monetary Issues, T h e Brookings Institution, Washington, 1933, p. 26. »Ibid., p. »6. 1

2

418

PRICE

REFLATION

method the world might, conceivably, in time work itself out of the present depression, the adoption of this course of action would mean, for the time being, a further intensification of the depression, with all its attendant dislocation and suffering. 1 T h e Lausanne Conference had previously "laid special emphasis on the necessity of restoring currencies to a healthy basis," adding that "in this connection, the restoration of a satisfactory international monetary standard is clearly of primary importance." Although many nations, which had been forced to abandon the gold standard, adhered to this view in principle, they nevertheless ventured upon monetary programs calculated to bring about a reflation of their price structures. As n o world-wide cooperation was conceivable under existing economic and political conditions, such priceraising programs had to be undertaken independently by each nation. T h e underlying objective of these programs was to stimulate domestic production by achieving a better balance between commodity prices on one hand, and costs as well as debt charges on the other. O n e chose, therefore, a road which, in the terminology of Professor Irving Fisher, is called reinflation of the price level. T h e basis for this action is clearly illustrated by the Draft Annotated Agenda of the Preparatory Commission of Experts meeting in Geneva: T h e decline in prices of recent years has created a series of difficulties [it pointed out], which must, by one method or another, be overcome in order to make progress in the monetary and economic field possible. In the first place, the burden of debts has increased considerably in terms of real wealth and made it more and more difficult for debtors to discharge their obligations and avoid a breach of contract. W i t h regard to international debts, a special transfer problem arises, with possible dangerous repercussions on the whole monetary structure. Secondly, as a rule, costs fall more slowly than prices, which tends to make enterprises unremunerative, with consequent disorganization and reduction of production as evidenced by an increase of unemployment. Even if unemployment benefits are granted, the reduction in earnings will, in its turn, diminish the purchasing power in the hands of the public. Moreover, a restriction of sales will make further sound extension—or even the upkeep—of industrial plant seem unnecessary and arrest activity with regard to new investments, causing not only particularly serious unemployment for workers engaged in producing capital goods, but also a tendency for savings to remain idle. * Pasvolsky, Leo, Current

Monetary

Issues, p. 26.

PRICE

REFLATION

419

T h i r d l y , the decline in prices has not proceeded at the same pace for all classes of commodities. Manufactured articles tend, for many reasons, to fall more slowly in price than natural products, and it is a well-known fact that retail prices are more resistant than wholesale. A special feature of the present depression is the tendency revealed in a number of countries for prices of certain classes of goods required for capital equipment to resist a fall, such as would have facilitated readjustments. T h i s tendency has retarded recovery and has rendered new capital enterprise unattractive, however low short- and long-term rates of interest may be. In some cases, the cause of this relative rigidity in the prices of investment goods w o u l d seem to be that they have, on the whole, been more controlled by cartels and other monopolistic combines than other goods. 5 A l t h o u g h differences of opinion as to the accuracy of this analysis may have arisen in some countries, it nevertheless served as a general background for the policies of reinflation, or reflation, that are being pursued in several countries. T h e s e countries have chosen to restore "a lost equilibrium between costs and prices" 6 by attempting to raise prices, rather than by a forced reduction of costs. A third way of restoring equilibrium would have been, of course, to limit the supply of goods and commodities. T h e British economist, John Maynard Keynes, voices objection to this policy, because it may well benefit the producers of a particular article to combine to restrict its output. Equally it may benefit a particular country, though at the expense of the rest of the world, to restrict the supply of a commodity which it is in a position to control. It may even, very occasionally, benefit the world as a whole to organize the restriction of output of a particular commodity, the supply of which is seriously out of balance with the supply of other things. B u t as an all-round remedy restriction is worse than useless. For the community as a whole it reduces demand by destroying the income of the retrenched producers, just as much as it reduces supply. 7 By a process of elimination, many countries have thus chosen to restore a lost equilibrium between costs and prices by attempting to reinflate prices by monetary and fiscal means. T h e definite objective of such a monetary policy is, according to Professor Irving Fisher, to "reflate to the normal; that is, restore the price level to a normal range of business solvency." 8 According ' The Program for the World Economic Conference, pp. 43, 44. 8 Draft Annotated Agenda, Part II, s, 2a. 1 Keynes, J. M., The Means to Prosperity, p. 19. 8 InflationT, Fisher, Irving, Adelphi Co., New York, 1933, p. 86.

420

PRICE

REFLATION

to the same e x p o n e n t of the reflationist school of thought, "a normal price level is a price level at which the two ends of every existing time contract (loan, wage, salary) have been measured by an unchanged monetary unit." T h i s implies, Professor Fisher continues, "that, once a price level becomes abnormal, it cannot become entirely normal until it has been put on one chosen level and kept there long enough to let all the time contracts originating on other levels, expire, leaving extant only such time contracts as have been made on the chosen level." 9 It should be emphasized here that in the Draft Annotated Agenda to the W o r l d Economic Conference, the term "prices" rather than "price level" was used. T h e difference of opinion arising out of this variation in terminology is brought out by Dr. Pasvolsky, in his criticism of the gold-purchase program of the United States government d u r i n g the autumn of 1933. H e says: " T h e price level is merely a composite of the prices of individual commodities and groups of commodities." 10 W e shall see the significance of this variation of concept later, when the means for reflation are discussed. In the concept of reflating to normal, as well as in the policy of "restoring a lost equilibrium between prices and costs," a definite limit is set for the rise in prices. Such a limitation for an upswing in prices is an inherent and essential feature in the concept of reflation. T h e difference between inflation on one hand, and reflation on the other, consists then in the fact that inflation knows n o predetermined limits, while reflation clearly recognizes a predefined border line for the price advance. T h i s is more or less self-evident, because a restoration of a lost equilibrium could not be aimed at unless one had a definite understanding of what such an equilibrium implied. T h i s analysis gives rise to several fundamental questions. First of all: what is an equilibrium between prices and costs? T o this Professor Fisher has given an answer when he says "a normal range of business solvency." Over an exceedingly long span of time, such a normal range may actually exist. O v e r shorter spans of time, as d u r i n g the periodic, rhythmic fluctuations of business, such a normal range cannot and does not exist. However, it seems evident that the concept of normalcy is invariably tied to the conInflation, Fisher, Irving, A d e l p h i Co., New York, 1933, pp. 73, 74. 10 Current Monetary Issues, p. 119 (italics mine).

9

PRICE

REFLATION

421

cept of equilibrium; this in turn gives rise to another question: is the equilibrium concept as a logical apparatus sufficiently adequate to supply a working hypothesis for an understanding of all the various short-, as well as long-term, phenomena of economic rhythm? T o this, the reply is that, it is not thus adequate, because the equilibrium concept can be used only with a reasonable degree of accuracy in two phases of economic progress, the instantaneous and the secular. In all other phenomena arising out of, and simultaneous with, the seasonal, the short- and the long-term cyclical changes, the equilibrium concept is an adequate tool. It is essentially a static concept, and insufficient as a means to explain or portray the rhythmical progress of modern, dynamic economic life. It eliminates the element of time, and thus limits the approach to a study of timeless exchange, with no adequate reference to the formation of new means of production, i.e., new capital. 1 1 T h e concept of equilibrium does assume, however, "complete mobility, but —in order to preserve equilibrium—no motion." 12 Assuming the reasonableness of this criticism, it would seem illogical in theory and unrealistic in practice to attempt to restore a definite and predetermined equilibrium between prices and costs. It would be idle to assume that the elements of cost had undergone no change during the period of so-called "lost equilibrium." A l t h o u g h cost factors may be more slow-moving than commodity prices, changes are constantly taking place, partly independently of price movements and partly because of such price movements. T h i s is, perhaps, the most fundamental difficulty encountered by a program of reflating prices to a predetermined level, as a means to restore lost equilibrium between prices and costs. Another and also important difficulty arises out of the very concept of a price level. It is, to be sure, a composite of prices of individual commodities and groups of commodities, and under certain conditions it is also an average of prices, commonly expressed in an index of prices. T h e component parts of such an index of prices may, however, diverge substantially one from the other, under the influence of monetary measures. 13 T h e very construction of an index of 1 1 See A k e r m a n , Johan, Ekonomiskt Framatskridande och Ekonomisk pp. 3» et seq., in w h i c h Walras's equations are discussed. 1 2 Ibid., p. 36 (italics mine). is For an illustrative picture of the spreading of individual prices, see Monetary Issues, p. 123.

Kriser,

Current

422

PRICE

REFLATION

prices lends a certain predetermination to the reaction of certain groups of prices to a given set of monetary measures. T h i s would, of course, make it possible to direct the movements of certain groups of prices and thus make it possible to restore a "lost equilibr i u m " between costs and prices, were it not for the fact that during the process of price restoration the interrelation between costs and prices is constantly changing under the influence of other than merely monetary factors. T h i s makes it nearly impossible to achieve the desired result—the predetermined equilibrium between costs and commodity prices, merely (assuming the feasibility of it) by directing the movements of certain groups of prices. From the above it would seem certain that a mere reflation of an index of prices is wholly inadequate and that a much more farreaching inroad upon the process of pricing must be made through such institutional factors as exercise a direct or indirect influence upon the process. Yet in the present system of dynamic economic life, even a very far-reaching control of all such factors as influence costs and prices may not afford a means of maintaining an equilibrium between costs and prices. It may be possible in theory, but surely it is not possible in practice, because the elements of time and change make prognostication of changes in kind and degree of equilibrium highly problematical. It should be added, however, that the very fact that certain and far-reaching factors of control are then in operation makes such prognostication somewhat simpler than would otherwise be the case. Although the formulation of a definite program of restoration of a lost equilibrium between prices and costs encounters some rather serious logical difficulties, it cannot be overlooked that in the practical application of such a program, the matter of degree, rather than that of kind, becomes the directing factor. T h e practical objective of restoring a lost equilibrium by raising commodity prices to a predetermined level can, therefore, mean only that one intends by such a policy to obtain a somewhat better balance between costs and commodity prices than that prevailing at the time of the inauguration of the policy. In the following pages the kind and efficacy of monetary measures, as a means to halt a decline and to bring about a rise of prices to a predetermined level, is to be considered.

PRICE

REFLATION

THE

423

MEANS

It has been widely assumed by economic writers that any monetary program, be it undertaken by a central banking institution or a government, calculated first to halt a decline and later to bring about a rise in prices to a predetermined level, must necessarily be a policy of expansion of the means of exchange. 11 T h e policy of expansion, according to the usual conception, is then undertaken after an equilibrium between prices and costs has been "lost." T h e general economic situation prevailing at the inauguration of the program of price reflation, as assumed by members of this school, may well be described as follows: after a boom period, followed by a crisis, a sharp decline of prices has occurred (the relative decline of separate price groups need not be discussed here); furthermore, there has occurred, it is assumed, a contraction of the volumes of production, employment and income. 15 T h e "psychology" of the business community has also suffered a change. T h e overoptimistic expectations which characterized the boom period have disappeared, and in their stead have entered uneasiness, timidity, and even pessimism, which all grow more and more marked as the process of deflation and contraction continues. As a general rule, it is under such circumstances that a policy of reinflation of prices is set in motion 18 and for the purpose of this discussion, the abovementioned conditions will be taken for granted as a point of departure in considering the various conventional monetary means of reflation and their respective efficacy. Fundamentally, the monetary means are ordinarily separated into two groups: ordinary and extraordinary. T h e ordinary group includes the means customarily at the disposal of a central banking institution, i.e., changes in the official bank rate, operations in the 1 4 The market-pricing process is, however, always influenced to a greater or lesser degree, dependent upon the social and economic structure of a nation, by social regulations. Indeed, these constitute a framework for the pricing process. Cf. Myrdal, Finanspolitikens Ekonomiska Verkningar. There will be no attempt made here, however, to analyze the part played by changes in the movable, and alterations in the immovable, institutional factors. T h e subject at hand is limited merely to the monetary factors in the generally accepted sense of that term. No attention is paid to re-deflation as opposed to re-inflation, both being "reflation." Cf. Irving Fisher. For a discussion of the broader aspects of reflation see Chaps. VII-VIII of this volume. i« See Myrdal, Ibid. is T h e question of a better timing of the starting point of a policy of price reflation will be taken up in the next section of this chapter.

424

PRICE

REFLATION

open market and, in some instances also, transactions in foreign exchange. T o the extraordinary g r o u p belong, on the other hand, such monetary manipulations as fall within the jurisdiction of a government rather than that of a central bank. In this latter group are hence included the issuing of fiat money, deliberate changes of the metal value of the currency unit, and extraordinary government expenditures. A s an expansion of currency and credit can be effective as a means to raise prices merely w h e n it occurs in conjunction with an increased effective demand for commodities, it becomes necessary to make a further subdivision of the monetary means. T h e y may thus be separated into such measures as under certain circumstances may induce increased money expenditure, and those that directly foster such expenditures. Broadly speaking, and for commodities as a whole, there is no possible way of achieving a rise in prices "except by increasing expenditure upon them more rapidly than their supply comes upon the market." 17 T h u s it becomes necessary for the authorities to attempt to induce an increased money expenditure, and also to cause a rise in prices by outright money expenditures, i.e., buying of commodities. T h e central banking authorities cannot compel the commercial banks to increase their total volume of loans; they have to limit their activities to such monetary policies as tend to facilitate loan expansion. For this purpose, they can make use of the ordinary monetary measures as a means to make bank credit cheaper, and the credit base wider. A lowering of the official bank rate tends, except under unusual circumstances, to lower the loan rate of interest, while operations in the open market and transactions in the foreign exchange m a r k e t 1 8 may be used to widen the credit base. Both of these measures encounter severe obstacles, however, because private enterprises will not seek to expand their borrowing until they are reasonably certain of profitable operations (a rise in the real rate of interest), while the banks are not in a position to grant loans until they also are reasonably certain that their credit risks are good. T h i s is a fundamental difficulty, for a policy of expansion, and it cannot be eradicated until con1 7 Keynes, The Means to Prosperity, p. 19. i s Notably in Sweden, where transactions in foreign exchange, because of a lack of open-market facilities, often serve as a substitute for such open-market operations as are customarily undertaken by the Federal Reserve system.

PRICE

REFLATION

425

fidence in the future of business (the trend of the real rate of interest) has returned. It matters little how low the loan rates of interest are, or how much the credit base has been widened, unless the process of deflation of the real rate of interest has first been halted. T h e ordinary measures, or those that tend merely to induce an increase of money expenditures upon commodities, thus fail to bring about a rise in prices as long as the above-mentioned process of deflation continues, although it may well happen that the loan rate of interest falls below the real rate of interest, which indeed should make it profitable to the borrower to increase his loan expenditures. T h a t a reversal of the process of price deflation does not occur, is then to be explained by the fact that it is only a relatively small portion of industrial enterprises that rely upon borrowed funds for their working capital, 18 and as far as long-term capital is concerned, the rate of interest plays only a minor rôle in private enterprises. Long-term borrowing for capital equipment in private industries is furthermore hampered by the constantly shortened process of depreciation and obsolescence of capital goods.20 In order to meet changing conditions and increasing competition, it becomes necessary for concerns to write off a larger sum per year than was formerly the case, thereby increasing their costs. Thus there can be little, if any, demand for long-term borrowing, no matter what the interest rates for loanable funds are, until profits have begun to reappear. T h e above-mentioned factors, exaggerated by the uneasiness, timidity, and pessimism that prevails in the business community during such a period as the one under consideration here, makes it exceedingly difficult, if not impossible, for the central banking authorities to bring about a reversal of the movements of prices merely by inducing greater loan expansion. T h e government, through extraordinary expenditures, then steps in with an effort to initiate a reversal of the price movement. It may forcefully depreciate the external value of the currency as a means to widen the market for the export goods of the country, and thus 1 8 T h e volume of loans for this purpose varies with conditions, as well as with customs and habits in each economy. 20 T h e revolutionary changes in the processes of production are further advanced, particularly at the later stage of a prolonged period of deflation, when the scramble for markets is renewed.

426

PRICE

REFLATION

increase the money profit of the export industries, while at the same time increasing the price of imported goods. T h i s latter price increase will not merely tend to raise import prices, but also related prices on the domestic market, as well as the costs for such industries as make use of imported materials in the process of production. A depreciation of the external value of the currency will thus have a dual effect: that, namely, of lowering the real rate of interest for one group of industries, while raising it for another. T h e effect upon the price structure as a whole depends largely upon the elasticity of demand for imported goods, and on the repercussions of the prices of imported goods on those of domestic goods, and vice versa. A devaluation of the metal content of the domestic currency unit, without a previous depreciation, has no uniform effect upon the price structure as a whole, except possibly after a very long span of time, as there is no immediate relationship between the value of a currency expressed in metal and the "general level" of prices. Its general effect is the same as that of currency depreciation. 21 Attempts to depreciate the internal value of the monetary unit, the issuing of fiat currency, may bring about a rise in prices, but only if the new issue of money is accompanied by an extraordinary demand for goods, as, e.g., government buying of commodities, or else if by the new money issue the public loses faith in the "inherent" value of the currency, thereby starting a flight away from money into goods. In this latter case, it may become exceedingly difficult to control the price rise so as to stop it at a predetermined level, which is the goal of price reflation. 22 It has also been suggested in some quarters that it may be possible 2 1 A change in the price of gold can, therefore, affect the price level only through changes which it might produce in the prices of individual commodities and groups of commodities. Hence, unless the effect of currency depreciation is to exert a uniform influence upon the prices of all classcs of commodities, or to raise some groups of prices sufficiently above the new level to offset the failure of other groups to rise proportionally, "there is no reason to expect a mathematical adjustment of the movement of the price level to the depreciation of the currency unit." Current Monetary Issues, p. 119. 22 T h e effect of direct government expenditures for relief and public works has already been taken u p for consideration in this volume by Mr. Vladimir D. Kazak£vich under the heading of " P u b l i c Works as a Reflationary Device" in his essay on " P u b l i c Works and Inflation." A further discussion here is therefore regarded as unnecessary.

PRICE

REFLATION

427

to increase the total buying power of the general public and thus achieve a rise in prices, 23 if the government, instead of collecting its taxes from the public, returned to the public a sum equal to that of the assessed tax of each person, be it an individual or a business organization. So far as is known, this scheme has never been tried, because of the tremendous volume of borrowing (presumably from the banks) which would be needed. T h u s , it would seem very difficult to bring about a rise in prices to a predetermined level by purely monetary means. T h i s is also the experience of most countries during the present world-wide depression, but, before drawing any conclusions it may be well to present some statistical data portraying the experience of two countries—the United States and Sweden. T o this brief statistical presentation we now turn. E X A M P L E S AND

CONCLUSIONS

In several countries efforts have been undertaken to raise prices —notably wholesale prices—in order to bring about a better balance between commodity prices and costs.24 T h e experience of such reflationary measures are particularly noteworthy in two countries —Sweden and the United States. T h e experience of Sweden has already aroused considerable interest, mainly because Sweden is the only nation that has had, for all practical purposes, a well-defined program to mitigate 2 5 her depression. T h e policy of reflation of prices was introduced in the Swedish Parliament in January, 1932, but did not become effective until the late spring (May) of the same year. It then became the explicit policy of the Swedish government, in conjunction with the Bank of Sweden, to attempt to bring about a gradual rise in wholesale prices "in the interest of production." T h e r e was no definite limit set for the price rise, other than it should not be permitted to raise the cost of living unduly. It seems, however, that the intention of the authorities was to raise the prices to the 1929 level. 26 2 3 It is assumed here that the payments of debts merely tend to shift the buying power f r o m one group to another in the community. 2 * See above, p. 419. 2 8 See Kjellstrom, E. T . H., Managed Money, C o l u m b i a University Press, 1934. 2« See O h l i n , "Sweden's Monetary Policy," Svenska Handalsbanken's Index, VIII (No. 81), «72.

428

PRICE

REFLATION

The Results Achieved

So Far

T h e index of "all goods," as computed by the Kommerskollegium, shows a rise from 109 in May, 1932 ( 1 9 1 3 = 100) to 1 1 3 in May, 1934, or an increase of 4 points. T h e average index for 1929 was, however, 140. Thus far the Swedish authorities have failed, by a margin of 27 points, to attain the desired result. T h e indexes for separate groups of prices also show a rise, of which the most notable has occurred in the price group which represents export goods, while import goods have been the ones least affected. T h e index of wholesale prices for "exported goods" rose from 109 to 119, or by 10 points, while that of 1929 equaled 144. "Imported goods" changed from 93 to 95, or by 2 points, while the index of the year 1929 equaled 126; and the so-called "domestic goods" rose from 1 1 0 in May, 1932, to 1 1 6 in the same month of 1934—an increase of only 6 points. There can be no denial of the fact that Sweden has achieved a rise in prices; yet the policy of price reflation has not been as successful as was hoped. 27 While Sweden chose the 1929 level as its goal, the United States has decided to reach a level that corresponds to the one prevailing during 1926. As measured by the general level of prices, the results obtained from the time of the inauguration of President Roosevelt until December, 1934, is seen from the data in Table 62. TABLE

62

INDEX O F PRICES IN T H E U N I T E D STATES, 1933-34 (1926 = 100; Bureau of Labor Statistics)

'933 March April May June July Aug Sept Oct Nov Dec

'934 60 60 63 65 69 70 71 71 71 71

Jan Feb March April May June July Aug Sept Oct Nov Dec

72 74 74 73 74 75 75 76 78 77 77 77

27 For a discussion of the means employed in Sweden, see Kjellstrom, E. T . H „ Managed Money.

PRICE

REFLATION

429

Although there has been a rise in the index of general prices, it is still far from the 1926 level of 100. Furthermore, there has been no uniformity in the movements of individual prices and groups of prices. 28 T h e American program includes depreciation of the external value of the dollar, as well as a devaluation of the gold content of the monetary unit to 59.06 per cent of its former value. It furthermore includes huge government expenditures, as well as a variety of other efforts to raise the spending power of the general public, the details of which have been discussed in other chapters and essays of this volume. Although by no means to be taken as a conclusive generalization, the experiences of Sweden and of the United States nevertheless give a clear indication of the difficulties which a policy of price reflation encounters during a period of heavy deflation. Even though there has been a rise of prices in both countries, the results, to date, are still far below their predefined goals, and the monetary measures have not been as effective as anticipated. T h e experience of these two countries show, furthermore, that price adjustment is of a highly complex character, and that a rise of a certain index of prices does not, per se, mean that all individual prices adjust themselves to the movement of the general price level, as a result of the application of purely monetary measures. T h e results achieved so far in these two countries invite a further conclusion, namely, that the difficulties encountered by a policy of price reflation are particularly great if the policy is set in motion after a prolonged period of deflation. T h e derangement of the entire economic structure accompanying the decline of prices has then had time to disrupt the balance between costs and prices to such an extent that an equitable equilibrium between them can no longer be predefined with reasonable accuracy. It would seem more logical, therefore, to inaugurate a policy of price reflation during the very early stages of a depression and thus attempt to prevent the vicious circle of deflation from causing a severe disruption in the relation between commodity prices and costs. It would seem still more advantageous to attempt to prevent the occurrence of a disequilibrium between prices and costs. Essentially, such a policy would have to be a broad "Konjunkturpolitik" in which all factors that influence the process of pricing must be made an integrated whole of the program. 28 Current Monetary Issues, p. 123.

430

PRICE

REFLATION

Furthermore, the fact should not be overlooked that price reflation, through monetary measures, also involves the danger of uncontrolled inflation, as by failure it lays the foundation for an expansion of currency and credit far greater than originally anticipated. This is well illustrated by the monetary situation of the United States. Although the "easy-money policy" of the government and the Federal Reserve banks has not led to the desired results, no efforts have been made to change the course of action. The result of this has been an excess of potential credit supply which endangers an orderly readjustment of prices and costs. It is, indeed, questionable whether it could be possible to control an advancement of prices so as to halt it at the predefined level of 1926, in the event of a sudden demand for credit on a large scale. Price reflation encounters, therefore, not only logical and practical difficulties, but it also involves, particularly after a series of failures and renewed efforts, the danger of uncontrolled inflation.

INDEX A Acceptances bankers, 177, «92 b u y i n g rate, 317 market for, 292 trade, 177 Act of Jan. 30, 1934, 35, 43, 51 Affiliates bank, 294 security, 303 Aftalion, A., 226, 388 Agricultural Adjustment Act, 263, 320, 321. 389 Agricultural commodities, falling prices of, 169 Agricultural prices, 141, 153 Agriculture A m e r i c a n farmer and, 75 d u r i n g war, 167-70 g r o w t h of American, 163-64 industry and, 253-55 inflated, 7 A k e r m a n , Johan, 401, 421 Anderson, B. M., 178 Angell, James W., 182, 183, 195, 200, 378 Ayres, Leonard P., 223

B Balance-wheel of industry idea, 348-50, 352 Bank, central, 155, 288, 290, 423, 424 Bank credit, see Banks Bank holiday, 306 Banking central, 135, 308. See also Bank, central inflation and, 19-38, 48-51 relation of, to production, 63-67 B a n k i n g difficulties, 119-20 B a n k i n g policy, 35, 208 B a n k i n g system administration of, 19 American, 66 English, 66 German, 65-66

Banking system (Cont.) inflation and. 25, 26, 35, 50-51, 363 investment of, 301, 302 money and, 19 prices and, 26 public works and, 356, 369 purpose of, 12 sound, 12 B a n k loans, 296 content of portfolio, 23 inflation and, 19-22 interest on, 168 liquidity of, 20 long-term assets, 89 national, 29-30 real estate, 30 retirement of, 203 secured, 20 solvency, 20 volume of, 29-30, 158 Bank of England, 41, 44, 97, 102 Bank of France, 97 Bank of New Zealand, 35 Bank of the United States First, 108 Second, 108 Banks assets of, 345 clearings of, 244 credit of, 83, 114, 132, 158, 223, 295 debits of, 250 failures of, 119-20, 200 frozen assets of, 153 functions of, 66 funds of, 191 illiquidity, 370 investments of, 315, 342 liquidity of, 71 portfolio analysis and, 331-43 portfolios of, and inflation, 331-43 real estate loans of, 295 reserves of, 85 security of, 295 unfreezing of, 363 Beckhart, Benjamin H., 314 Black Friday, 151 Bloch, Viktor, 412

INDEX

432

Board of Trade, English, 57-58 Bohm-Bawerk, E. von, 400, 401, 404, 407, 408, 410 Booms brokers' loans in latter years of, 3 1 5 business, 71-74, 255, 308 depressions and, 60-61 forms of, 61-6a land, 31 "New Deal," 323 of 1919-20, 293 overproduction and, 61 result of oversupply of credit and distortion of public psychology, 37

stock, 317 Borrowings at Federal Reserve banks, 83 government, 290 Breakdown of 1929, 90-93 Brokers' loans, 297, 314-18 Bryan, William J., 161 Budget balanced, 97 national, 184, 354, 370 Roosevelt's, 246 unbalanced, 196, 358-59 Business cycle, 60, 288, 398, 4 1 1 Business man and inflation, 176-89 "Buy now" campaign, 154

c Call-loan rates, 316 Campaigns, presidential, 113, 114 Capital accumulation, 400, 401 amortization, 409 circulating, 406 creation, 399, 410 demand for, 414 expansion, 204 fixed, i8g, 194, 404 flight of, 196, 198-99 idle units, 70 meaning of, 237 money, 285 movements of, 373 new, 421 placement of, and booms, 72 replacement of, 202 shifting, 73, 1 1 3 subsistence fund and, 404, 406, 407

Capital (Cont.) "timid," 364 use of, 67, 415 value concept of, 405 working, 213, 425 Capital assets, 237 Capital funds, 3 1 3 Capital goods, 190, 193 investment in, and inflation, 190 overexpansion of, relative to savings, 202 "write o f f " of, 34 Capital-goods industries, 274, 277, 327 and government expenditures, 10 stimulation of, 62 Capitalism and overproduction, 62-63 private, 246 Capital issues, 304, 309, 3 1 3 Capitalistic society, 64, 66, 77, 162 Capitalists, 186, 198, 259 Capitalization of values, 22 Capital market, see Market Cash discount system, 177 Cassel, Gustav, 230, 372, 382 Catchings, W., 229 Central banking, 288, 290, 423, 424 Chapman, J . M., 28, 192, 294, 331 Civil War, 176, 177 inflation at time of, 109, 201, 222 depreciated currency of, 109, 1 1 0 Civil Works Administration, 361 Clark, Evans, 117, 164 Clark, John M., 28 Cleveland, Grover, President, 161 Commercial paper market, 89 Committee for the Nation, 16 Commodity prices advances in, 3 1 , 89, 129, 208 bank portfolios and, 20, 21 capitalization of values, 22 currency depreciation and, 324, 374, 375. 380, 381, 385 deflation and, 5-6 depression and, 344 during early war years, 80 index of, 3 1 1 inflation and, 5-6, 16, 131 reflation and, 5-6 relation to money factors, 320 relation to security prices, 20-21 volume of money, influence of, on, 9 wholesale, 82, 3 1 1 , 389

INDEX Commodity standard, see Standard of value Construction estimates, 366 allocation of, by types, 367 Consumers' goods, 328 Control, exchange, see Exchange control Controversy, the price, 131-49 "Corner," 151 Corporate earnings, 314, 318-20, 325, 328. 330 Cost of living, 195, 244, 324, 427 declined in 1933, 258 index of, 247, 250, 252 Costs decreasing, 280-87 incremental curve of, 282 labor, 255 overhead, 255, 271, 287 spreading overhead, 282 Credit available, 147 bank, see Banks efforts to restrict, 293 extension of, 32, 118, 125, 144, 243 fiat, 290 frozen, 23, 25 government, 289-90 in depression, 70 inflation and, 60, 224, 243, 294, 295, 298, 301, 308, 371 long-term, 3 1 1 , 314 money and, 394 post-war, 302 quantity of, 53, 55, 76, 83 release of bank, 21 short-term, 3 1 1 , 314 speculation in, 293-94, 317 surplus of, 26 velocity of, 55 Credit analysis, 305 Credit base, 425 Credit expansion, 53, 208, 223, 290, 291, 294, 318 Credit liquidation, 33 Credit liquidity, 288, 302 Creditor class, 99, 104 Credit system, 292 Crisis, 24, 31 Currency depreciation of, 17, 1 1 0 , 1 1 2 , 1 1 7 , 193, 195, 202, 205, 208, 226, 227, 372, 373. 374- 375- 3 8o > 3 8 ' . 385

433

Currency (Cont.) elastic, 64 expansion of, 424 fiat, 426 Bight from, 196-98 foreign, 381 foreign trade and, 373-75 in European countries, 97 inflation and, 34-35, 103, 196-98 irredeemable, 1 1 0 redistribution of, 14 silver, 1 1 3 sound, 207 stabilization of, 14 stable, 106 value of, 426 Currency management, 103, 104, 221, 224-25 Czecho-Slovakia, 97

D Dal ton, H., 260, 261 De Bordes, J . van Walré, 197 Debt and monetary inflation, 46-48 business men and, 93 foreign, 393 internal, 116-18 government, 265, 327, 357, 363, 368, 369 growth of, 93-94 long-term, 1 1 7 public, 86-88, 96, 110, 241 public, effect of, 289 Debt amortization, 118 Debt moratorium, private, 102 Debtor class, 7, 1 1 1 , 212 Decreasing costs, 280-86 Decreasing returns, 280 Deflation clarifying factors in discussion of, 8-9 economic view of, 6 identified with falling prices, 5 inflation and, 414 in 1930-32, 309 meaning of, 8, 10, 276 means of, 423-427 norm and, 7, 8 overinvestment and, 272, 273 period of, 429 policy of, 147

434

INDEX

DeHation (Cont.) popular conceptions of, 4 price movements and, 5, 107 production and, 413 readjustment and, 92 Deposits bank, so, 136 demand, 81, 83, 87 time, 87 Depreciation of capital goods, 425 of currency, 193, 20«, 2 1 1 , 309, 380 of exchange, 225-27 of land values, 1 1 0 Depression agriculture and, 167-68 combating, 94-95 control^>f, 344 follows cycle of production, 70 later stages of, 190 of 1892-93, 161 of 1920-21, 93, 163 overproduction and, 277 public works and, 365, 368 Devaluation amount of, 53 depression and, 60 inflation and, 35, 44, 46, 74, 1 1 2 , 1 1 3 money, 15, 16, 426 of dollar, 128, 396 prices and, 79 process of, 35 use of term, 43-45 Distribution of income, 8, 237-67 of individual incomes, 251, 256-57 of wealth, 1 1 , 12, 13, 23, 59, 101, 108, 109, 114, 207 Dividends, 252 corporation, 300 decline in, 300 payments of, 3 1 3 Doane, R . R., 265 Dodd, David L., 3 1 3 Dodge, F. W., Corporation, 361, 368 Dole-tax-mechanism, 287 Dollar cheap, 171, 323 content of, 5 1 , 128 definition of, 42 devalued, 178, 396 gold, 128, 321, 323 "money," 48

Dollar (Cont.) purchasing power of, 40 silver, 1 1 2 stabilized, 14, 212, 324 weight of, 16 Dollar exchange, 387-97 Dulles, Eleanor L., 223, 226

E Earnings corporate, 312, 318-20, 325, 328, 329 stock prices and, 330 Economic balance, 269, 270 Economic forces in equilibrium, 8 Economic planning, 1 0 - 1 1 , 77, 370. See also Planned economy assumptions of planners, 11 banking, relation to, 1 1 - 1 2 credit, relation to, 1 1 - 1 2 difficulty of, 11 meaning of, 11 money, relation to, u - 1 2 Economic processes, 274 Economic theory, 399 Economists attitude of, toward credit, 9 attitude of, toward money, 9 attitude of, toward planned economy, 9 Economy, planned, see Planned economy Edie, L. D., 227 Egle, Walter, 399 Egner, Erich, 402 Elasticity of demand, 140 Elements in inflation controversy, 8-10 England, 266 going off gold, 41, 57, 102 wholesale prices in, 57-58 Equation of exchange, 136 Equilibrium Böhm-Bawerk's theory of, 410 depression and, 94 economic forces in, 8 position of, 240 price, 421, 422 supply and demand, 77 "Excess reserves," 38. See also Reserves Exchange depreciation of, 225-27, 391 dollar, 387-97 foreign, 371-97

INDEX Exchange (Cont.) foreign rates of, 37a inflation and, 371-97 market for, 373, 424 means of, 423 medium of, 371 methods of control of, 373 present position of, 390, 391 rates of, 379, 384 sterling, 379-86 stabilization of, 395-97 Exchange media circulating, 43, 1 1 1 , 132 credit as, 12 purpose of, 1 1 - 1 3 relation to wealth distribution, 12 Exchange process, 40 Expenditures, government, see Government expenditures Exploitation of natural resources, 1 1 1 Exports, total, 383. See also Foreign trade

F Failures, bank effects, 120 government financing and, 121 Farm commodities, 164. See also Agricultural commodities Farmer and cheap-money propaganda, 17071 index of prices of goods bought by, 254 index of prices of goods sold by, 254 inflation and, 163-75 prices paid by, 165-67 prices received by, 165-67 Farm land high prices of, 168 improved, 163-64 Farm prices and World War, 164-67. See also Agricultural prices Farm program, and inflation, 173 Federal Emergency Relief Administration, 351 Federal Employment Stabilization Board, 349, 351 Federal Farm Board, 170 Federal Housing Bill, 365 Federal Intermediate Credit banks, 170 Federal Reserve Act, 1 1 5 , 291

435

Federal Reserve banks discount changes, 292-93 easy credit at, 158, 288 easy-money policy of, 430 inflationary policy and, 321 loans of, on government securities, 223 notes paid out by, 42 open-market operations of, 291 ratio of reserves and, 55 recovery program and, 390 Federal Reserve Board, 315, 321 Federal Reserve system borrowing at, 83 brokers' loans, failure to restrict, 3'7 influence of, 155, 288-93 member banks of, and inflation, 33143 recovery program and, 356, 359 reserve balances of member banks of, 83 Fiat money, 96, 109, 221-24, 426 Financing, government, see Government finance Fisher, Irving, 418, 423 "Flight from capital," 198-99 "Flight from currency," 196-98 Forced savings, see Savings Foreign currencies, 225-26 Foreign exchange, 198, 225-27 Foreign exchange prices, 195 Foreign trade capital account and, 373 currency depreciation and, 373-74 depreciation and, 374 exports, 81, 374. 381, 383 imports, 81 inflation and, 179, 189, 371-97 invisible, 373 stability of demand in, 378 theory of, 371-97 visible, 373 Foreign trade goods, prices of, 374-75 Foster, W. T . , 229 Franc, value of, 43-44, 97, 98 France inflation in, 199, 309. See also Franc, value of stabilization in, 174 "Full dinner pail," 161 Funds speculative investments of, 1 1 1

436

INDEX

G Gayer, A r t h u r D., 357 Germany inflation in, 43, 97, 99, 102, 176, 182, '83, 193, 195, 197, 198, 200, 309, 378 insurance in, and inflation, 201 stabilization in, 174 Gill, Carrington, 367 Glass, Carter, 293 Gold exports of, 83, 320 flow of, 372 holdings of, 50 imports of, net, 83 loss of, 292 monetary stock of, 81, 83 movement of, 83, 97 Gold Reserve Act, 307 G o l d standard abandoned by Great Britain, 15, 57, 386 abandoned by United States, 15, 57, 37*. 379. 386 dissatisfaction with, 13 effect of, on debtor, 107 equilibrium, 385 "going off the standard," 41-42, 144 Great Britain returns to, 45 ratio of gold dollar to silver under, 321 return to, 107 Government expenditures, 243, 244, 265, 363 and inflation, 9-10 capital goods, relation to, 10 construction and, 368 heavy taxes and, 9 purchasing power, creation of, by, 222-25 Government finance, 120-22, 327 G r a h a m , Benjamin, 313 Great Britain, 44, 99 Act of 1925, 45 abandoned gold standard, 44, 57 wholesale prices in, 57-58 Greenback Party, 161 Greenbacks, 222, 268

H Haberler, Gottfried, 283, 398, 401 H a h n , Albert, 402

Haney, Lewis H., 378 Hansen, A l v i n H., 408 Hawtrey, R . G., 375 Hayek, F. H . von, 272, 283, 399, 401, 402, 404, 405-7, 408, 410 Hinrichs, A . F., 402 Hobson, J. A., 62, 63, 67 Hollander, J. H „ 288 Hoover, Herbert, 125, 362, 364 Hornbostel, Henri, 225

I Imperial Economic Conference, 395 Import price, 375 Imports, see Foreign trade Income accounting concept of, 238 concept of, 240-241 corporate, 312, 318-20, 328, 330 distribution of, 67, 237-67, 271 fixed, 194, 233 gross farm, 258 importance of group prices to, 8 indexes of, per capita, 261 index of real, 247, 248 individual, 242, 245-46 inflation and, 190, 193-96, 243 money, 248 national, 241 recipients of national, 241-43 redistribution of, 233 sources of, 241-43 Incremental cost curve, 282 Indebtedness long-term, 203 mortgage, 183 Index of all goods, 428 of bank clearings outside of New York (1914-20), 244 of bank debits (1923-28), 250 of business, clearings, 299 of changes in output (1922-29), 298 of commodity prices, Dun's, 298 of common stocks, 329 of cost of living (1914-20), 244 of cost of living (1923-27), 250 of fifty stocks, New York Times, 297 of finished goods, 298 of incomes of salaried employees (1923-27), 252 of incomes of wage earners (192327), 252

INDEX Index (Cont.) of individual incomes (1929-32), 257 of per capita incomes (1916-26), *6i of physical volume of production of finished goods, 298 of prices, 422 of prices in the United States (193334). 428 of prices of goods bought and sold by farmers (1914-29), 254 of productive activity manufacturing. 299 of raw materials, 298 of real incomes (1914-20), 244 of real incomes of salaried employees (1914-20), 248 of real incomes of wage earners (1914-20), 248 of semi-finished goods, 298 of volume stock sales, 297 of wholesale prices (1914-20), 247 of wholesale prices (1923-28), 250 Industrialist [65 financed by banks and savings, 64German banking system and, 65 inflation and, 181-84 Industry agriculture and, 253-55 inflation and, 59-79 Inflation as regressive tax, 260 as repudiation, 13 banking and, 19-38, 48-51 bank portfolios and, 331-43 basis of, 143-46 business and, 71-74, 146, 176-89 cases of relation to banking, representative, 27-31 causes, 8-9, 184 Civil War, 109-10 commerce and, 186-89 concept of, 240-41 conclusions as to, 206-17 contemporary position of, 16-19 controlled, 215 costs of production and, 280-86 course of, 321-23 credit and, 243, 244, 250 current usage of term, 5-7 debt and, 46 decreasing costs of production and, 280-87

437

Inflation (Cont.) definition of, 5-7 depreciation and, 393-94 depression and, 413 devaluation and, 44, 46 difficulty of defining, 10 direction of, 122, 127 distribution of income and, 237-67 distribution of wealth and, 10-11, 13, 101, 108, 200, 221, 232 domestic, 371-73 economic planning and, 10-11 economic processes and, 225 economic view of, 6 economist and, 7-10 effects, on various classes, 1 1 , 85, 142, 217 exchange, 385-86 farmer and, 163-75 financial use of term, 6-7 flight of capital and, 198-99 foreign trade and, 178-79, 371-97 German, 195, 197 government expenditures and, 9-10 greenbacks and, 222, 268 group struggle and, 4-5 growth of, 88 idea of, 3-18 implications of, 15-16 income and, 193-96, 237-67 index of, 127 industrial, 74-77, 181-84 industry and, 59-79 in European countries, 95, 102 insurance, effect on, 201 investment and, 22-24, 190-205 literature, discussion of, 221-37 loans and, 19-22, 24 managed currency and, 103, 104, 284 meaning of, 6, 8, 10, 14, 16-18, 19, 37-38, 41, 59, 227, 240-41 money and, 39-58 monetary, 46-50, 246 national income and, 241-43 "New Era," 309-10 "New Deal," 320-21, 330 non-monetary, 59 norm, 7, 8 of '933-34. 76, 1S7-29 over-production and, 268-79 philosophy of, 13 policy of, 16, 47, 123, 128, 321 political aspects of, 7, 13-14

438

INDEX

Inflation (Cont.) popular conceptions of, 3-5, 70 portfolios, effect of, on, 24-25 prewar, 80-84 price movements and, 5, 32, 114, 184 problem contemporary, 80-107 production and, 398-416 profit, 244, 245, 255 propaganda of, 14g public works and, 344-71 purchasing power, increase of, and, 228-32 redistribution of wealth and income and, 232-36 relation to banking and currency, >9-38 relation to credit, 224 rise in prices, 5, 227-28 savings depositor and, 199-201 securities, 288-308 speculation and, 150, 159-62, 216 stabilization and, 395, 397 stock market and, 309-30 tests of, 35-36 theoretical aspects of, 206 trade derangeid by, 172 types of, 242-43 uncontrolled, 430 United States in, 108-30 usage, attempt to define, 5-7 views Of, 221 war experience with, 84-89, 115-16 Inflationary movement banks and, 69, 130 boom as, 315 World-War, 80 Interest call loan rates, 315-16 relation to speculation, 155 Interest payments, 249, 250 Interest rate, increases in, 275, 377 Investment and inflation, 190-205 Investments. See also Overinvestment bank, 331-43 classes of, 126 common stock, 126 funds for, 314, 327-28 member-bank, 340, 341 national-bank, 29-30 portfolio and, 25 ratings of, 192 risk of, abroad, 199

Investments (Cont.) savings and, 270 values of, 22-24, 214 Investment trust, 192, 294, 314 Investor attitude toward price changes, 191-

93 institutional, 201-4 "Iron laws," 239

J Jones, Bassett, 275

K Kazakivich, V. D., 331, 426 Kemmerer, E. W., 197 Keynes, J. M., 271, 350, 351, 362, 375. 402, 405, 41g, 424 King, W i l l f o r d I., 248 Kjellstrom, E. T . H., 427, 428 Knies, K., 66 Koopmans, J. G., 3gg, 401 Kuznets, Simon, 347, 366, 367

L Labor groups, 213 inflation and, 74, 85, 91 mobility of, 414 supply of, 284 Labor costs, 255 L a m p e , A d o l f , 401 Land boom in, 31 percentage of, improved, 164 readjustment of values of, 110-14 under cultivation, 163 Landis, Walter S., 225 Lausanne Conference, 418 " L a w of one price," 372 Law of proportions, 281 League of Nations, 28 Lindahl, Erik, 401 Liquidation credit, 33 financial, 275 of overproduction, 274-75, 278 Liquidity, see Bank loans Lira, value of, 43, 97 Loans and investments, peak of, 334

439

INDEX Loans (Cont.) bank, see Bank loans commercial, 315, 342 of member banks, 331-43 on securities, 314, 332, 337 rate of interest on, 425 real-estate, 336, 337, 343 London Economic Conference, 395, 396, 417 I.orenz curve, 261 Loria, Achille, 238

350,

M Machlup, Fritz, 283 McKinley, W i l l i a m , President, 161 Mahr, Alexander, 399 "Managed currency," 103-6, 143, 221, 224-25 Market capital, 66, 326 commercial-paper, 89 commodity, 152 foreign-exchange, 373, 376, 424 securities, 159 sellers', 84 stock, 146 " M a r k e t equity," 159 Market value, 190 Marshall, Alfred, 408 M a r x , Karl, 62, 63, 400 M e d i u m of exchange, 371 M e m b e r banks changes in portfolios of, 338-43 composition of portfolios of, 335-43 investments of, 338-42 loans and investments of, 331-43 portfolios of, 331-43 Merchants income of, 193 inflation and, 176-89, 214 Mill, John S., 55, 132, 135, 349, 400 Mills, Frederick C., 126, >53 Mins, L . von, 401 Money banking policy and, 48 cheap, 155, 160, 172, 291 depreciation of, 211 devaluation of, 15 easy, and speculation, 154-57 fiat, 96, 109, 222-23 gold stock and, 81, 83 in circulation, 81, 83

Money (Cont.) inflation and, 39-58 managed, 103, 106, 224-25 neutral, 236, 284, 399, 411 planned, 358 purchasing power of, 22, 47, 132 quantity theory of, 53, 56, 157-58 relation to banking, 74 requisites of good, 12 "sound," 107, 113, 161 stability in unit of, 4 value of, 193 Money income, 236, 248 Money trust investigation, 114 "Moral suasion," 315 Mortgages bases of, 109 farm, 117, 169 problems presented by, 279 urban, 117 Myidal, G., 401, 423

N Nadler, Marcus, 395 National Bank Act, 177 National banks composition of assets of, 124 loans and investments of, 29-30, 124,

«95 portfolios of, 332 real estate loans of, 295 U. S. bonds held by, 124 National Bureau of Economic search, 28, 31 National Recovery Administration, 321. 356, 359. 361. 3 6: *. 3 8 9- 396 Nerlove, S. H., 264 " N e w Deal," 253, 257, 320, 323, 33o. 345- 35i. 355- 359. 360. 362 " N e w Era," 149, 158, 169, 250, 305, 309, 310, 311, 314, 317, 320, Nogaro, Bertrand, 392

Re263,

328, 302, 324

o O h l i n , Bertil, 427 Open-market policy, 291 "Orderly marketing," 169 Overinvestment and deflation, 272, 278 Overproduction analysis of, 268-69 booms and, 61 capitalism and, 62-63

INDEX

440

Overproduction (Cont.) capitalization and, 62-63 inflation and, 168-79 liquidation and, 274-75 liquidity, desire for, and, 71 reflation and, 275-79 result of, 269 versus underconsumption, 68-69, 273

P Panic of 1873, 109 of 1893, 27, 112 of 1907-8, 28, 29, 113 of ig20-21, 90 of 1929, 27, 119 Pasvolsky, Leo, 417, 420 People's Party, 161 Pigou, A . G., 364 Planned economy. See also Economic planning economists' attitude toward, 9 price level and, 9 Policy, inflationary, 16 Political importance of inflation, 1314. 17 Poor Laws, 348 Populist Party, 161 Portfolios, bank and inflation, 331-43 changes in, 27 contents of, 23 effects of inflation on, 24, 26 frozen, 23, 25 investments in, 25 long-term assets of, 89 of member banks, 331-43 of national banks, 332 trend of, 332 Pound sterling, value of, 44 Price changes, investor's attitude toward, 191 Price controversy, 131-49 Price doctrine, origin of, 132-33 Price fixing, 85 Price level abstract conception, 210 business cycle is instability of, 60 change in, 135 commodity, 8 general, 3, 411 higher, 158, 227-28, 424

Price level (Cont.) index of, 82, 124, 422 inflation and, 37-38, 221 international, 392 money supply and, 57 of Great Britain, expressed as percentage of U. S., 384 planned society and, 9 prosperity and, 158 reflation of, 420 reflation of, to 1926 level, 6 relation of, to bank, 33 rising, 398 Price reflation, 417-30 Prices advances of, 54, 88, 104, 148 bargaining strength as a determinant of, 375 basis of theory of, 133-37 depreciation and, 375 devaluation as a means of marking up, 79 effect of credit on, 55 export, 376 farmer and, 163-75 general level of, 311 group relationships among, 8 higher, 158, 184-86 " i m p a c t , " 375 indexes, 57-58, 85, 124, 139, 140, 142, 3" inflation and, 5, 240 international, 292 meaning of, 139-43 monetary factors affecting, 9-10 movement of, 32, 57-58, 86-89 older theory of, 54 " p e g g i n g " of, 32 production and, 61 prosperity and, 158-59 relation of, to inflation, 131 rise of, 84, 160 security, 322 stock, 91 theory of, 54-58, 131-38 volume of consumption and, 61 wholesale, 57-58 " P r i m i n g the p u m p , " 344 Production banking, relation to, 63-67 capital for, 63-64 costs of, decreasing, 280-87 cycle of, 70

441

INDEX Production (Cont.) distortion o f , 67-71 factor of, 407 industrial, 311 inflation and, 67-71, 280-86, 398 of finished goods, 298 period of, 404 process of, 409 relation of, to banking, 63-67 " r o u n d a b o u t process" of, 403 structure of, 398-416 Profits amount of, 252 inflation and, 242, 244, 247, 255 rising prices and, 233 short-term, 78 speculation, relation to, 155 Prosperity booms and, 72 high prices and, 158-59 inflation and, 17 of decade 1919-29, 118 postwar, 249 speculation and, 150-62 Prosperity reserves, 349, 357 Public debt, see Debt, public Public works aftermath of experiment in, 363-64 allocation of construction work, by types, 367 balance-wheel-of-industry idea and,

348-5°. 35«. 369

basic ideas of program of, 345-46 construction and, 350-52, 360, 365, 366 control of, 265 data on, 365-69 depression and, 344 345. 354 difficulties of a program of, 352-54 distribution of, in percentages, 369 employment and, 347-48 expenditures on, 364, 365 inflation and, 344-70 possible alternative to program of, 364-65 program of, 363, 370 "prosperity reserves" and, 349, 357 reflation device, 355-56 relation of, to Federal budget, 354,

358-59

relief, 346-48 Roosevelt program of, 356-58 slum clearance and, 364-65

Public Works (Cont.) theory of, 346-48, 360-61 volume of, 365-69 Public Works Administration, 351, 362 Purchasing power creation of, 222-25 distribution of, 207 expansion of, 232, 234-35 external, 392 foreign-exchange, 386 income and, 187, 193 inflation and, 70, 221, 228-32, 236, 267, 386 of franc, 98 " p l a n n i n g , " 212 price level and, 210, 226 speculation and, 151 stable, 47 supply of, 134, 137, 140, 141, 225 Purchasing power parity, 227

Q Quantity theory of money, 53, 56, 134, 157-58, 227, 228, 377

R Real estate loans, see Bank loans Reconstruction Finance Corporation, 121, 266, 306 Rediscount r a ' e changes in, 292-93, 317 lowered (1927), 155, 315 Redistribution deflation by, 10 inflation as, 13, 221 of wealth, 14, 17, 95, 221 Reflation business m a n and, 179 examples of, 427 farm program and, 173 means of, 276-77, 423-27 of commodity prices, 417 overproduction and, 275-79 policy of, 279 price, 417-30 progressive, 278 public works and, 355-56 relation of, to commodity prices, 5-6 relation of, to inflation, 277, 419 results of, 428-30 to 1926 price level, 6 use of term, 5-7

INDEX

442

Reichsmark, 97 Relief Federal, 263 inflation for, 17, 143, 171 recipient of, 194 Report of Federal Reserve Board, 81 • 84 Repudiation as policy, 46 bank failures as, 120 inflation and, 17, 44, 46, 49, 109 meaning, 42-43 use of term, 42-43 Reserve requirements, 291 Reserves, see Banks, reserves of Reserves, excess, 38 Resumption of specie payment, 109 Riddle, Gilbert N „ 192 Robertson, D. H., 280, 375, 402, 409, 4'3 Rodbertus, J . K., 400 Rogers, J . H., 230 Roosevelt, F. D., 369, 428 Runciman, Walter, 350

S Saint-Simon, C. H., 346-47 Salaries, 242, 247, 248, 262 Savings corporation, 264 decline in, 199 forced, 271, 400, 411 inflation and, 204 investments and, 270 rate of, 409 relative to capital, 202 Savings-bank depositor and inflation, 199-201 Schiff, Erich, 401 Schmidt, Carl, 3 1 , 193, 196 Schneider, F. A., 230 Schumpeter, Joseph, 401, 413 Securities classes of, 126, 192 Federal, 1 1 7 financial, 1 1 7 fixed interest-bearing, 289-90 government, in banks, 289 industrial, 117, 3 1 1 , 329 inflation in, 288-308 loans on, 295, 314 mortgages as, 109, 117

Securities (Cont.) new issues of, demand for, 301 public-utility, 117, 3 1 1 , 329 railroad, 109, 117, 3 1 1 , 329 state and local, 117 volume of, 1 1 7 Securities exchanges, 312 Security affiliates, 303 Security collateral, 296 Security expansion, 292 Security loans, 295, 296, 315 by classes of banks, 295 Security prices, 155, 192, 3 1 1 , 324 Security "rights," 301 Security values, 91, 3 1 3 and commodity values, 20-21 "Sellers' market," 84 Silver act of 1890, 1 1 2 , 161 free coinage of, n o , 1 1 1 Silver-purchase act (1890), 112 "Slum clearance," 364 Smith, Adam, 400 Solvency, see Bank loans "Sound currency," 107, 113, 207 South Sea Bubble, 310 South Sea Company, 310 Soviet government, 42 Specie payment, 115 Speculation commodity, 156-57 defined, 150-51 easy money and, 154-57 inflation and, 159-62, 216 interest rates and, 155 land, 153, 154, 156-57 politics and, 160-62 prosperity and, 150-62 purpose of, 150 real-estate, 72 security, 155, 3 1 3 security exchanges and, 152 "short interest," 151 stock, 299 Speculative investment of funds, 1 1 1 Stability currency, 107 foreign-trade, 378 importance of, to certain groups, 4 lack of, 101 of purchasing power, 47 relative, 77

INDEX Stabilization of currency, 14, 97 inflation and, 397 in France, 199 in Germany, 174 international, 14 relation of, to industry, 196 Stabilized dollar, 14, six, 3x4 Standard of value and bank notes, 4s commodity, 39 "going off the standard," 41-48 idea of, 39-41 inflation and, 209 monetary unit and, 122 purchasing power and, 40 stable, 107 Standard Statistical Bulletin, base book, 81 Standard Trades and Securities, base book, 82 Steiner, W. H., 177 "Sterling bloc," 381 Sterling exchange, see Exchange Stock market collapse of, 345 inflation and, 309-30 "Stock split-ups," 303 Strigl, Richard, 401 "Subsistence fund," 403, 404, 406, 407 Surplus credit, 26

T T a x , regressive, 260 Taylor, W. G. L., 232, 402 Technocratic philosophy, 62, 67 Theory of prices, see Prices Thorp, W. L., 156, 157 Trade, international, 226 Trade, foreign, see Foreign trade Trust, investment, see Investment trust Twentieth Century Fund, 93, 117

u Underconsumption, 68, 272 Unemployment, 286, 287 United States abandonment of gold, 41, 57, 102 financial position of, 80 inflation in, 108-30 trade position of, 80-81 war experience of, 84-86 wholesale prices in, 57

443

United States Department merce, 163, 167, 255 "Unspent margin," 215 Utopian Socialists, 347

of

Com-

V Voluntary-saving school, 400, 402

w Wages higher, 207 income from, 242, 247, 248, 262 inflated level of, 7 rates of, 284 real, 258 Wagner, A., 66 Wainwright Commission (New York), 348 Walras, Léon, 402, 421 Warburg, P. M., 232 War financing currency units and, 101 exchange rates and, 101 experience of United States in, 8486 international trade and, 101 Wealth distribution of, 113 national, 93 readjustment of, 101 redistribution of, 181, 232-36 Wealth saving, government expenditures and, 265 Weiser, F. von, 402 Weston, W. J., 230 White, Andrew D„ 180, 181, 188 White, Horace, 222 Whittlesey, C. R., 373 Wholesale price, 124, 195 commodity, 82, 389 index of, 244, 250, 380 Wicksell, Knut, 401, 407 Willis, H. P., 28, 192, 294, 331 Wilson, Woodrow, 114 Wolman, Leo, 348, 366, 369 Wood, Fernando, 347 World Economic Conference, 420 World War, 27, 43, 44, 48, 60, 65, 72, 8o, 95, 115, 118. 120, 134, 137, 152, 168, 174, 202, 288, 312 Wright, Philip G „ 201

COLUMBIA UNIVERSITY PRESS COLUMBIA UNIVERSITY NEW YORK FOREICN ACENT O X F O R D UNIVERSITY PRESS HUMPHREY MILFORD AMEN HOUSE, LONDON, E . C . 4