Depression and Reconstruction: A Study of Causes and Controls 9781512815658

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INDUSTRIAL RESEARCH WHARTON

DEPARTMENT

S C H O O L OF F I N A N C E AND

COMMERCE

U N I V E R S I T Y OF PENNSYLVANIA

RESEARCH STUDIES XXVIII

DEPRESSION AND RECONSTRUCTION

INDUSTRIAL RESEARCH STUDIES I. E a r n i n g s a n d W o r k i n g O p p o r t u n i t y in the Upholstery W e a v e r s ' T r a d e in 25 P l a n t s in Philadelphia, by A n n e Bezanson. $2.50. I I . Collective B a r g a i n i n g a m o n g P h o t o - E n g r a v e r s in P h i l a d e l p h i a , by Charles Leese. $2.50. I I I . T r e n d s in F o u n d r y P r o d u c t i o n in the P h i l a d e l p h i a A r e a , by A n n e Bezanson a n d Robert G r a y . $1.50. IV. Significant P o s t - W a r Changes in the F u l l - F a s h i o n e d Hosiery I n d u s t r y , by George W . T a y l o r . $2.00. V. E a r n i n g s in Certain S t a n d a r d M a c h i n e - T o o l Occupations in P h i l a d e l phia, by H . L. F r a i n . $1.50. VI. H e l p - W a n t e d Advertising as an I n d i c a t o r of the D e m a n d f o r L a b o r , by Anne Bezanson. $2.00. V I I . An Analysis of P r o d u c t i o n of W o r s t e d Sales Y a r n , b y A l f r e d H . W i l liams, M a r t i n A. B r u m b a u g h , a n d H i r a m S. Davis. $2.50. V I I I . T h e F u t u r e M o v e m e n t of I r o n Ore a n d Coal in Relation to the St. L a w r e n c e W a t e r w a y , by Fayette S. W a r n e r . $3.00. I X . G r o u p Incentives—Some Variations in the Use of G r o u p Bonus a n d G a n g Piece W o r k , by C. Canby Balderston. $ 2 . 5 0 . X . W a g e M e t h o d s and Selling Costs, by A n n e Bezanson and M i r i a m Hussey. $4-5°· X I . W a g e s — A M e a n s of T e s t i n g T h e i r Adequacy, b y M o r r i s E . Leeds and C. C a n b y Balderston. $1.50. X I I . Case Studies of U n e m p l o y m e n t — C o m p i l e d by the U n e m p l o y m e n t Committee of the N a t i o n a l F e d e r a t i o n of Settlements, edited b y M a r i o n E l d e r t o n . $3.00. X I I I . T h e F u l l - F a s h i o n e d Hosiery W o r k e r — H i s C h a n g i n g E c o n o m i c Status, by George W . T a y l o r . $3.00. X I V . Seasonal Variations in E m p l o y m e n t in M a n u f a c t u r i n g Industries, by J . P a r k e r Bursk. $2.50. X V . T h e Stabilization of E m p l o y m e n t in P h i l a d e l p h i a t h r o u g h the L o n g R a n g e P l a n n i n g of M u n i c i p a l I m p r o v e m e n t Projects, by W i l l i a m N. Loucks. $3.50. X V I . H o w W o r k e r s F i n d J o b s — A Study of F o u r T h o u s a n d Hosiery W o r k e r s , by D o r o t h e a de Schweinitz. $ 2 . 5 0 . X V I I . Savings and Employee Savings Plans, by W i l l i a m J . Carson. $1.50. X V I I I . W o r k e r s ' Emotions in Shop and H o m e , by R e x f o r d B. Hersey. $3.00. X I X . Union T a c t i c s a n d Economic C h a n g e — A Case Study of T h r e e P h i l a delphia T e x t i l e Unions, by Gladys L . P a l m e r . $2.00. X X . T h e P h i l a d e l p h i a Upholstery W e a v i n g I n d u s t r y , by C. C a n b y Balderston, R o b e r t P . Brecht, M i r i a m Hussey, Gladys L . P a l m e r , a n d E d w a r d N . W r i g h t . $2.50. X X I . W a g e Rates a n d W o r k i n g T i m e in the B i t u m i n o u s C o a l I n d u s t r y , 1912-1922, by W a l d o E . Fisher a n d Anne Bezanson. $3.50. X X I I . T e n T h o u s a n d Out of W o r k , by E w a n C l a g u e a n d Webster P o w e l l . $2.00. X X I I I . A Statistical Study of Profits, by R a y m o n d T . B o w m a n . $3.00. X X I V . T h e D o l l a r , the F r a n c , and Inflation, by E l e a n o r L a n s i n g Dulles. $1.25. ( T h e M a c m i l l a n C o m p a n y . ) X X V . Executive Guidance of I n d u s t r i a l Relations, by C. C a n b y Balderston. $3-75X X V I . Prices in Colonial Pennsylvania, by A n n e Bezanson, R o b e r t G r a y , a n d M i r i a m Hussey. $4.00. X X V I I . E a r n i n g s of Skilled W o r k e r s in a M a n u f a c t u r i n g Enterprise, 1 8 7 8 to 1 9 3 0 , by E v a n Benner A l d e r f e r . $1.50.

DEPRESSION AND

RECONSTRUCTION A S T U D Y OF CAUSES A N D

CONTROLS

BY

ELEANOR LANSING DULLES Industrial Research Department Wharton School of Finance and Commerce University of Pennsylvania

PHILADELPHIA UNIVERSITY OF PENNSYLVANIA PRESS

1936

Copyright,

1936

U N I V E R S I T Y OF P E N N S Y L V A N I A PRESS

M a n u f a c t u r e d in the U N I T E D STATES OF A M E R I C A

A C K N O W L E D G M E N T

I WISH to take this opportunity to express my gratitude to all those who have helped me in different ways to prepare this book. I wish to thank Dr. Anne Bezanson and Dr. Joseph H . Willits in particular for what they have done to make this book possible and for reading the manuscript and giving me the benefit of their criticisms. Dr. Simon Kuznets has made many helpful suggestions as a result of his consideration of this analysis during its revision. Others have been most generous in reading and criticizing portions of the text. Among these I would like to mention especially, D r . Thomas Balogh, M r . Hiram Davis, Professor Waldo Fisher, Dr. Emily Huntington. I wish also to thank those in the Industrial Research Department, and particularly Miss Miriam Hussey, who have helped in many ways in preparing this manuscript for the press. I can only acknowledge in general terms my very great debt to others with whom I have been associated in different stages of this depression study. ELEANOR February 1936.

ν

LANSING

DULLES

CONTENTS T H E

P R O B L E M

CHAPTER I II III

PAGE

T H E TASK AHEAD THE

Ι

P R O B L E M OF D E F I N I N G C A U S E S

17

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

R E V I E W

IV

THE

W A R HERITAGE

V

THE

SIGNIFICANCE

VI

THE

TURNING

VII

THE

BREAK

OF

49

E V E N T S 80

OF T H E

"NEW

ERA"

POINT—1926

103 135 160

R E C O N S T R U C T I O N VIII I X X X I XII

I N D U S T R I A L B A L A N C E T H E F O U N D A T I O N OF P R O S P E R I T Y

198

PRODUCTION R E S E A R C H

227

THE

252

F I N A N C I A L A T T A C K ON I N S T A B I L I T Y

I N V E S T M E N T AS A N A I D TO B A L A N C E MAJOR

LESSONS

LEARNED

FROM T H E

INDEX

282 DEPRESSION....

313 333

vii

ANALYSIS THE

PROBLEM

CHAPTER I

PAGE 1-16

T H E TASK AHEAD

a. Purpose of the Study b. T h e Present Emergency c. T h e Central Problem of Formulating Economic Laws d. Studies Needed by the Practical M a n II

7 11

T H E P R O B L E M OF D E F I N I N G C A U S E S

a. b. c. d. e. f. g. h. III

1 3

Current Explanations Inadequate T h e Meaning of Normal Complete Explanation Secondary in I m p o r t a n c e . . T h e Inherent Weakness of the Economic System T h e Timing of Depression Economic Inconsistencies as Continuing C a u s e s . . Cumulative Forces and Wholesale Deflation . . . . Summary

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

a. b. c. d. e. f. g. h. i.

17 23 29 33 36 39 41 44

49~79

Four T y p e s of Causes T h e Prime Importance of Policy Errors Five M a j o r Areas of Strain Serious Distortion in International Relations . . . . Wild Speculation and Catastrophic Deflation . . . . " N e w E r a " Ideas and False Policies Agriculture, a Persistent Area of Disturbance . . . Excess in Capital Equipment and Construction . . Errors in Judgment and Policy

49 53 55 57 64 67 69 71 76

A R E V I E W OF E V E N T S IV

T H E WAR HERITAGE

a. b. c. d.

80-102

Paying for W a r Reconstruction Activity T h e Failure to Recognize Readjustment Problems Three Other Changes in D e m a n d ix

80 85 87 91

ANALYSIS

χ CHAPTER

PAGE

e. Fallacious Hopes of Keeping Special Advantages f. Many Questions Still Unanswered V

T H E SIGNIFICANCE OF THE " N E W E R A "

a. b. c. d. e. f. g. h. VI

a. b. c. d. e. f. g. VII

103 110 112 115 120 125 129

132

ΐ35-!59

Three Phases of Development: 1920-1929 A Departure from Normal Rates of Change Physical Production, a Major Sign and Cause . . . The Critical Year A Time of Opportunity The Need for Further Analysis of 1926 Search for Definite Norms and Quantitative Standards

T H E BREAK

a. b. c. d. e. f. g. h.

103-134

A Partial Basis for New Ideas Four General Forms of the Idea: 1921-1925 . . . The Personnel Movement Forecasting Credit and Price Control The Theory of High Wages The "Old E r a " The Nature of Progress

T H E TURNING P O I N T — 1 9 2 6

95 98

135 136 140 142 150 154 157

160-197

Conclusive Errors Lack of Consistent Aggressive Policy, 1927 Financial Excess, 1928 The Security Panic, 1929 Four Stages of Depression Policy, First, 1930... The Freezing of Credit, 1931 The Final Period of Inaction, 1932 Fourth Phase of the Depression, 1933

160 164 169 174 179 183 187 191

RECONSTRUCTION VIII

INDUSTRIAL BALANCE T H E FOUNDATION OF P R O S PERITY

198-225

a. Balance Essential 198 b. Adjustment of Production to Need 203 c. The Choice Between Relative Freedom and More Control 206

ANALYSIS CHAPTER

PAGE

d. The Use of Prices as Guides to Production e. Limits to Production Regulation f. Principles to Guide Production IX

X

XI

zi 213 217 222

227-251 a. The Necessity of Research under Any System . . . 227 b. An Urgent Need for Carefully Interpreted General Studies 230 c. Untested Current Assumptions 233 d. The Formulation of Questions for Research to Answer 239 e. The Understanding of Demand and Price 244 f. Further Study of the Significance of Costs 247 g. Materials and Instruments of Production Research 249

PRODUCTION R E S E A R C H

252-281 a. Money and Credit as Key Factors 252 b. The Hope of Stabilizing Production by Financial Means 254 c. Operating Rules 258 d. Basic Needs and Aims 262 e. Money and the Monetary Uses of Credit 265 f. How to Safeguard Three Major Qualities—One, Accounting Functions 268 g. Two, Elasticity 276 h. Three, Stability 278 i. A More Complex Balancing and Stabilizing Influence 279

T H E F I N A N C I A L A T T A C K ON I N S T A B I L I T Y

282-312 Credit and Investment 282 The Choice Between Saving and Spending 286 Need for Smooth and Efficient Flow of Credit . . . 289 Rising Prices as a Stimulus to Investment 292 Need for a Guiding Disciplinary Agent 294 The Control of Investment 296 Examples of Unmanageable Conditions in 1929 and 1930 . . 299 h. Three Main Dangers in Investment Changes . . . . 301

I N V E S T M E N T AS A N A I D TO B A L A N C E

a. b. c. d. e. f. g.

xii

ANALYSIS

CHAPTER

PAGE

i. Instruments of Credit and Investment Control . . 307 j. The Relation Between Credit and Investment . . . 311 XII

.313-331 Progress Despite Depression 313 Steps Forward 319 Recent Critical Stages 322 The Dependence of Sound Economic Decisions on Adequate Relief 325 e. Responsible Agents for Economic Control 328

M A J O R LESSONS LEARNED FROM THE D E P R E S S I O N .

a. b. c. d.

CHAPTER

I

THE TASK AHEAD P U R P O S E OF T H E S T U D Y

RECENT events have impelled serious thinkers in many fields to try to discern the causes and discover the cure of the depression problem. This study, written in 1933 and the early months of 1934, shares with many others the effort to increase understanding of policy and practical decisions in the economic sphere. Its manner of treatment—inclusive and suggestive rather than narrowly selective—is based on the conclusion that no more simplified approach is sound or useful. T o some extent, the entire territory of political and sociological relations as well as the central problems of production and finance must be canvassed in any constructive analysis. This overwhelming task presents difficulties which make a really satisfactory exposition impossible. T h e bulk of material and the mass of detail tend to defeat the end in view. Brevity is essentially misleading, while a comprehensive analysis confuses with a multiplicity of detail. In the face of this dilemma, it has seemed wise to show at many points the scope and breadth of treatment required and to indicate in the discussion as it unfolds the exacting and urgent task of demonstrating economic principles so clearly that they can be the basis for action. T h e work here undertaken falls into three main parts: first, an analytical discussion of the nature of the task and the relation of theory to policy ; second, a brief, and at the same time inclusive, description of the causal years from 1920 to 1929 and the period of rapid deflation, 1929 to 19335 third, an analysis of problems of reconstruction and prevention. This last section of the study has been divided into two I

2

DEPRESSION AND RECONSTRUCTION

main parts: the first emphasizes efforts to influence the volume of output; the second attempts to control production by influencing value. In this concluding section specific attitudes and measures are urged. There is, however, no attempt to discuss concrete practices or laws. There can be no short summary of the immediate needs of economic improvement or of long-time reform. One or two things stand out, however, as definite guiding principles which must be observed irrespective of time, place, or system of control. These conclusions have been set forth at some length in the text and only six can be listed in an introductory statement. ( ι ) It is essential to recognize certain long-time influences and trends in business decisions even at the cost of short-run profits. ( 2 ) A unit of account, based on well-established monetary principles, is a prime requisite to an active profit economy. ( 3 ) Investment funds are the only effective means of adjusting inter-industry relations and here private and "central" banking institutions exert a critical influence. ( 4 ) No "planning" or "control" can do away with the necessity of making a real profit. ( 5 ) Widely diversified and comprehensive research will be an essential to lasting improvement of economic conditions. And, finally, (6) trial and error methods are too slow to overtake economic change and to make an effective base for policy. Deductive reasoning must move quickly from past experience to future programs in order to keep pace with rapid developments in production and finance. W e come, then, to the urgent task of clarifying intricate economic relationships in a complex political setting. Doubt has been cast on many time-honored ideas and working principles as the economic world has been swept very close to the verge of complete collapse in the course of three years of destructive deflation. It is urgent that statesmen, economists, and business men should marshal all available resources for the difficult task of reconstruction which lies ahead. In this period of stress the decline of many familiar institutions and the hurried introduction of new systems, the rapid shifts of wealth and power, and the threatening shadow

THE TASK AHEAD

3

of internal and external political crises present grave problems. There is need for a concerted effort to combat the widespread confusion and fear as well as the more concrete obstacles in the way of prosperity. Indiscriminate action will not suffice. There must be a serious effort at calm and courageous analysis as a preliminary to the adoption of any far-reaching programs. THE

PRESENT

EMERGENCY

T h e moment in time which became so critical in the history of economic development is marked in the long curve of up and down swings by a deep cleft of falling prices in 1 9 3 0 . T h e steep decline, although almost uninterrupted in its fall, represents in reality not one depression but, from the point of view of causes and characteristics, t h r e e — 1 9 2 9 , 1 9 3 0 , 1931—superimposed, interacting, and highly cumulative in their effects. T h e results of this decline as it has become effective in the everyday life of the individual are as striking as are the shifts in the policies and aims of nations. Very few have been spared so far, and all will eventually share in the grave mistakes of 1 9 2 9 - 1 9 3 4 and benefit by the ultimate recovery in the years to come. These three successive depressions were the result of various causes which call for further analysis, but they united in an almost irresistible pressure for deflation which influenced every branch of economic life and brought many instruments of production to a standstill. T h e situation was made the more complex by the various long-time adjustments which the world was called on to make in the post-war decade. These adjustments took place not only in the economic world but also in education, communication, international relationships, and other spheres. T h e y were all parts of the complex set of causes, but they can be distinguished from the shorttime factors in that they were persistent and deep-rooted or else in that they were to be found mainly in the political and sociological fields. It is sufficiently obvious in retrospect that the world was

DEPRESSION AND RECONSTRUCTION

faced with changes growing out of the war for which it made no adequate provision. This fact was to become increasinglydisturbing. Shifts in boundaries, changes in currency ratios, new hopes of wealth, as well as artificial political interference with international trade and finance, all constituted disturbing elements. These influences might have been modified at a number of points, but as the result of a blind pursuance of ill-thought-out programs, they were recurrent causes of deflation and economic friction. In addition to the world-wide changes, the United States in particular was passing into a new stage of material development. The five most conspicuous signs of this new phase were the leveling off of the curve of population growth, the completion of the spread of agriculture over all the more fruitful areas of the continent, the shift of the nation from a borrower to a lender position, the multiplication of credit instruments, and the increasing complexity and mechanization of economic life. It is true that development in these five directions was hastened by the war, but it was already in sight before 1914. By that time the natural resources of the nation had been pretty well sampled, even if not thoroughly exploited. The shift in immigration policy, combined with a decidedly new standard of comfort and literacy, tended to repress the growth of population. The high degree of development of the capital equipment of industry encouraged a favorable balance of trade and discouraged further borrowings from abroad. Many signs pointed to the need of new markets, external and internal, and a more elastic instead of a somewhat repressive banking system. These two latter tendencies were realized more clearly after 1 9 1 3 as the balance of trade became favorable and the Federal Reserve System developed. At the same time, and in contrast to this new stimulus to enterprise, the emergence of certain new terms, recent in current discussions, indicated the increasing maturity of the nation. For the first time in the United States ideas oí security, stability, and control gained wide support. The restless

THE TASK AHEAD

5

mobility of the worker was more frequently attacked as a vice; there was a real effort to achieve a better consolidation of manpower and skill; and earnest attention was turned to the possibility of a more harmonious adjustment of labor and capital in the interest of industrial welfare. These various altered conditions might not have led to strain or disturbance if they had been recognized more clearly. A s it was, they were f o r the most part obscured by war influences and by the feverish recovery in the years after the 1 9 2 0 boom and collapse. I t was natural that further confusion should have grown out of continuous, rapid changes in methods, while false hopes of financial control by the banks were buoyed up by abnormal market demands. M o r e over, the incomplete liquidations and adjustments of 1 9 2 0 , 1 9 2 4 , and 1 9 2 7 may have prevented those corrections and shifts in institutions and methods necessary at frequent intervals in all profit-making, credit-using, highly specialized economies. T h e holding-over of depressing cyclical tendencies from 1 9 2 1 was the result in part of the interaction of these influences. I t is probable that the 1 9 2 2 recovery was too rapid and l e f t many wages and prices out of line. A period of rapid expansion was founded on a basis of partial readjustment after war excesses. A s fears of insecurity began to arise, illconsidered efforts to support some branches of weaker enterprises, notably in agriculture, led to further disproportions in production. Laissez faire was greatly restricted. T h e n later, as feverish activity drove some prices up, the crash of securities struck an unrealizing public with stunning force. A s the depression deepened, speculative sentiment, disappointed by the failure to work out a comprehensive solution caught hold of first one and then another weakness and made it the vehicle of a widespread decline. T h e dark days of 1 9 2 9 and the next f e w years were the result. A n examination of the economic situation arouses feelings of such grave alarm that many are led to fear a return to the dark ages. T h e rapid pulling apart of a closely knit sys-

6

DEPRESSION AND

RECONSTRUCTION

tem of production, the wholesale waste of time, labor, and capital equipment have entailed a loss estimated to equal more than twelve months of the normal real income of the nation 1 and has certainly made lasting scars on the organic structure of economic life. Closer consideration makes it plain that the trend in the future is not in all likelihood downward. T h e difficulty so far has been mainly in the realm of policy, organization, and planning, and not in any inherent ineffectiveness in the productive processes as they have been elaborated in recent decades. In fact, the critical importance of certain types of decision has become so striking that some observers have gone to another extreme and minimized the importance of improvements in method and process in production. Similarly, they discount the importance of real costs and of all the effort that goes to produce real wealth. They assert that the most serious problem facing a complex economic system is that of the diffusion of purchasing power and the more equitable distribution of income. So far as they are speaking of a tendency and not of an accomplished fact, there is much justification for this emphasis on institutional factors, but society is still far from attaining the effortless creation of goods. Granted that the substitution of mental exertion for muscular has gone on at a rapid pace in recent decades, the time and attention of millions of workers, as well as a great deal of physical effort, is constantly required to sustain life. Indeed, it is at those very times when the greatest scientific advance is being made that mistakes of policy may be most costly. An eçror in judgment or clumsy handling may destroy machines which embody years of labor. False ideas may cripple the economic institutions on which thousands depend. There is thus an ever-increasing call for patiently developed means of cooperation, correction, and control. When the balance sheet of the present is drawn up, it be1 National Income, 1Ç2Ç-32, Report of the Secretary of Commerce (Washington, January 4, 1934), pp. 17, 2$,

THE TASK AHEAD

7

comes apparent that there have been, on the one hand, grave errors in policy and practice which cost the w o r l d a heavy price and, on the other, a rich accumulation of technique and equipment capable of producing immense wealth. T h e machinery of the present is a marvelous legacy f r o m the past. T h e accumulated results of physical, chemical, and engineering science are richly available for the use of those directing economic enterprise. Intricate systems of production, complex factory organization, and detailed knowledge of the best methods of operation can be put into fuller and more efficient operation in a short space of time. Vast networks of trade contacts, selling organizations, habits, standards, and desires are in the main intact. In the opinion of many seasoned observers, it is only temporarily that the development of material and financial obstacles has prevented the smooth flowing of goods from producer to consumer. Unfortunately, the doubts and fears which come with a sharp decline in prices and interrupt the normal marketing processes tend to break down the w h o l e fabric of economic principles which guide wise business decisions. If this process is l o n g continued, a rich heritage of scientific ideas is rendered almost useless because it is misunderstood, w r o n g l y applied, and thrown into general disrepute. T h i s result is one of the most serious outcomes of the 1929 depression. T h e suggestions of a new economic situation made in the previous decade were easily transformed under depression conditions into assertions that an unprecedented catastrophe was taking place. F o l l o w i n g such natural signs of alarm came the widespread conclusion that familiar relations no longer obtained. Once a feeling of general skepticism gained ground, it was easy to throw over many guiding concepts. T H E C E N T R A L P R O B L E M OF F O R M U L A T I N G ECONOMIC LAWS

T h e inevitable l a g of diagnosis and interpretation behind the necessity for action is one of the most serious obstacles to be overcome in a highly developed system of production and

8

DEPRESSION AND RECONSTRUCTION

exchange. I t leads to unreasonable fears, to random changes in methods and institutions, to swift attempts to outplay economic forces by sleight-of-hand, to the elaboration of regulations which are only temporary, and to the recourse to expedients which are admittedly uncertain and untried. Such actions are taken when no clear course can be mapped out and when distress has forced millions to the point of desperation. I t is the first task of the economist to meet the central need for clarity in the thinking about economic relations, to explain the meaning of past experience, and to formulate tentative laws and their application. T h e importance of general economic principles is often underestimated in a period of swift change. T h e neglect, in boom or depression, of those fundamental truths and relationships which make possible the formulation of a few economic " l a w s " leads to strains and disturbances and a widespread feeling of cynicism. A widening of perspective beyond any particular crisis to include a view of the past indicates enduring tendencies of primary importance. Among the most important of these are certain laws of cost which, broadly viewed, indicate the gains and losses involved in various types of action. T h e business man acts according to economic theory in determining his business policy. H e is usually unconscious of the relation between his individual efforts to maximize profits and such theories as those discussed in a variety of academic analyses under the headings of diminishing returns, variable proportions, opportunity cost, and doctrines of interest and rent. Nevertheless, when he ignores these principles in his practical life, he suffers the inevitable penalty. A knowledge of these conditions is an essential to wise policy and any program-making which denies their existence is bound to go astray. T h e process of developing a system of new principles and revising the old will continue to be slow, but persistent effort is urgently needed. Certain pitfalls must be observed and avoided. Moreover, if the economist is to exert any real

THE TASK AHEAD

9

constructive force, he must first undo some of the harm which has come with the confusion of recent years. One cause of confusion has been that those who have set out to clarify general principles have sometimes taken on new and inappropriate functions which make it difficult for them to perform their primary work. They have become journalists or speculators or have entered other related lines of enterprise. In the second place, many have failed to distinguish aims from principles, and have substituted social expedients for universal rules, in the effort to further specific ends. Theorists have also failed, on some occasions, to formulate clearly those questions which must be answered by the research worker and the laboratory assistant if the growth of knowledge is to be swift and conclusive. The alleged failure of economists as a group, which, of course, does not hold for large numbers of individuals, is that they have made no emphatic statement regarding the firm foundations on which they stood and their unanimity on many principles. Moreover, they have allowed the abstract manner of presenting their conclusions, hedged around by many qualifications, to alienate the confidence of the public. Many bitter controversies have been waged in an irresponsible manner to the exclusion of the numerous points of agreement. Meanwhile the man with vested interests, whether business man, politician, or laborer, has taken advantage of these differences of opinion to find on one side or another theoretical support for his immediate aims and has engaged scientists to devote time and effort to the development of programs for particular ends, at the expense of an impartial and unbiased exploration of truth. The work is so vast and the problems are so complex that it is important to have a wise division of labor resulting in a carefully planned effort to synthesize the preliminary as well as the more conclusive findings. The steady trend of specialization in various branches of science can aid economic theory still further. The age is long passed when the barber acted as surgeon, the goldsmith as banker. Similarly a hap-

10

DEPRESSION AND RECONSTRUCTION

hazard combination of specialties can no longer serve economic ends. The concentration of the efforts of different men on immediate and urgent problems, while calling for specialization, does not entail a rigid restriction to a narrow approach, for when it is frankly recognized and made the part of a broad attack on the unknown, such concentration involves a dependence of one expert on another and brings the inevitable recognition that the first stages of discovery are incomplete without the later process of interpretation and combination. The rehabilitation of neglected truths, as well as the full admission of the points of ignorance, is thus a step in the process of conquering error and achieving prosperity which must be taken now. Impelled by the threat of the collapse, not of civilization but of a civilization with which we are familiar, we must direct new effort to conserve and to expand what is good in the worlds of material things and of ideas. There is, in any case, no possibility of the complete rejection of the new aims which have emerged, just as there cannot be an alteration in basic economic laws merely because of changes in certain institutions. There is reason to think that even a violent reaction from recent attempts to impose a framework of cooperation on production would not go so far as to shake off all the ideas and standards which have been outlined in 1934. In some form or other cooperation and rationalization are certain to increase. New hopes and new groups have become important 5 conditions of decency and comfort have been considered possible recently which were not contemplated a few decades before. There can be no calm acceptance of a lower standard of well-being than that which has been held out as a reasonable expectation to the large mass of the people. Any changes, material or intellectual, such as those growing out of the depression go through the sequence of initial ideas, quick action, abuses, reaction and slow, steady working out of new forces, such as those here outlined. They alter for all time the point of equilibrium and swing the zone of action and

T H E TASK AHEAD

reaction inevitably to some extent away from the position of earlier stability. In most cases, the result of swift changes, even of a constructive nature, is that many useful things are lost or destroyed and that many new errors are introduced which may nullify in some part progress at first achieved. For this reason it is more important to move in the right direction than to move very fast. STUDIES N E E D E D

BY T H E PRACTICAL

MAN2

There is a varied and comprehensive mass of data and a rich store of material on depressions available to both the man in the street and to the specialized student. T h e more formal books fall mainly under one of four headings, that is, theory, history, reform, or special aspects of the depression. There remain, however, serious gaps calling for additional effort. T h e inadequacy of this large body of writing is due in part to the failure of synthesis to harmonize varying explanations and of analysis to present clear and acceptable definitions. As soon as possible, theorists and research workers should be asked to restate many of their basic assumptions. They will recognize then that there are five steps in the further progress of their analysis. They must appraise their equipment at its true worth and make a clear declaration of the principles to which they hold. This work is a combination of deductive and inductive analysis ; when it has been carried further the handicap of meaningless contradiction can be cast aside. By the sound and not impossible process of formulating more careful definitions, economists can stimulate a much needed development of the common language for the discussion of concepts now for the most part lost in the muddy " The World Degression igig, Λ List of Books and Pamfhlets in the New York Public Library, compiled by William W. Shirley (New York, 1 9 3 4 ) . See also references and bibliographies in The Encyclofaedia of the Social Sciences., vol. iii, "Business Cycles," pp. 9 3 - 1 0 7 ; A. H. Hansen, Business-Cycle Theory (Boston, 1 9 2 7 ) ; W. C. Mitchell, Business Cycles, The Problem and Its Setting (New York, 1 9 2 7 ) ; W. M . Persons, Forecasting Business Cycles (New York, 1 9 3 1 ) ; and other standard works. The work of developing and keeping up to date depression bibliography is a highly specialized task. The best present guides are the references in five or six outstanding works on the subject. See infra, pp. 30 and 54.

12

DEPRESSION A N D

RECONSTRUCTION

water of loose phrases. T h e n again if scientists, because of political or social theories, prefer to increase the leverage of one force and minimize that of another, this preference must not be confused with the conclusions of scholarly work but recognized, rather, as a deliberate political choice.3 Furthermore, if ideas lag behind the need for decision and action, that lag, too, must be taken into account so that an economical use of limited time and resources can be made. There are many books on this and earlier depressions, but no one of them can stand alone because of the immense area to be covered and the variety of questions involved. In all the unavoidable variety of treatment and difference in theory, it is useful to recognize the four types mentioned above. A careful survey must also take cognizance of another mass of literature covering the earlier price movements and monetary experiments in the eighteenth and nineteenth centuries, particularly discussions in the time of Ricardo. E v e n in the period before the development of factory production and credit, in the eighteenth century, there are suggestive analyses of trade fluctuations which describe strains and adjustments similar to those in the present. T o a certain extent, the results of these earlier treatises are embodied in recent discussions, but this assimilation cannot be taken for granted, for there has been a widespread conclusion that this depression is peculiar and unparalleled, a conclusion which has interfered at some points with the possibility of learning the lessons of the past. Contrary to these views, it may prove that the inevitable recurrence of such problems as the bringing into balance of cost and selling price, consumption and investment can be an important aid to the solution of difficult questions. A number of challenging studies of the depression have grown out of an opposite assumption of persistent and progressive change in important economic relations. T h e y have "Lionel Robbins, An Essay on the Nature ani Significance of Economic Science ^ (London, 1932), p. 129. "As we have seen already, there are no economic ends."

T H E TASK AHEAD

13

tilted the curve of future long-run tendencies in mechanization, debt accumulation, consumption, or investment to the unusual angle of depression peaks and declines. The Technocrats, for instance, because unemployment has been increasing at an exceptional rate during depression years, have sometimes projected the curve of this increase into the future as a possible trend line. They have refused to average the recent past with the period that has gone before and, instead, forecast the future in terms of sharp up or down swings. In so doing they have denied the validity of applying old principles and tests or of assuming the persistence of former relations. In place of an elaboration of the accepted theories of the past in terms of new situations, they call for an aboutface, not only in programs but also in the interpretation and classification of ideas and forces. The books written on the assumption of drastic change or revolution constitute one of four or five types of depression studies. They fall sometimes under the heading of new theories, and sometimes in the group of programs and panaceas aimed to change laws and economic practice. In almost every case the approach, because it tends to emphasize the newness of a situation, runs in terms of specific and often sporadic manifestations rather than in terms of the underlying needs and conditions which lie back of the particular phenomena. So far as they correctly appraise shifts in the economic forces of the moment they are extremely useful, but they cannot, of course, supersede or nullify the importance of the more searching and profound studies. Even though there is at times an apparent conflict between new theories and reforms and the slower progress in reformulating older economic principles, the theoretical attack on the problem cannot be relinquished. The most serviceable criticism of general theories has, therefore, been directed not so much to the point of view which leads to this abstract approach as to the imperfect recognition in many cases of the need for expressing general conclusions in a form which will show how they touch on specific proposals. Clearly there

14

DEPRESSION AND RECONSTRUCTION

must be a more complete recognition on the part of the man who formulates abstract principles that business decisions cannot wait indefinitely for his final word. Both the reform literature and the abstract analysis have lagged behind swift-moving events, and both will have to be restated or revised later in terms of more mature j u d g ments based on recent experience. There have been attempts already to outline some parts of the history of the depression and the years when the causes of later difficulties developed. The studies of the National Bureau of Economic Research have rendered conspicuous service in putting a large body of facts at the disposal of the student. Naturally, in all such studies of the depression the ability to draw broad conclusions is limited by the nearness to the object, and history, so far as that term means a complete and seasoned account, has had to wait on time. Even now, however, a preliminary history is growing up and a careful survey of the books which present the raw material for theory can lead to important conclusions. In addition to these three approaches to the problem— theory, reform, and history·—there are also a number of books which take up special divisions of the depression question. Such aspects as the gold standard, mechanization, bank credit, and agriculture have been marked off from the larger area of interrelated factors in order to make possible special attention to detail and a more closely reasoned treatment of complex problems. None of the books which might be listed under these four headings, however, can give a solution to the whole problem. None of them is able to show how to go forward confidently in a sound uninterrupted development. There is frequently and almost unavoidably a one-sidedness of approach that leads to profound skepticism. In those cases where the author has brought forward an alleged cure, no one has been able to achieve that difficult task of foreshadowing, in one great effort, the economic thinking that will be bound to occupy the theorists and historians of the next decade. T h e task is

T H E TASK AHEAD

15

too great for any small group of people or for any short period of time. There is too rapid a movement in most of the series of interdependent factors. No single analysis can serve to elucidate all the complexities of the practical situations which business faces. And yet, in spite of the incompleteness in even the best of the literature, there is no reason for complete discouragement. Facts are there, assumptions are there, and an underlying foundation of established truths remains as a support for further work. Economic science, which was applied first to small units when life was simple and undifferentiated and was gradually extended from the household to the village to the nation, is now forced to develop a synthesis which will extend over the whole network of world relations and also, as far as possible, over long spans of time. If ideas respecting profits and production are entirely relative to conditions of the moment there is little help available in handling the changes that occur so rapidly in modern times. It has taken a prolonged period of distress to demonstrate the urgent need of further steps in thinking and planning. Meanwhile, the theoretical economist has fallen temporarily into disrepute in some quarters. H e has lost ground partly because he claimed too much. H e was not quick to interpret his material during rapid changes of economic relations. H e stuck too close to stereotyped headings; he omitted for the most part the consumer's problems, and he made vague assumptions regarding theory. Such practical situations as those caused by cut-throat competition, dumping, unstandardized interference with foreign trade, and many frictions and lags escaped his attention or were covered by the phrase "other things being equal." Absorbed by his difficult intellectual puzzles, he failed to recognize quickly enough the vital importance to the real world of the points of disagreement or uncertainty in his analyses. Meanwhile, the practical economist has picked theories here and there and used them as the basis for a vigorous drive to accomplish something. T h e resulting confusion of thought and action has been serious,

16

DEPRESSION AND RECONSTRUCTION

but there is reason to suppose that it will give place eventually to a calmer period of revision and analysis. Even before the emergency is passed, however, it is important to reshape thinking so that it may fit both the unchanging realities and the more conspicuous facts of the moment. The complete study which explains the depression can be written only after the work of hundreds of men is brought together. Long before it is written, however, preliminary assumptions will here and there be discarded in favor of new portions of knowledge. The world will move haltingly but persistently from tentative assumptions to demonstrable facts and will, at the same time, bring forward new aims calling for constant flexibility of interpretation. Because of the changing rates of change, the problems of economics are in many respects unsolvable. Man uses each point of security as a platform from which to reach for more prosperity. To those with imagination, the challenge of fact and the incompleteness of theory bring a constant enlargement of the field of vision.

CHAPTER II T H E

P R O B L E M

O F

D E F I N I N G

C U R R E N T EXPLANATIONS

C A U S E S

INADEQUATE

CLEAR understanding of the general nature of depression causes must be a first step before the identification of specific causes can be made. This process of clarification in its turn presupposes certain basic assumptions. Moreover, it must be recognized that, just as reconstruction is the purpose, so a capital-using, profit-seeking, relatively free 1 economic system such as that described by classical economics is the background and atmosphere of further analysis. The explanations here sought must then suggest new action, indicate past responsibility, and harmonize with those general conclusions of economic history and theory which are reasonably well established. It is relatively unimportant to focus attention on uncontrollable and immutable forces, for instance, if the purpose of the inquiry is to increase stability. Similarly, even though certain long-time tendencies may accentuate fluctuations, if they are considered desirable in the interest of material progress they should not be given prime importance in a search for necessary reforms. The victims of the depression, and in some way almost all are victims, are not concerned with a purely abstract description of economic relations. They are seeking to discern causes in the interest of reconstruction. They wish to lay hold on those factors and forces which can be reshaped to improve economic life. For this reason all mystical or philosophic discussion must be subordinated to emphasis on those recognizable acts which were important and which might conceivably have been different if knowledge or policy had been different. A

1 There is much comment on increasing rigidity in the economic system, but improvements in transportation, communication, and variety of products have so increased choice that doubt is cast on any hasty assumption that there is less real freedom.

17

18

DEPRESSION AND RECONSTRUCTION

If one ignores for the moment these criteria, one finds a multitude of explanations of the depression. The public has been supplied with hundreds of reasons and has invented additional theories of its own. There are dozens of books to tell how the trouble came about and any number of programs to prevent the recurrence of the disaster. Much of value is to be found in this varied mass of material, but in spite of all this effort, men of power and intelligence are still, for the most part, groping blindly in a maze of conflicting ideas. The reason for the confusion is not far to seek. The very intensity of the desire to understand what has happened has driven many thinkers to extremes. They have either seized on one obvious type of disequilibrium and have tried to expand it into an explanation of everything that has happened, or else, impressed by the multiplicity of change and the variety of its manifestations, they have attempted to outline theories so comprehensive and so abstract that it would be possible to include in their compass every separate aspect of the problem. The average man, placed between these two extreme types of theories, finds no point at which he can take hold. His common sense knowledge of the nature of human affairs quickly rejects a unitary explanation. H e knows from his own experience that many different exaggerations and maladjustments have developed in his economic environment. On the basis of everyday observation he is convinced that the attempt to invent adequate descriptions and to stress vital interconnections does not permit a completely homogeneous theory. Moreover, he finds the abstract explanations which depend on inclusive hypotheses and apply to all time and all space completely unusable. Every one is willing to grant the existence of certain underlying forces which persist or recur, but in the new form in which they appear may lie the destructive force which confuses and disorganizes business relations. Every one is willing to recognize that some one economic force such as defla-

P R O B L E M OF D E F I N I N G CAUSES

19

tion, speculation, labor displacement, or war comes to exert an all-powerful influence at certain times. It is still true, however, that as time goes on one such influence may be replaced by another equally disturbing in its effects. It is evident, therefore, that more specific and at the same time more comprehensive explanations are needed to aid in the search for causes. Theories must develop gradually by means of the patient efforts already under way to accumulate fact and clarify opinion. T h e y must have a pragmatic validity and also achieve a satisfactory synthesis of all the more valuable though fragmentary theories. I f , for example, a theory of cause is to be of use it must emphasize in a definite manner those points in time and space at which a different policy in business or in government might have lessened the danger or prevented the collapse which constantly threatens an essentially unstable system. 2 T h e object of an explanation is to show those who make the practical decisions of economic life clearly when to act and when to wait. T h e y must know not only the general aims which can be formulated in vague terms but also a good deal concerning the advantages and disadvantages of various methods of intervention. This is a high standard for any theory to meet, but fortunately past experience can give some guides to future action. In the face of so difficult a task, there must be an attempt to unite all possible resources in a cooperative effort to solve the problem. One part of this work is to make clear a common basis of admitted truths. These remain even when conditions change. T h e r e is a natural tendency for economic variables to fluctuate, but even this instability can be incorporated into a reasonable and permanent body of theory. Production is carried on for future consumption and to-morrow's demand for goods manufactured to-day can never be accurately measured or definitely forecast. T h e most usable manifestas Since this chapter w a s w r i t t e n in 1 9 3 3 , J. M . C l a r k ' s exposition of "strateg i c f a c t o r s " has been published and g i v e s a v a l u a b l e treatment o f this g e n e r a l point of v i e w , Strategic Factors in Business Cycles ( N e w Y o r k , 1 9 3 4 ) .

20

DEPRESSION AND R E C O N S T R U C T I O N

tion of this chronic uncertainty is found, under the present system, in fluctuations of the price level, but the same general condition would exist in some other form if demand should no longer be expressed in money terms. Nevertheless, it is true that certain types of economic systems have come to exaggerate these shifts in demand. In recent years, for instance, they have been multiplied manyfold by means of credit, large-scale capitalization, and speculation. It is even true that, although credit and similar influences are not causes in one sense, they do multiply the effects of small fluctuations.3 Since these small fluctuations are easier to master than the more violent swings, the institutions and methods which tend to exaggerate initial fluctuations are in a sense the causes of the later difficulties. It would facilitate progress, however, if it were generally agreed that the uncertainty of demand, the sensitivity of credit, and other underlying characteristics of economic life cannot be taken as the only points of leverage in preventing depressions, since they will not in all likelihood be eliminated from the modern world. Once the increased effectiveness of a specialized, capitalized productive machinery has been widely recognized, it is impossible to go back to the primitive state of self-sufficient economic life on a low level. For this reason, it is safe to assume that fluctuations in the relation of goods to desires will continue to occur on a large scale and in all future civilizations. It is at this very point—changes in demand—that most of the popular theories attempt to find both cause and cure. Even the popular but sometimes crude overproduction theories are frequently reshaped so as to emphasize the fact that the supply is in excess only because of the failure of consumption to respond to the new possibilities of production. Most analyses, however, have shifted their emphasis quite deliberately to the purchasing power side of the delicate * T h e fluctuations of prices and production in the Philadelphia area since 1720 amply demonstrate the existence of other causes. Anne Bezanson, Robert Gray, Miriam Hussey, Prices in Colonial Pennsylvania (Philadelphia, 1 9 3 5 ) -

PROBLEM OF DEFINING CAUSES

21

equilibrium. They find that one arm of the balance fails to exert the amount of pressure which is needed to keep the relationship stable in a time of increasing creative efficiency. This line of argument cannot be successfully refuted unless the reasons for its prevalence are taken into account in some sound theory. Depending on the point of view, however, the apparent glut of the market may be either the cause or result of a deficiency in demand. Looked at from one angle and in respect of certain aspects of change, these diverse theories are almost all right. There is a disastrous and progressive shrinkage of markets in every industrial depression. In recent years many different groups of buyers have withdrawn from the market. One country after another, successive income groups, and different types of persons have failed, by choice or by necessity, to take their share of goods. Here again, however, as in the case of the more abstract equilibrium theories of the classical economist, these popular theories have fallen short of their goal in that they have failed to give impelling guides to action. There is, it is true, no scarcity of suggested cure-alls growing out of these comprehensive explanations. For instance, those who allege that the overmechanization of industry has been the force which has destroyed buying power would reverse the course of progress and substitute an artificial demand for men instead of machines. Those who think that wages lag behind profits and investments would use law and coercion to subtract from one income group to increase the purchasing power of another. Those who think savings withdraw too many funds from spending would intervene in an aggressive way to prevent more investment. Others who hold that money seeps out of active circulation in a destructive way would meet the deficiency by initiating inflation, that is, artificial purchasing power at some point. A t first glance many of these theories seem to provide charts to determine the possible course of the economic system in the years to come, but there are disturbing contra-

DEPRESSION AND RECONSTRUCTION dictions between the best of them. Moreover, the logical analysis which they offer is insufficient to guide practical choice. M a j o r difficulties remain in making wise plans on the basis of sweeping criticisms of the main characteristics of production and exchange. T h e more helpful of the theories put forward must be fitted into a complex mosaic whose outlines are as broad as all economic life. There is, without doubt, a measure of truth in many of the suggestions and criticisms of systematic and institutional weaknesses. T h e r e are times, for example, when swift mechanization may lead to overrapid obsolescence ; there are times when investment in capital goods is out of balance ; there are periods of hoarding, and years of unjustifiably low wages. A l l these factors and many more growing out of war excesses and peace-time mistakes have cut down the buying power of nations, but business men can seldom act on the basis of most of the schemes, Utopian or contradictory, so f a r outlined. T h e criteria of a useful explanation may change somewhat with the passage of time, but they may be formulated briefly here for the purpose of this study. In the first place, it is important to observe that no particular theory can be a sound basis for action unless it can be fitted into the framework of comprehensive generalized explanations which have stood the test of time. In the second place, no causes can be considered of consequence in the practical world unless there can be found some clearly defined examples in economic experience since 1900. In the third place, no one of the simpler explanations can be held to be valid unless it applies to the experience in different countries, for the depression has taken on different forms in different places. Finally, analysis of the significant relations must point to actions on the part of business men and others which may be adjusted to further the aims of a sound stability. In analyzing the problem it must be recognized that the points of unbalance have appeared in widely separated areas of business life and yet the major disturbance has been everywhere the same. On the basis of a few such tentative rules it is possible,

PROBLEM OF DEFINING CAUSES

23

then, to proceed to a preliminary consideration of a few points in depression theory, to attempt to find particular identifiable representatives of the general concepts in the stormy history of the post-war period, and to try to knit together the various explanations and programs in a coherent and usable form. THE

M E A N I N G OF

NORMAL

A n y recovery program or constructive reform is on the defensive unless it is clearly directed to eradicate the m a j o r causes of abnormality and distress. If it does less than this it can offer only palliatives. A search for the causes and an attempt to describe them in a useful way, so necessary to a constructive policy, calls, therefore, for some consideration of what is normal and what is prosperity. T h e s e terms are not easy to define since the most reliable indications of the economic situation are usually found in curves which show a continuous fluctuation of values and quantities over time. M e r e change in variables is thus no sign of danger. M o r e over, it is impossible to take one year in the curve of exports, of wheat prices, or of any combined index or average and say that all departures f r o m this level are abnormal. T h e complexity of the interconnections of economic factors rules out any such simple statement. T h e r e is no real starting point ; there is no fixed center of gravity. Nevertheless, it is fairly clear in practical experience w h e n a state of depression prevails. T h e theorist is apt to refer to the condition which is termed depression as a marked disturbance of equilibrium. T h e general observer thinks of it more specifically in terms of largescale unemployment and the decline of the v o l u m e of production below some previous average established in recent years and considered to set a standard of accomplishment. A clear idea of what is normal is certainly an essential part of the analysis of depression causes, but such an idea inevitably escapes precise definition in a dynamic and changing world. Nevertheless, more clarity must be injected into the

DEPRESSION A N D

RECONSTRUCTION

discussion because there is reason to believe that much of the trouble which has occurred in the past was due to an inexact idea of what was meant by balance and what was to be considered a healthy state of affairs. A typical example of a false concept of the normal is the idea that a particular price trend or level, such as that prevailing in 1926 or some other year, is essential to a proper adjustment of factors. Some one general average of prices may be better than another at a given moment but it is not a necessary characteristic of normal economic life. A generalized description of well-adj usted equilibrium would take into account the unceasing changes that go on between prices and other forces. 4 T h e realistic description of a flowing complex of interrelated parts is a more difficult concept than the more static descriptions of equilibrium, but the simplified statements of balance are misleading at important points. T h e process of change between economic factors has proved to be necessary and healthy and is not usually a cause of upset. F u l l account must be taken of the dynamic nature of production and exchange. A t the same time it must be recognized that the closely knit economic system cannot sustain unusual and persistent pressure in any one direction without grave loss. T o put the matter more concretely, it is clear that ratios of cost to selling price undergo gradual change, but a sudden large rise in a number of prices, distorting many relationships, may stop production in several areas. Similarly interest rates rise and fall slightly from year to year, but any sharp fluctuation will interfere with the investment of funds. T h e number of workers in different trades varies inevitably from time to time, but the sudden cessation of demand for any particular kind of labor will work severe hardship. Gradual changes in the size of debt are easy to absorb, but a sudden increase or decrease may bankrupt a nation. Experience has shown that some ebb and flow is necessary to renew economic life blood, to permit the replacement of old parts, 4

A. C. Pigou, Industrial

Fluctuations

(London, 1929), pp. 207-226.

P R O B L E M O F D E F I N I N G CAUSES

25

and to allow for the emergence of new methods and inventions. Moreover, deep-rooted in human habits of thought and action is a desire for change which sometimes finds expression in the meaningless substitution of one style for another but which serves indirectly as a constructive influence so far as it tends to promote a flexible and creative attitude. Occasionally it can be an important force in the onward movement of civilization. Such difficult points of discrimination as these make the definition of normal in any short formula an impossibility. Striking evidence that the abnormal must be distinguished in degree and not in kind is seen when one recognizes that some characteristics of a normal period are beneficial in a mild form but are a highly destructive aspect of depressions when they are extreme. For example, some price changes are admittedly good, even though it may be desirable to keep the fluctuation of the general average of prices within a fairly narrow zone. It is unthinkable, for instance, that the prices of obsolete and undesirable commodities should be kept up to some arbitrary point, just as it is unreasonable to expect that new inventions and new products can be successfully promoted if they are priced for considerable periods above the reach of the general public. The possibility of adjusting the prices of all commodities so that the inevitable gains and losses will offset each other is interesting to contemplate, but such an objective must be gained, if at all, by some process of compensation and it is not likely to be furthered by introducing more rigidity into the price system. In any case, even with respect to the more standard commodities, the price relationships and not the level as compared with a past average are of major importance. Moreover, under any form of stabilization or control there will inevitably be some bankruptcies, some defaults, and considerable labor mobility which may result in acute unemployment at some points and temporary labor shortages at others. Natural growth and the renewal of economic vitality call for such changes.

26

DEPRESSION AND RECONSTRUCTION

A l o n g with many short-time fluctuations in both directions, the past indicates that there are apt to be slow progressive movements to decrease hours of labor, to increase physical production, and even, according to some methods of comparison, to equalize the shares of wealth going to different groups. 5 A n y one of these or similar tendencies may, if accelerated beyond a point which can be only v a g u e l y determined ahead of time, rack the intricate system of interconnected parts and bring about a sharp recession. A l l of them have been characteristic of prosperity for decades. T h e depression is already well under way, however, when the customary volume of unemployment doubles or trebles, when price fluctuations are so large that all values are drawn in one direction for a considerable time, when the fluctuations in income are v e r y marked and lead to widespread failures. W h e n this stage is reached, general uncertainty leads to a cessation of the operation of large groups and units of industry. Widespread poverty is the sign and the dislocations are the intermediaries or instruments by which the process of getting and spending wealth is seriously deranged. T h e conclusion which must be drawn f r o m any survey of depression characteristics is, therefore, that it is not the changes but the rates of change which are significant. T h e r e is no one factor which brings about collapse unless that factor goes to an extreme in terms of standards and relations established in the recent past. 6 N o maladjustment becomes important until it is prolonged and multiplied by aggressive action on other forces. T h e sign of approaching disturbance * Although the differences between extremes of wealth and poverty may be greater, the inner two quartiles of income distribution probably show less essential differences in well-being; in fact those individuals whose income was close to the average income gained in real wealth. Some evidence on this point may be found in a comparison of wages, particularly skilled wages, with dividends, and then in a consideration of this ratio in connection with the rising trends of both. See also the steady increase of taxable income and of numbers paying income taxes. Morris T . Copeland, " T h e National Income and Its Distribution," Recent Economic Changes in the Unitei States ( N e w Y o r k , 1 9 2 9 ) , pp. 767, 831, 835. ° These standards must be used with due allowance for infant industries. See infra, Chapter VI.

PROBLEM

OF DEFINING

CAUSES

27

will not be new situations so much as rapid acceleration of the processes by which various elements are renewed or replaced. Charts which show a rising ratio of movement, an increasing percentage of gain or loss in important fields, will be the best signs of the need for preventive action. This dangerous rate could be represented by a concave or a geometric curve. It is neither possible nor necessary at this point to elaborate the accepted ideas of balance and mutual adjustment. These abstract formulations of facts are found in a large body of theoretical writings easily available to the reader. It is important rather to indicate the variation in ideas of prosperity and to reiterate the conclusion that large-scale unemployment is the one major and infallible sign of depression, and that this degree of unemployment is only significant when it exceeds a certain customary percentage of the population. Furthermore, even this sign is relative to certain conditions, for if it should come about that wage rates in any society were completely flexible and fell with the falling money demand for labor, there might be no unemployment and yet an acute depression situation, accompanied by a declining standard of living, might prevail. Some other criterion of depression conditions would then be needed. For the present time, however, this one is the most serviceable. 7 T h e task ahead is, then, to find causes of economic dislocation which are accompanied by large-scale unemployment. 8 It is essential to find what is behind the unusual rates of change which tear apart the economic fabric and make both production and sale diminish sharply in volume. If this work of analysis is to serve any purpose, the factors which seem responsible must be described in everyday language and not in mystical terms. It is generally granted that the prime need is for guides for the policy of governments and for the daily decisions of men of affairs. So far as possible, it would be helpful if causes could be listed as more or less separable factors or as distinguishable areas of activity which are famil7 Account must be taken also of the growing awareness and increasing accuracy of recording unemployment. " A . C. PigOU, The Theory of Unemployment (London, 1 9 3 3 ) , p. 6.

28

DEPRESSION A N D

RECONSTRUCTION

iar and in which measures of reform can be contemplated. In many cases constructive effort is apt to intensify and project further various former attempts to safeguard economic stability. M a n y of these familiar procedures have the stamp of past success to give them acceptability j some, not so familiar, are justified by the best a priori reasoning of the past decades of economic thinking. T h e attempt to describe and define the depression situation, difficult at best, is somewhat facilitated by efforts to characterize prosperity. H e r e it is essential to distinguish boom expansion from a smooth and healthy functioning of the economic system. For this reason neither money profits, rising prices, nor the volume of production is a sufficient guide. A l l three are important aspects of the situation, but they must be appraised in such a manner as to show, for instance, whether or not the apparent profits of one year have anticipated the gains in the future, whether price changes are inflationary, and whether markets can absorb a rising volume of goods. Without disregarding these three elements or the variety of price movements that can accompany good times, it can be said that there is no real prosperity unless the standard of living of the masses is rising. Clearly unemployment of more than five or ten per cent of the industrial population 9 is a sign and, looked at from one angle, even a "cause" of depression. Prosperity depends inevitably on many things—on a fairly steady use of production factors, particularly men and machines, on reasonably predictable conditions in industries which permit most concerns to keep earnings above costs, on saving and investment, and on a spirit of hope, as well as on a standard of living which is rising through a change in the ratio of population to desirable goods. T h e "normal" situation for which all ing is manifested not by steadily rising erate fluctuations and a flexible balance. goods more evenly distributed. It brings

economists are curves but by It depends on as by-products

* Sir William H. Beveridge, Causes and Cures of Unemployment 1931), p. 5; Unemployment (London, 1930), p. 39.

strivmodmore more

(London,

PROBLEM OF DEFINING CAUSES

29

health, more leisure, a more varied and probably a richer type of life. Depression robs men not only of present but also, when prolonged, of future well-being. C O M P L E T E E X P L A N A T I O N SECONDARY IN I M P O R T A N C E

It is natural that a great deal of the study of the causes of depression has been directed to the attempt to find one comprehensive explanation. It is important that there should be continuous progress in the clarification of ideas in this realm. Obviously nothing short of a generalized theory, applicable to many instances, is satisfactory f r o m a philosophic standpoint. Nevertheless, this type of explanation is not the prime requisite for constructive action in the economic world. Other approaches to the depression problem may be more immediately important. A general theory, when it has been formulated, must run in terms of more or less permanent economic elements and institutions. T h e laws of human behavior, physical conditions of production, and other immutable or slowly changing factors w i l l f o r m the core of such a theory. Unless it is expressed as a result of some such enduring forces, it fails to cover the many cases to which it is supposed to apply. T h e v e r y nature of such a type of explanation, however, makes it difficult to use. It is of value mainly because it indicates certain typical weaknesses or exaggerations, but it fails in that it gives little or no clue to remedial action. It is even now possible to outline certain obvious allinclusive explanations which do not contradict each other even though they may seem to do so at first glance. T h e r e is already a system of business cycle theory which is of real and growing importance. M o s t explanations which have been seriously brought forward by seasoned economists fit somehow into this body of thought. T h e y are true, but they often seem at first glance to be in conflict with each other because they emphasize different phases of the economic depression or different angles of attack. In any case, they are limited in usefulness in that the implications of most of these all-in-

30

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elusive explanations cannot be worked out in practical measures which apply directly to specific instances of economic dislocation. It is clear, for instance, that in a profit-making society, when the profit differential disappears, or even threatens to disappear, production will decline and unemployment w i l l increase. T h e failure of the profit incentive may, therefore, be given as a cause of economic depressions, but such an explanation is not a good aid to the policy-maker w h o must attack practical problems at a specific point. Similarly, it is obvious that the decline in the demand for goods in any terms, that is, in money or in psychological desire, w i l l bring on depression, so that the fall in the price level is alleged to be the general reason bringing about large-scale unemployment. N o one can say that this explanation is false, but no one can claim that it makes prevention much easier. T h e n again, it can be stated quite definitely that if costs are relatively rigid while deflationary tendencies exist, a large part of the productive machinery will be brought to a standstill. T h i s manner of stating a problem is undoubtedly sound, but so far as it suggests lines of future policy, its implications are too broad to bring about quick constructive action. Statements such as these, found in the writings of serious students of business cycle problems, 1 0 are v e r y h e l p f u l to clarifying thought, but they do not constitute all-sufficient explanations. E v e n when they have been set forth in clear and unequivocal language, they merely prepare the w a y for a search further back among earlier causal factors for anterior reasons. T h i s search is apt to result in further concepts, comprehensive, stimulating to thought, but too general for immediate use. It is possible, for instance, to find such underlying, independent reasons in changes in weather conditions, 10 A . H . Hansen, Economic Stabilisation in an Unbalanced World (New Y o r k , 1 9 3 2 ) , pp. 1 5 6 , 2 8 1 ; W . C . M i t c h e l l , "Business C y c l e s , " Encyclofœdia of the Social Sciences, v o l . 3 ( N e w Y o r k , 1 9 3 0 ) , p. 1 0 4 ; see also sufra footnote 2, p. 1 1 . T h e authors' names in the text and footnotes hereinafter cited are recapitulated in the index to furnish a suggestion of f u r t h e r e x c u r sions into the vast literature o f the subject.

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31

in fluctuating human moods, in the shift of political forces, or in the frictions and delays which prevent the proper coordination of the complex economic factors in a specialized society. Interesting as such a task may be, it is decidedly less urgent than the more practical work of seeking out typical weaknesses which can be recognized by men of affairs or of government and typical areas of disturbance or of interruptions to the flow of production and consumption. Nevertheless, it would be unfortunate to minimize any effort which may be made to reduce these many studies of causes to an orderly system of ideas. Some of those who are endeavoring to render this service are trying to trace an intricate pattern of symmetrical curves which represent the fluctuations in economic factors. They seek to demonstrate a regularity of movement which, if it exists, will be of considerable help in preventing extreme movements in either direction. T o a certain extent, a demonstration of periodic up and down swings in any economic values would make it less necessary to seek further generalized explanations. From another point of view, the proof that these fluctuations occur would merely make more definite the further work of investigation for those who wish to seek the causes behind these rhythms. 11 T h e incompleteness of such theories is not, however, the main criticism which must be directed towards them. T h e difficulty is rather of a more practical nature. It comes from the fact that even when this knowledge has been achieved, its importance to stabilization will be limited by two things. In the first place, the changes in value which are expected to take place according to the formulée, based on actions and reactions over a period of time, will constantly be modified both in time and in amount by deliberate speculation.12 For instance, when it is known that foreign exchange requirements in certain money markets increase regularly at given 11 Joseph A. Schumpeter, The Theory of Economic Develofment (Cambridge, 1 9 3 4 ) , pp. 2 1 2 - 2 5 1 . 12 Compare J . M . Clark's statements on the paradox of knowledge and error in using forecast, o f . cit., p. 162.

32

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seasons, speculation anticipates these demands and so changes the time at which the increase of purchases occurs. This general process is carried on in every department of economic life in which the assumption of recurrent fluctuations can be reduced to mathematical formulas or recurrent sequence of changes. In the second place, the point at which the many different curves converge or cross would be the unpredictable result of the complex interaction of many factors, and yet it is this point about which we need most knowledge if we are to use these curves as a guide for action. It is clear, for instance, that the fluctuations of the variables which are represented by these curves do not necessarily act on the economic system in a destructive way unless they come to move in the same direction or unless a many-sided compensation of rise and fall fails to maintain a general state of balance. It is probable that the movements of productivity in many branches of industry and trade may be expressed eventually in terms of mathematical laws. It is likely that inventiveness, optimism, free spending, and capital investments change in a somewhat predictable fashion from time to time. It is useful to know all we can about these and similar phenomena, but it is not possible to wait for the ultimate clarification of these problems while other more specific flaws in the economic system call urgently for aggressive intervention and reform. A broad survey of the theory of economic crises and business cycles indicates that most of the general explanations fall into one of the two classes suggested. They are either comprehensive descriptions of the failure of the motive power which keeps enterprise going, or they are more concrete attempts to reduce to mathematical terms the somewhat regular changes which the quantitative data suggest. Both approaches posit the fundamental instability in the relationships of one part of the economic machine to another. Neither can forecast the particular causes which may bring about the next depression. Their strength as well as their weakness lies in their generality. Gradually, as knowledge is added to as-

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33

sumption and as abstract principles come to be expressed in more definite terms, this body of theory will take on a larger usefulness than it has had in the past. A t the present time, unfortunately, the gap between abstract analysis and the remedies of the politician and the business man is very wide and accounts for much of the confusion and lack of direction in practical life. T h e further search for causes must therefore be divided into four parts which call for some additional elaboration. There is, first, the task of explaining the persistent weakness of the economic system. T h e r e are, second, random, precipitating causes which are of minor importance in and of themselves, but which reveal at what point in time an emergency situation has become actual. T h e r e are, third, those policy causes and errors, some early and some late, which prevent corrective reactions and obstruct balancing tendencies normally operating to keep fluctuations within narrow limits, 13 and there are, in the fourth place, those factors, mainly financial, which prevent or delay recovery by exaggerating a decline and increasing the movement in one direction. 14 These different types of causes can be singled out and identified in the case of each major depression. Each one is of special concern to those formulating national policies, each one has a bearing on the problem of prevention and recovery, but those in the third group are of constant and urgent importance. T H E I N H E R E N T W E A K N E S S OF T H E E C O N O M I C S Y S T E M

Enough has been said already to indicate the general recognition of the instability of economic relations. T h e uncertainty of values is the ever-present causal condition which makes possible both the minor swings and severe depressions. This uncertainty seems often to be the outgrowth of institutional factors, but conclusions on this score (often the result of superficial thinking) do not get to the core of the problem " T h e s e are to be compared to J. M . Clark's "responses," though they differ in some respects, of. cit., pp. 187-190. 14 These are discussed further in Chapters III to V I I .

DEPRESSION AND RECONSTRUCTION

since insufficient account is often taken of the fact that changes in demand grow out of characteristics deep-rooted in nature and in human nature and underlie the more temporary agencies which give them concrete expression. For this reason demand can never be completely controlled nor can it be exactly forecast, and so there will always be many unpredictable changes. These lead inevitably to overand under-production, or business cycles. Profits, credit, the mechanization of industry, investment processes, and other characteristics of modern life are responsible in some measure for the disturbances in production. Many of these are important, but credit changes have the most far-reaching influence. They are all expressions of the general endeavor, sometimes thwarted and misguided, to increase the effectiveness of labor of every kind by means of a less costly application of effort. They grow out of a specialization in time through the use of capital equipment and in space through geographic differences. No mere change in organization or method, in production or exchange can eliminate these problems from an advanced civilization. Only false hopes, therefore, would come from a ready assumption that a revolution in institutions or a radical change in procedure would definitely remove material uncertainties and the danger of economic fluctuations. T o a limited extent, and at important points, reforms can buttress the structure and strengthen weak places, but the future will always be unknown and the years of simple hand-to-mouth production and consumption are past forever. Fortunately, many of the changes which occur as the different parts of an intricate economic machine engage and disengage are balanced and compensating. Habits and institutions, like gears and wheels transmitting power from one part of the system to another, offset each other in stress and strain to a considerable extent. For a considerable period of years the correcting tendencies may keep the disturbing oscillations of the whole within a narrow zone. As long as this internal readjustment takes place, upward or downward

PROBLEM OF DEFINING CAUSES

35

movements of production or prices are checked before they have gone v e r y far. Such a situation is the " n o r m a l " state of affairs which has been indicated above. T h e existence of such a period of relative calm is in no sense an indication that the balance has become stable -, the dangers and uncertainties remain, but they are temporarily unnoticed and the minor losses are offset by larger gains. T h e best protection against the sudden upset of this desirable condition is perhaps to assume its imminence and to pay the price which may be necessary in the introduction of new restraints and artificial correctives. 15 O n l y an acute awareness of the constant menace of the runaway tendencies of the machinery of production, exchange, and credit can make repressive measures seem justified to those who influence decisions. General theories, such as those already suggested, w i l l develop further with the slow and painstaking analysis of many successive depressions. T h e y w i l l tend gradually to make clear the nature of the persistent weakness of the system. T h e y will elaborate the meaning of the natural instability and specify certain typical points of v u l nerability. It is because of this hope that the efforts devoted to the abstract consideration of theory and general principle are justified even in the midst of emergency conditions and general turmoil. T h e peculiar nature of some of the questions which call for further clarification might be indicated by suggesting the urgent need of a search for the reasons behind the stability which has actually existed for considerable periods in the past. T h i s balance has occurred in spite of conspicuous areas of economic difficulty, in spite of times of distressing uncertainty, and in the face of a large degree of dependence on speculation as a substitute for knowledge. T h e answer to the questions which this fact raises can be made only by combining the different types of causal factors suggested here. E v e n when a satisfactory synthesis of theory and observa" F o r e x a m p l e , the use of a h i g h e r b a n k rate, a d d i t i o n a l t a x a t i o n , m i n i m u m w a g e , depression reserves, or other devices.

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tion is made feasible in later years as the result of further research and study, there will still remain inevitably a considerable measure of doubt. Hopes of progress are justified, but the reasons for the coexistence in time of many contributing causes or the fatal conjuncture of circumstances will continue to defy man's best efforts to understand. T H E T I M I N G OF D E P R E S S I O N

One of the persistent mysteries will always be why certain particular events in the stream of similar events, political, economic, or physical in nature, mark the turning points of economic activity. They are even in some cases incidental and partial causes of the subsequent downward sweep. These are usually referred to as random or precipitating events. Some of them have seemed relatively unimportant at the time they occurred. Others, such as the World War, led to so many drastic changes that their influence on economic balance has been subordinate for a time to their political aspects. Few of these occurrences except war have in and of themselves been powerful enough to account for the revolutionary changes which followed. T h e y have served to set apart a moment when, because of fundamental weakness, a shift in speculative tendencies and a complex interaction of forces have brought about a new condition. T h e impact of such an event may be destructive when it comes in contact with a delicate equilibrium, but, even so, its influence would be short-lived unless the momentum is increased by either deliberate interference with corrective forces or new errors introduced by ill-advised policies. Many widely different examples of precipitating agents can be brought forward 5 the failure of a bank, a dramatic forecast of a possible price change, an unexpected increase in crops, or a landslide vote for a new political program 18 may act on the economic system of several continents in such a way as to bring about general disaster. This type of cause cannot be completely ignored. It was at one time given con" Note the effects of the vote for Hitler, September 14, 1930.

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37

siderable importance in explanations of crises. E v e n now such events often loom up in the minds of those who have been close to them. T h e y cannot, however, be fitted into any satisfactory classification. T h e y are varied, unpredictable and often non-economic in character. If they are listed in a scheme of parallel headings for the sake of summary, these headings are apt to have little meaning in the theoretical analysis of economic causes. There are, however, two different groupings which must be made in considering the importance of the precipitating type of cause. On the one hand, there seem to be a number of "outside" events unrelated to each other and similar only in that each one serves to jar the equilibrium of interacting forces. W h e n , after some time has passed, retrospect permits a careful tracing of relationships, there still seems to be a large element of chance in the fact that these events were so placed that they served to initiate a sustained movement of values in one direction. E v e n economic events sometimes seem to take on a fortuitous importance. T h e history of almost any depression will show towards the beginning of a downward movement the occurrence of bankruptcies, crop failures, labor disputes, or other events that have shaken unstable conditions. It is possible, of course, that these events take on the appearance of causes because of illusions growing out of the intellectual need of finding concrete reasons for important changes. Nevertheless, it is impossible to ignore the more important episodes which occur at the peak or the trough of any marked swing. Sometimes they serve as warnings of future difficulties even though they are not all-sufficient causes, and sometimes they serve as explanations because it is possible to trace interconnections between them which seem to give them a greater importance. Some of the really important examples are to be found in such stirring political events as the outbreak of war and the flare-up of revolution with their warping effect on demand. Although such shocks as these differ widely in nature from

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case to case and are mainly political, the repeated blows which they inflict on economic organizations are originating forces which bring after them many economic strains and distortions. In earlier times natural disasters constituted, in some instances, a significant type of precipitating cause, but it is probable that there has been a steady diminution in the contagious nature of the effects of crop failures, floods, earthquakes, and similar phenomena. This progress in the control of natural forces is unfortunately somewhat offset by the fact that sometimes minor events occurring almost at random are caught up by the speculation of buyers and sellers and have an unjustified influence over business decisions. Indeed in the stage which in terms of centuries may be called transitional between laisse-z faire and a more conscious control, it is thought by some that man-made errors have come to wreak more destruction than the forces of nature in earlier times. The destructive influence of modern warfare is certainly more to be feared than famine in past centuries. The important thing to note in regard to the random precipitating events is that only because of a failure of brakes and restraints to stop the motion initiated do they become serious. A bankruptcy, a financial scandal, errors in judgments in scattered fields of business can hardly upset the machinery of economic life, but multiplied by large-scale speculation they can influence the price level and serve as danger signals and guides to corrective measures. If, instead of caution and foresight, a false optimism leads men to explain away the minor disasters and disturbances, the troubles will grow and multiply. If, on the contrary, the observance of the unusual situation becomes a direct stimulus to new measures for balance and to wise policies which will offset the impetus introduced more or less by chance, the threat will in all likelihood disappear. The nature of these controls and the manner in which they are sometimes overlooked will be considered further.

PROBLEM OF DEFINING CAUSES E C O N O M I C I N C O N S I S T E N C I E S AS C O N T I N U I N G

39 CAUSES

Granted, then, that the system is unstable and that it is constantly subject to shock from many directions, the critical question remains as to why, at some time, the automatic balancing forces fail to operate. The answer lies occasionally, though rarely, in the precipitating cause itself. As has been indicated above, there are times when a series of natural or political events so combine in a powerful attack on the economic system that all indications are disturbed, all relationships change, and the future becomes completely unpredictable. This is what people usually mean when they say "the law of supply and demand has ceased to work". Even granted the force of circumstance, however, it would be unwarranted by fact or theory to assume that man is deprived of his power to act so that he cannot check most of these abnormalities. If, in some instances, the disease progresses so rapidly that no cure is possible, the case should be considered as exceptional. The more usual situation, in which there is power to act, should be taken as the type to guide future plans. Even in the decade after the recent war, for example, it is possible to point out times at which it was economically and politically feasible to do away with the maladjustments and to keep the fluctuations in business activity within fairly narrow limits. Attack on this kind of situation must be made both by removing the overwhelming sources of difficulty and also by outlining prompt remedial action to fit an ever new and changing world. It is the second line of action with which the economist must be mainly concerned even though recognizing the ways in which war and revolution menace industrial and financial institutions. Some understanding of the nature of economic balance is a commonplace of economic science. The general terms have become so familiar that they have lost much of their meaning to the practical man at just those times when he has involved himself in serious trouble by ignoring their impor-

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tance. T h e main forces which act to keep economic life healthy are those which lead, on the one hand, to the restriction of the supply of goods when those goods tend to become unusually plentiful and, on the other hand, to a change in the quantities of goods which are taken from the market by demand as the price of the available supply falls. This tendency can be translated into concrete and familiar terms and has never ceased to be the main principle of economic stability. For instance,-a larger supply of steel at any time should lead both to lower prices stimulating a larger volume of consumption, and also to a decline in investment in this type of enterprise. So far as the principles implied in these tendencies are effective, they serve to keep production on an even keel and prevent cumulative errors of over- or underproduction. Unfortunately, there are a number of conditions which tend to delay or obstruct corrective forces, and in the most important sense of the term these are found to be causes of depressions. H e r e , as in the case of general explanations, one is forced to choose frequently between vague all-inclusive language or specific instances of when the "brakes" failed to work. If one chooses the former course, one is reduced to expressing the continuing causes as errors in judgment, mass changes of opinion, and speculative exaggerations, indicating in particular how these tend to diminish demand at certain times of falling prices or to increase supply at times when it is already overabundant. This situation is familiar in certain operations of the highly technical markets for securities and commodities and has been described by Professor Taussig as a fenumbra area in which normal reactions do not occur. 17 T h e conditions under which a similar situation develops on a large scale and in many markets at one time has not been so carefully observed and still calls for further factual investigation. T h e meaning of this kind of influence becomes more clear 17 F. W . Taussig, "Is Market Price Determinate?" Quarterly Economics, vol. x x x v ( 1 9 2 0 - 2 1 ) , pp. 394-411.

Journal

of

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41

after a listing of some typical measures of restraint which man has invented to reënforce natural tendencies. Such are, for instance, the discount rate, which is used so as to make more emphatic the need for the adjustment of the supply of funds available to those who need the funds. Similarly, in certain instances, tax rates have been used to oppress or encourage production when it fails to respond to real needs because these needs are inadequately expressed in money terms. Wage agreements have sometimes made effective a real demand for labor which has failed to emerge spontaneously because of weakness in the bargaining power of labor and have sometimes served to obscure and confuse real conditions. High-pressure salesmanship has also worked now against and now in favor of a natural equilibrium on a sound basis. At almost every point in economic adjustments, production and consumption, investment and spending, in agriculture, commerce, and finance, there have been at certain times sound efforts to express and to reënforce the fundamental need for keeping demand and supply in balance. Paralleling these, there have been false attempts by the use of the same instruments to stave off the inevitable results of real changes in the economic world. The conflict of the rational and irrational is best understood by a survey of events in the postwar decade with an attempt to indicate where in time and place there was artificial interference in credit, prices, and production misleading and distorting in its influence on practical decisions. In short, one must search for inconsistencies in policy and violations of principles, for these were the real causes of the depression. The survey of these policy causes as outlined in Chapter I I I is expanded and placed in an historical setting in Chapters IV to VII inclusive. C U M U L A T I V E FORCES AND W H O L E S A L E

DEFLATION

In the foregoing discussion the sequence of change has been carried from a state of stability through a time of initial disturbance into a period of increasing distress. The origi-

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nal instability has been accentuated by some jarring minor event and the failure of natural or deliberate corrections to act quickly has led to an unusual falling off of demand in the face of an extraordinary increase in supply. Once business has entered into a period of disturbance such as this, only the most drastic and well-coördinated measures can prevent the development of the cumulative period of precipitate deflation.18 This deflation affects all values to a greater or less degree—securities, commodities, real estate, good will, patents, and plans for future production. It is in this aspect of the depression that those who hold monetary theories find their most dramatic illustrations and events. In this phase of economic fluctuations the universal fear that prices which are falling will swing to still lower levels leads to the drying up of both money demand and psychological demand. Markets represented by every class of society and in various parts of the world disappear. Political efforts to exploit those consumers who are still ready to buy leads to the erection of barriers on all sides and to a progressive shrinkage of trade. It is easy to observe this catastrophic situation as it has occurred in many countries in many periods. Scores of writers have pointed out the reasons why such a situation is apt to develop out of the second stage of business depression and why it is apt to continue for a considerable period of time. In fact, many business cycle theories are concerned almost exclusively with this phase. It is less clear in these explanations how the downward tendency will ever come to an end, and there are many such explanations which lean almost exclusively on past experience to show that recovery has always followed depressions. This analysis is at best an unsatisfactory statement and has led to the recurring accusation that the economist is willing to sit idly by and watch world distress. In rare instances, such a condemnation may have been justified. In others, it is apparent that those who make these assertions with re18

The term deflation is usually used to refer to a decline in prices. In certain later chapters it is used in a more technical sense.

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gard to the return of prosperity through the restoration of a new point of balance have seen vital constructive tendencies at work. Some healthy realignments of forces are usually evident in the downward adjustments of interest rates, in the f a l l in real costs because of more effective means of production, and in certain other basic value changes. T h e s e aspects of deflation are exaggerated in the depression phase of the cycle if the cumulative forces develop a strong momentum. Granted the existence of these value tendencies, g o o d and bad, there is no reason to think that the period of decline needs to run its course without direct interference nor to abstain f r o m all possible effort to stimulate the quick action of corrective forces. T h e deflationary tendency which sweeps over all branches of industry and finance and which makes agricultural enterprise a gamble is like an avalanche rushing downward ; after a certain time which varies with different cases, it tends to recede over a wide front. It is possible to offer explanations of this phenomenon which run in terms of economic theory. Part of the impetus for recovery one can explain by economic action—the adjustments of interest rates and costs, as suggested above, or by psychological changes such as the coming of age of new g e n erations of men with new hopes and plans, the reaction of mood which dissipates fear. T r u t h w i l l be found in both directions, in automatic recovery of initiative and in deliberate intervention. In any case the ratio of costs to selling price is always critical among many other important relationships. T h i s later phase in business depression, which is the most distressing and uncontrollable, seems to run in terms of motion and momentum and induces in many a fatalistic attitude because of the almost irresistible spread of a destructive influence through all branches of economic life. It can be described as a mass movement or panic, as a kind of economic insanity, and as an irresistible speculative force. E x t r e m e statements with an emotional tone are frequently used in discussing this phase of depression and they are often f o l l o w e d by radical suggestions based on the tacit assumption that a

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temporary state of chaos proves that democracy and free competition, economic theory and political leaders, have all failed and should be rejected en masse. A state of mind often develops which looks eagerly to inflation as a cure for deflation, which calls for further destruction disguised as a reform, and which is unwilling to recognize the exacting demands of sound economic development indicated by the experience in past periods of depression. This fourth stage, then, is likely to be the period of incubation not only for the ensuing recovery but also for a later period of depression. The deflation-inflation circle is thus complete. One can trace events through recovery, boom, instability, and panic. The original upset occurs more or less by chance and is followed by a period of serious errors and delays running into a cumulative decline. This phase eventually moves on towards a partial recovery, to some extent artificial, and then into a new cycle of up and down swings. SUMMARY

It is impossible to answer definitely and in simple terms, clearly and irrefutably, the question of what causes a depression. In spite of this fact, we know enough about the reasons behind each disturbance to act quickly and effectively in the future. It must be recognized always that there are many different types of causes and many factors constantly operating in active and passive fashion to bring about either an up or a down swing of business activity. Obviously, production for future use is accompanied by a considerable amount of uncertainty, and this source of error is a permanent characteristic of the economic system. Thus we come to what is here set forth as the first type of cause. In one sense of the word cause., changes in demand are responsible for every decline. From another angle it can be said that political forces start the movement of prices in a new direction. Sometimes it seems as if the conjuncture of a miscellaneous set of events has given the initial shove towards depression. This type of "outside" influence has been described under the

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second group of causes. M o r e important than these generalizations about over-all or random influences, however, is the discovery of the particular reasons in individual cases for the failure of a fairly flexible system to cancel and correct minor dislocations and restore balance. T h i s third type is sometimes referred to here as a "policy cause". T h e s e reasons must be taken pragmatically to be inconsistencies of policy and to constitute the strategic errors which can be recognized and avoided. F i n a l l y , and following close on the heels of the third type of cause, there are cumulative and accentuating tendencies, partly institutional and partly psychological, and expressed almost entirely in value changes which increase the rate of decline and bring a rapidly contagious deflation. It is probable that the great importance of understanding the changing relationships of economic phenomena over periods of time has been widely realized for only about twenty years. Before that time efforts to measure fluctuations in time were conspicuous because they were exceptional. T h e average business man regarded them with skepticism either because he distrusted methods which seemed to him far removed f r o m his day-to-day decisions, or because the conclusions, tentatively brought forward, were v a g u e l y and abstrusely set forth. I n the past two decades there has been a marked change in the discussion of economic cause and effect. It is partly due to the natural accretion of information that comes with the patient piling up of exact data, but it has been the result also of a notable and g r o w i n g tendency for the economist to confer with the business man and for the business man to express his critical j u d g m e n t of the economist's conclusions. 19 E v e n more, however, it is attributable to a growing apprehension over the destructive effects of violent fluctuations in values. T h e r e is a wider understanding than before that a whole system is threatened and that the technique, the wealth, the habits, and the institutions which are the product 19 Benjamin M . Anderson, "Education for Business and B a n k i n g , " Chase Economic Bulletin ( M a y 1, 1934.).

The

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of centuries of constructive effort may be destroyed if we fail to understand the reasons for declines and to check the beginnings of violent change. A f e w general conclusions as to causes are already sufficiently clear to be brought together at this stage of analysis. In one meaning of the term "cause" it is unlikely that w e can attain a complete understanding of w h y business depressions occur. Certainly it is true that most of the explanations brought forward so far are either so complex as to be confusing or so simple that we cannot apply them in real situations. In order to achieve a comprehensive and usable theory of underlying causes, one w o u l d need three things: ( a ) a much clearer analysis of human motives than is at present available, ( b ) a more accurate description of past crises than any which now exists, and furthermore, ( c ) a philosophy and an explanation of the relation between political and economic problems. E v e n when great progress has been made in understanding the human factors, considerable mystery w i l l still be attached to the timing and significance of those natural phenomena which j a r economic institutions and upset the normal flow of enterprise and production. T h e s e practical limits to the completeness of a theory of cause need not, however, discourage the politician, the business man, and the student. W h a t is most needed is not such all-comprehensive philosophic answers to the broad economic questions, but a careful understanding of w h y and when the smaller fluctuations pass through a danger zone and become violent forces to upset working estimates and throw the machinery out of gear. M o r e specifically, a study of causes should show: ( i ) at what times and under what conditions action will be most effective} ( 2 ) what sort of action is advisable} ( 3 ) in what areas there can be the best coordinated, least costly, and most constructive reforms. T h e material is constantly coming to hand f o r a more careful diagnosis of the disease. Furthermore, it is clear that the climax w i l l take on certain all too familiar characteristics unless the harm can be checked at an early stage and, finally, the nature of the

PROBLEM OF DEFINING CAUSES

47

convalescence is painfully evident to observers of past depressions. T h e third type of cause is by all odds the most important. It lies in the field of deliberate policy. It takes the form of disregard of certain principles outlined in a body of longstanding economic theory. T h e form in which policy flouts theory is usually an attempt to ignore cost factors and to stimulate an unstable demand. Continuous and widespread efforts to artificialize either supply or demand will lead inevitably to depression under any economic system. M u c h has been done to lessen the number of unexplained factors and to give a greater degree of realism to the specific warnings and programs, but much remains to be done. Some of the more conventional reasoning may have to be abandoned. Simplified statements of economic balance expressed in terms of forces opposing each other in a theoretical vacuum will have to be modified to take account of the greater complexity and variety of movement of the interacting parts. Familiar descriptions of the impact of demand and supply, as seen in the bargaining in the market place at a given moment of time, may be actually misleading if they are taken as guides to action over a continuous period of time. It is possible, then, that there should be less emphasis on equilibrium with its implication that there can be a point of balance and a more or less stable norm. So far as the problem of cause can be generalized, it leads rather to a search for the reasons for the changing rates of change and cumulative shifts in demand. T h i s can be observed concretely in ratios of the volumes of production, in changing prices, in the growth or decline of certain kinds of enterprise, and in the expansion and contraction of credit. In fact, the very complexity of the problem throws us back constantly upon a reexamination of familiar forces. T h e most fruitful method of search for causes consists probably in a selective history of recent data and events and a summation of this evidence in general terms. Neither the statistician nor the historian can give a complete picture. Such

4-8

DEPRESSION AND RECONSTRUCTION

investigations and the desired conclusions cannot be accomplished after a short period of work and will not solve all the problems. They could not do so even if time and resources permitted a vast accumulation and intensive examination of the facts. There are certain problems which call for contrasting methods of approach. There must be a synthesis of quantitative and qualitative changes. T h e method of attack suggested here calls for selection and judgment in its emphasis on manageable factors. It is based on the conclusion that an understanding of past inconsistencies of policy and stress on the gaps in our knowledge is essential as a preparation for the problems of the next decade. T h e prime need is for guides, on the one hand, for government action and, on the other, for the daily decisions of men of affairs. It is apparent that causes must be identified in such a concrete form that they can be attacked in a vigorous manner. They must be found in those phases of cyclical change where they are most susceptible of modification. They must be seen, not as a complex conjuncture of many interacting influences, but as a list of more or less separable economic factors or a number of distinct areas of activity with which we are familiar and wherein measures of reform can reasonably be contemplated. Here and there, of course, there will be a kind of newness attached to depression cause and prevention, but in the main, constructive action will probably intensify and project further efforts already begun, and new agencies will be modifications or extensions of existing institutions.

CHAPTER III SPECIFIC

CAUSES

OF

THE

DEPRESSION

FOUR TYPES OF CAUSES

THE framework of a theory of causes outlined in the previous chapter can be used as a guide in appraising and analyzing the recent depression. The fourfold approach setting apart the underlying, the precipitating, the continuing, and the cumulative causes, based on four distinguishable phases of prosperity-depression here suggested, can be made specific by the examination of concrete factors, even though it will be many years before the story is complete. There is no attempt to make any departure from familiar terminology in these distinctions. They correspond to the groupings suggested by Dr. Gottfried Haberler 1 in his outline of theories, although the analysis is not completely parallel. He refers to three types of causes in his summary and suggests at least one more in another connection—the stresses in the economic system, outside forces or independent influences, errors, and the cumulative process. The difference between this study and some other treatment is mainly an emphasis on different spatial or time relationships between these types of causes. That is, the first is constantly present, the second occurs or rather is important at a peak or trough, the third comes in various forms fairly early in the incubation period and recurs in the period when recovery efforts are most aggressive. The fourth is a late aspect of an acute depression and does not play a part in all cycles. Between these groups there may lie doubtful influences and uncertain types, but the more pressing causes are subject to a classification such as this which takes account of the time element and also of the agencies which are responsible. Al1 Gottfried Haberler, Systematic Analysis (League of Nations, Geneva, 1 9 3 4 ) .

49

of the Theories

of the Business

Cycle

50

DEPRESSION A N D

RECONSTRUCTION

ready it is possible to fit specific examples from recent years into this fourfold outline of causes. E v e n now it is fairly clear that the general underlying causes of weakness have been the same in the United States as in other countries and at other times. For example, the failure to know the future marketability of goods, enhanced by a natural but unjustified optimism, led to a temporary overproduction and an unnatural underconsumption which brought on large-scale unemployment. T h i s situation is an undeniable fact, but it is not a usable explanation and points to no particular solutions. Precipitating events occurred in considerable number and at those critical stages when the different sets of disturbing influences which have been said to constitute the three superimposed depressions of 1929, 1930 and 1931 came into action. T h e war is accountable indirectly for many of these events. It is essential to observe, however, that as a decade intervened between the end of hostilities and the beginning of the great decline, the factors which had their origin in the war and which caused serious distortion in the later period were not inevitable consequences but were the result of failures to reform obvious evils. Clearly, there were errors in policy which exaggerated initial strains, and these later more significant influences fall under the third and fourth types of causes. T h e war fer se was not an all-sufficient cause. In any case there were at least six shocks to the system which seem to have exerted a peculiar force at times when the structure was tottering on an unsure foundation. T h e y include such things as ( 1 ) the increase in the Federal Reserve rediscount rate in N e w Y o r k on August 7, 1929, ( 2 ) the decline in the quotations of certain popular investment trusts in that month, ( 3 ) the Massachusetts decision regarding the capital structure of the Commonwealth Edison, ( 4 ) the fall in the price of copper, ( 5 ) the increase in the Bank of E n g land rate, and ( 6 ) the H a t r y failure in London. 2 Each of a B . M . Anderson, The Chase Economic Bulletin pp. 9, 10; see also infra, Chapter V I I , p. 1 7 5 .

(November 22,

1929),

CAUSES OF T H E

DEPRESSION

51

these affected some part of the market for securities as well as public sentiment in general and introduced a pessimistic note as a prelude to the crash. In the later periods, one can note similar events occurring at those times when, on some grounds, recovery from the first or second depression seemed likely to remove the danger of a disastrous decline. These events, however, were similar to others happening every year and so bear a comparatively small burden of responsibility. It is probable that when the economic system is susceptible to such slight disturbances as these, some deflation is actually desirable. In fact, efforts to mitigate the effects of precipitating causes may very well be themselves continuing or intensifying causes of later depression. In 1930, following a marked rally in stocks and a general increase in optimism, there came a second downward plunge ushered in by such influences as the disappointing report in M a y of the United States Steel Company and in June the failure of the Y o u n g Loan to meet a cordial response. T h e passage of the Smoot-Hawley tariff was a serious disturbance in some quarters. T h e y were severe shocks to a sensitive public opinion both in America and abroad. A l l of these incidents and others that might be cited had more effect through their general influence on attitudes and expectations than through direct consequences in the material world. T h e y marked turning points and are of significance even though they cannot be considered as major reasons for the new currents of economic motivation. T h e third wave of depression in 1931 seems to have been given its impetus mainly by events in the financial field. Some of these fall under the heading of policy causes3 rather than of precipitating events, and they are so closely related and so much an outgrowth of a complex situation and a series of ill-coordinated or inadequate efforts to halt deflation that they can scarcely be called separable episodes. T h u s the failure of certain large European banks, the suspension of the 3

See sufra, Chapter II, for comment on J. M . Clark's "responses".

DEPRESSION AND RECONSTRUCTION g o l d standard in E n g l a n d , and the default of many foreign creditors, in 1 9 3 1 , all demand consideration both because of the disturbing shock which they administered in a period of partially established equilibrium and because they were a part of a general system of false financial obligations. A n attempt to carry further the parallelism between the theoretical categories of causes and the actual situation calls for a survey of the continuing reasons and errors in planning which interfered with a quick reaction f r o m an initial disturbance before the break and during the decline. T h e s e basic causes take the form of widespread misinterpretation of fundamental economic relationships, deliberate artificial efforts to maintain prices, attempts to keep up or even to increase supply, or other actions which interfered with natural correctives. A t various points of breakdown one must examine laws, administrative measures, business plans, banking policies, relief measures, forecasts, and theories. N o t all of these stand out conspicuously in the complex picture of changing events, but most of them are easy to discover. Cumulative factors sometimes take on much the same concrete f o r m as the policy causes referred to above. T h e main difference which indicates the need for separate treatment is that the impact of psychological and monetary influences is much more homogeneous in this later phase than before and, f o r a time, only the price and debt changes seem to be of importance. 4 T h e s e value factors bring on a landslide of deflation, such as that observed in the United States after 1930. Domestic dumping of goods, sweatshop wages, widespread bankruptcies, panic in security markets, and banking paralysis have proved in recent months to be not only the result of the earlier phases of the depression but in a v e r y real sense the cause of the final long-drawn-out period of deepening distress. ' i t is this stage more than the p e r i o d of diversified errors w h i c h P r o f e s s o r I r v i n g Fisher stresses in his Booms ani Defressions ( N e w Y o r k , 1 9 3 2 ) , p . 39, t h o u g h he is c a r e f u l to trace it b a c k to its o r i g i n s .

CAUSES OF THE DEPRESSION

S3

N o one of these three types of influence w o u l d have carried so far nor have lasted so long if it were not for the fer'petual instability of future demand for productive machinery and consumable goods, a demand which cannot be appraised accurately until after the goods are brought to market. T h e interdependence of all four has to be recognized throughout the historical analysis. T h e episodes mentioned would have been of minor importance if not f o l l o w e d — a n d p r e c e d e d — b y mistaken -policies and errors in judgment. T h e rapid deflation could not have developed so quickly nor have wreaked so much havoc if it had not been for the continuing strains in a system constantly subject to new shocks. T H E P R I M E I M P O R T A N C E OF P O L I C Y

ERRORS

T h o u g h it may be possible now to develop a general explanation and to distinguish different types of cause, as above, the formulation of a complete account of all the effective influences that bring to pass or prolong depression is a task f o r the future. H e r e it is possible only to indicate that the causes which one must seek to discover first are those mistakes in action and failures to seize opportunities which may be avoided in future years. T h e attempt to understand and describe these causes is a large task and one which calls for further definition and subdivision. It requires an openminded approach to the problem of when the depression was generated, a willingness to examine all the unusual policies and events which occurred from the time of the war until 1931 and 1932. N o progress can be made in the direction of control unless it is granted that action different f r o m that actually taken was possible. T h e r e were moments of time when the nation as a w h o l e or m a j o r institutions acting separately and deliberately m o v e d towards nationalism or internationalism, expansion or contraction, saving or spending, violent change or slow socialization. T h e s e choices were made in many different branches of economic life. Causal threads, such as those decisions imply, must be traced through the woof and the warp of economic fabric,

54

DEPRESSION AND RECONSTRUCTION

through a long stretch of time, and back and forth in different areas of production and consumption. Dozens of students will be called on to investigate one part or another, many scores of books will be written, and even after long and patient research much will still be left for later generations. T h e part of the work which can be undertaken here is definitely limited in scope. It is possible nevertheless to give an account of what happened on a broad enough scale to refute the idea of a unitary explanation of the depression. T h e focus of attention in the discussion which follows will be shifted rapidly over a number of varied and somewhat widely separated areas of economic enterprise. T h e suggestions already made regarding an inclusive research attack on the problem can be given further emphasis by illustrations of widely different instances of distortion and strain. Much of this exposition has been done with slight differences of method by others, and so a brief survey will suffice to connect the separate points and relate them to the attack on the problem outlined in Chapter I I . T h e writings of Professors Clark, Hansen, Fisher, Mills, Ohlin, Schumpeter, Dr. Loveday, Sir Arthur Salter and a dozen others5 all contribute interesting theories and helpful data making available large amounts of material to aid in a broader understanding of the questions at stake. It remains for the universities, the government agencies, and business institutions to mark off different parts of this all-important work for more thorough investigation and well-considered analysis. T h e regions in which this work must be carried on are distinguishable from each other, even though they are closely related and occasionally overlap because of their influence on values and procedures. Some of the areas which must be " A n y list of important contemporary writers on business depressions should include, among others, the following· names: Leonard P . Ayres, Albert Aftalion, Gustav Cassel, J . M . Clark, G. D. H. Cole, Irving Fisher, W . T . Foster, Waddill Catchings, Henry Clay, T . E . Gregory, Gottfried Haberler, A. H. Hansen, F . A. Hayek, R. G. Hawtrey, J . M . Keynes, Simon Kuznets, Alfred Loveday, F . C. Mills, W . C. Mitchell, Bertil Ohlin, Warren Persons, Charles Rist, Lionel Robbins, D. H. Robertson, Sir Arthur Salter, Joseph Schumpeter, Carl Snyder, and Paul VanZeeland.

CAUSES OF T H E DEPRESSION

55

subjected to careful scrutiny as possible sources of depression are the many separate branches of mining, manufacturing and agriculture, building, real estate, transportation, commerce, banking, public utilities, public finance, and investment. Such broad and inclusive fields as these all call for much further subdivision before they are manageable in terms of research. Even a cursory glance over events in these different subdivisions of economic life, however, indicates that in every one of them serious difficulties have arisen at a fairly early stage of the readjustment period which followed the war, and in each, there have been mistaken endeavors to prolong an uneconomic situation resulting in a temporary and somewhat artificial prosperity. The pursuance of this task can never result in a sense of work satisfactorily completed since only confusion would come from a comprehensive and mainly factual attempt to list and describe all the different points of disequilibrium. The product of the adding machine and the rich store of census data in the hands of a few technical analysts could accomplish more than the wisest leaders of economic science if this were the nature of the task. The outstanding need, however, is for something qualitative in the way of judgments in the first instance, and then later for more comprehensive detail as the corollary and aftermath of a selective approach. The assumptions which result from a wide sampling of economic experience and wisely interpretative conclusions will then be ready for more exact testing by laboratory economists and mathematical research. F I V E M A J O R A R E A S OF S T R A I N

Important assumptions are made by all intelligent observers of recent years. Some of them strike the careful observer with the force of overwhelming conviction even before they have been supported by well-authenticated factual and theoretical proof. In the case of the present depression a comparison of different theories suggests the singling out of five

56

DEPRESSION AND RECONSTRUCTION

major areas in which there were outstanding instances of mistaken policy and lost opportunity in recent years. These five cannot be weighed against each other with respect to importance, but they have come to be recognized as major regions for adjustment and, perhaps, control. Even though any selection is pragmatic rather than absolute in validity, it may serve a useful purpose in analysis. The five here emphasized are international relations, agriculture, the heavy industries, the security markets, and the "new era" industrial policy.8 A more complex analysis of the situation than that outlined above has been made by most writers, while a few have preferred to stress one or two types of strain, subordinating all others to them. Professor Hansen, who adopts the former method, lists some seven causes of the depression,7 all of which have clearly an important bearing on the increase in unemployment. Professor J . M . Clark discusses eleven "responses" in their causal relationships.8 These are comparable to the policy causes discussed here as they appear in the five areas of disturbance. Professor Fisher, more interested in the financial aspects of the problem, puts a more highly-focused emphasis on the problem of debts in order to lay the groundwork for proposed reforms in the field of money. It is, perhaps, a matter of individual preference whether it is better to group together many things and call them by some general name or to stress the separateness of many different influences. With respect to economic action, however, the decision must be guided by the fact that some problems are only generally recognizable and that some corre6

Banking became distorted through speculative activities and is considered under this heading. T h e questions of over- and under-investment are viewed from two angles: first, security speculation and second, heavy industries. In other industrial areas they are considered to be of minor importance for present purposes. 7 A . H. Hansen, Economic Stabilization in an Unbalanced World (New York, 1 9 3 2 ) , p. 144. 8 J . M . Clark, Strategic Factors in Business Cycles (New Y o r k , 1 9 3 4 ) , pp. 1 8 7 - 1 9 0 .

CAUSES OF T H E DEPRESSION

57

spond more closely to a practical alignment of forces which may facilitate reform. From this point of view, it is wise to add to any description in terms of a succession of changes in demand or markets, or in terms of profit-seeking or inequality of income, some more manageable points of attack. Otherwise there is danger that the analysis will be so general that it fails to lead to constructive action. It is probably more useful at the moment to indicate groups of policies which are already the direct concern of widely scattered and broadly representative groups. In any case, the five "areas" of difficulty here mapped out cannot be completely separated from each other in time, because changes were occurring through all parts of the economic system during the years immediately preceding the collapse. The dislocations in different fields were more apparent at some times than at others, but, generally speaking, it is more correct to recognize the increasing strain over a considerable period of time than it would be to cut the period into distinct segments. Similarly, because of inherent interdependence at many points, it is not valid to assert that there were several completely separable lines of policy in each of these areas. There was constant interaction of ideas and a contagion of point of view which was to have many serious effects. Nevertheless, the laws and plans in one branch of activity were not directly compared or closely related to those in another. SERIOUS D I S T O R T I O N I N I N T E R N A T I O N A L

RELATIONS

The first and most important of these areas of maladjustments, that which lies in the broad field of international relations, cannot be accurately measured or set forth primarily in quantitative terms. It includes some aspects of the field of diplomatic relations, commercial agreements and policies, and embraces many phases of the major problems of money and banking. It relates to many kinds of business and concerns specialists of widely varying types. In spite of the com-

58

DEPRESSION AND RECONSTRUCTION

plexity of these relations, however, there is no room for serious doubt that the main reason why this depression has been so severe and lasted so long is the destructive and prolonged discrepancy between foreign and domestic policies.9 A fundamental conflict, beginning immediately after the armistice, set in opposition to each other American attempts to take advantage of opportunities as a creditor nation and the desire to expand commodity exports. Hopes of gain have led Americans in positions of influence to push commercial opportunities for the benefit of home producers. T h e result has been a struggle which has emerged in different forms, sometimes as an allied debt problem, sometimes in connection with Germany, again in the enactment of a higher tariff, and at other times in the launching of ambitious investments in foreign countries. In this set of distorted relationships between commercial and financial policies lie most of the causes for the sharp decline in world prices, most of the reasons for the drying up of long-term credit. New conditions in commerce arose, and many unexpected and unpredictable changes in production. As the decade moved on, uncertainty over markets increased when the sudden discovery of new outlets for goods was followed by unexpected obstacles of a political or economic nature. It was impossible for those who were producing for foreign trade to make any reasonable estimate of the volume of output which could be disposed of without dumping. They could not adjust their cost and overhead qharges to the situation in a prudent manner. T h e high yield of seven and eight per cent on loans was considered as a sign of large opportunities for financial gain, and the potential losses through default were not balanced against current income in a conservative manner. Since the unpredictability of the future is a major underlying cause of depressions, the havoc wrought by unpredictable changes in policy in this realm can certainly be held to ' See Paul VanZeeland's discussion of international disequilibrium, A of Eurofe, 1932 (Baltimore, 1 9 3 3 ) , pp. 7 - 1 0 ·

View

CAUSES

OF T H E

DEPRESSION

59

be an important contributing factor, accentuating inevitable uncertainty and responsible for a very large share of the losses during the depression in the United States. Seen from the European angle, the difficulties center around the unremitting pressure on foreign exchange reserves drained to a minimum in the effort required to pay the United States for war loans. Most observers can now trace cause and effect so as to explain in this way the steadily increasing strain, the abnormal gold accumulations, the illbalanced relation of long- and short-term credit, erratic price movements, currency instability, intense competition in foreign trade, and many other aspects of distress. Although some of the difficulties were the inevitable aftermath of the war, others were the outcome of a reprehensible failure in many nations to face unavoidable changes. M a n y of the later disturbances might have been avoided if real cooperation between countries could have been established to carry forward the work of reconstruction. A s the seriousness of the problems and the slowness of recovery became evident, a competition between nations and between business interests dictated by the blind instinct of self-preservation led to inconsistent actions and laws, and to mutually destructive exploitation and price-cutting. Nationalism was an acute expression of a many-sided economic struggle. T h e concrete manifestations of economic conflict are to be seen particularly in such acts as the raising of new tariff barriers and the destructive use of the gold exchange standard 10 at certain times to make money markets uncontrollable in various countries. H e r e and there depreciating currencies were made an instrument for underbidding rivals in world trade. E v e n when the dangers of such a procedure became evident, stabilization was accomplished with a view to attaining some of the more attractive immediate objectives rather than to building up a permanent structure of sound financial relationships. 10 Refort of the Gold Delegation of the Financial Committee, League of Nations (Geneva, 1 9 3 2 ) , pp. 52-55.

6o

DEPRESSION AND RECONSTRUCTION

Even though it is possible to demonstrate that most nations were motivated by the same selfish desires to better their competitive positions, and even though it is granted that this is usually the case in international economics, it is still true that the United States has to bear a special responsibility for these post-war distortions in the international sphere. This is true because the United States was the only nation having a considerable margin of funds at its disposal, the only nation with a secure foundation of gold reserves to facilitate a constructive policy. There was at certain times, if the experience of political leadership in recent years has any meaning, a real choice of relinquishing claims on foreign countries in the interest of ultimate commercial expansion. Notable concessions could have been made without incurring a considerable added burden in taxation. No other country was in so fortunate a position. For this reason, the legal right of the United States to collect its debts in full will seem insignificant in after-years in comparison with the interests of foreign commerce and political liberalism. The distressing inconsistencies of policy will stand out in sharp relief against a background of false hopes and insecure prosperity. The constructive economic principles indicated by past experience and theory were clearly and forcefully urged by a number of writers at various times.11 When it was too late to influence trade and prevent the spread of dictatorship, the bulk of the familiar reasoning of classical trade theory was accepted in its broad outlines even by those who were at first inclined to reject old ideas. But this change did not come until it was too late to reverse dominant trends and until America had almost completely lost the opportunity to restore world trade and credit. Moreover, the hope of collecting large sums loaned to other countries had vanished. Contrary to the long-run interests of commerce, action was taken on a number of occasions to decrease the buying power of Europe through 11

Such writers include Professors Ε. M . Patterson, Edwin F. Gay, Allyn A. Young, and many others.

CAUSES OF THE DEPRESSION

6i

pressure for debt collection, g o l d sterilization, 12 import restrictions, and unprecedented efforts in common markets to supplant other nations. A t the same time both the readiness to lend and the production of commodities at home were geared to supplying impoverished countries with large quantities of goods. T h e result of this sharp conflict of policies was to bring about contemporaneously an increase in plant capacity in export trades and a piling up of uncollectible foreign debts. T h e slow downward settling of the world price of certain commodities such as wheat, cotton, coffee, oil, and coal registered the g r o w i n g realization that the productive efforts of the United States were being undermined here and there by increased business activity in those countries which had bought large quantities of foreign goods just after the war. T h e downward tendency was pushed further by a fairly universal failure to recognize in domestic production policy this shrinkage of markets. In fact, there was an effort to assist some enterprises by artificial legislation and by the expansion of extraordinary credit facilities. T h e r e were, thus, in these post-war years a number of m a j o r factors which worked on each other to increase strains and caused later a vicious spiral downward. T h e decline in prices tended to accentuate the unfavorable balance of payments of certain countries. T h i s loss in value weakened currencies and made central banks lean more heavily on the gold exchange standard and foreign credits as instruments of financial stability. T h e r e was, however, no security in the gold exchange standard. O n the contrary, the further extension of its use led to the pyramiding of credits and the piling up of large uncontrollable speculative funds in the two main money markets of the world, London and N e w Y o r k . W h e n eventually the whole system of interlocking exchange support and duplicate currency reserves of these reconstruction years was threatened in 1930 and destroyed in 1 9 3 1 , there 12 T h e policy of " g o l d sterilization" was not really successful. S. E . Harris, Twenty Years of Federal Reserve Policy (Cambridge, 1 9 3 3 ) , vol. i, pp. 367-9.

62

DEPRESSION AND RECONSTRUCTION

was a rush to withdraw funds, and these withdrawals helped to dry the usual streams of credit, brought on deflation, l e d to panic, and drove domestic as w e l l as w o r l d prices to lower levels. M e a n w h i l e , the overexpanded debt structure of all kinds began to be liquidated along with the g o l d exchange standard, and the contagion of forced sales and repudiations cut off large streams of purchasing power f r o m many already impoverished markets. T h e details of these relationships need not be outlined here. T h e y have been competently discussed already in a number of books. 13 It is enough to indicate the close connections of one part with another—that the w o r l d price l e v e l could not remain steady with g o l d piling up in a f e w large reservoirs, that debts could not be collected with prices f a l l ing everywhere, and that commerce could not flow between countries in a normal way in these circumstances. Unstable currencies, diminishing credit, and mutual distrust led to destructive actions on the part of many nations. A number of critical times can be pointed out when a v e r y different course of action might have been taken. F o r instance, the 1 9 1 9 reparation demands were fantastic and impossible to satisfy. T h e disturbing episodes of 1 9 2 1 , the Paris U l t i m a t u m , the L o n d o n Agreement, laid the basis for grave future trouble. T h e rapid increase of American foreign lending after 1924 was unchecked by natural caution or an examination of previous experience ; the money policy of 1927 seems now, looking back, to have been over-optimistic. 14 Later events showed that the Y o u n g L o a n was too large for a thin bond market and that the annuities required 18 Sir Arthur Salter gives a readable and illuminating account of these problems. Paul Einzig throws light on critical episodes. D r . Pasvolsky analyzes significant aspects in his discussion of gold standard problems. Comprehensive discussions have been published by the League of Nations in their Gold Reports; see also Sir Walter T . Layton, Re-port of the Committee appointed on the Recommendation of the London Conference, 1931 ( B a s l e ) , and Refort of the Special Advisory Committee, December 1931 (Basle) 5 see also P a u l VanZeeland, of. cit. 14 C. O. Hardy, Credit Policies of the Federal Reserve System (Washington, 1 9 3 2 ) ) PP· 4-6-48.

CAUSES OF THE DEPRESSION

63

of G e r m a n y were still excessive. 15 T h e S m o o t - H a w l e y tariff of 1930 1 6 struck the final note of disillusionment upsetting the foundations of international credit. T h e forces involved were powerful and hard to control, but the theory of international trade could have been a fairly clear guide. In actual fact it was ignored more frequently than f o l l o w e d in this period after the war. Instruments of restraint existed, and experience might have warned that a slower pace of commercial expansion was advisable, but the desire for large profits overrode all caution. A thorough exploration of these problems, which has been begun by many students working in a number of related fields, is not l i k e l y to lessen the blame which attaches to those responsible for the m a j o r decisions. T h e most valid excuse to be urged in explanation of the serious errors that have been made must be found in the fact that the field was vast and the amounts of wealth involved confusingly large. M o r e o v e r , the impression that the war had changed the face of the w o r l d was intensified in the United States by a partial realization of the new credit position of the country. So serious were the later troubles resulting f r o m mistakes in handling international questions and so great the disturbance because of the growth of false nationalism that these errors may be called the main causes of the depression. It is true that other factors should not be neglected, but they do not carry the same weight of responsibility. T h e r e are direct connections between the contradictory policies aimed at holding all temporary advantages and the subsequent deflation which affected all major business activity. T h e attempt to adjust business estimates to material facts l a g g e d further and further behind realities as the confusion increased and the accumulation of strains went on. T h i s picture is even darker if one contrasts it with the hopes " E . L. Dulles, " T h e Evolution of Reparation Ideas" in Facts and Factors in Economic History, Edwin F. Gay volume (Cambridge, 1932), pp. 557579· M F . W. Taussig, " T h e Tariff Act of 1930," The Quarterly Journal of Economics (November 1930), pp. i - z i .

6+

DEPRESSION AND RECONSTRUCTION

and expectations during a considerable part of the post-war decade, but it is fortunate, at least, that the issues are so clearly evident that they can help to guide future policy and lessen the excuse for similar blunders in the years to come. WILD

SPECULATION

AND

CATASTROPHIC

DEFLATION

T h e second outstanding cause of the 1 9 2 9 - 1 9 3 4 depression was the speculative boom in real estate and securities that raged in the U n i t e d States f r o m before 1926 until the collapse three years later. Viewed from one angle, this contagious orgy of gambling was itself the product of many forces, but it can nevertheless be singled out as a distinct and important type. T h e fact that this kind of mania has broken out in the world on other occasions does not make it the less important in the appraisal of causes nor does the part played by defective institutions in facilitating speculation and in m a g n i f y i n g its effect lighten the responsibility resting on those who influenced the course of the movement. Various political and monetary factors combined to increase the speculative fever. It is certain that the unequal distribution of g o l d , enhanced by war debt settlements, was an important instrument in expanding the v o l u m e of public speculation in securities. It is certain that the weakness of the banking structure, its lack of centralization, and the confusion of financial leaders were the principal reasons w h y the results were so disastrous. It would be unwise to treat this wave of speculation as a mania entirely unjustified by any advance in science or wealth, for there was actually some ground for a substantial increase in security values. Nevertheless, both in real estate and in stocks, the movement became at times h i g h l y irrational and surpassed all recent experience. So much was this the case that outside observers, looking back on the wildest periods in the speculative markets, are inclined to stress the

CAUSES OF T H E

DEPRESSION

65

peculiar and unmeasurable aspects of the situation and give considerable weight to psychological forces. Certainly if there had not developed, for various reasons, a widespread idea that one could buy equities to sell them, after an appreciation in value, for a quick profit, the worst phases of the depression could have been avoided. This speculation in stocks had a pernicious effect in many quarters. It pulled in large- and small-scale investors, involved most of the banks in dangerous ventures, and stimulated erratic movements of foreign funds. Because of the hope of easy gains, it drew money from more permanent and constructive uses and absorbed the attention and energy of those who would normally concern themselves with productive enterprises and professional services of real value to the community. Moreover, because of the easy recourse to brokers' loans, it fostered a growing tendency to borrow on the basis of uncertain assets and was a factor in the vast expansion of personal and corporate debts in the country. These grew to such an unaccustomed total that panic was inevitable if at any time a large group of cautious observers should realize the meaning of these debts and try to protect their individual holdings from the threat of deflation and repudiation. It is possible that this area of disturbance would have developed without the false stimulus exerted by international policy already discussed. It is quite certain, however, that the two sets of forces worked on each other in a most pernicious fashion. Together they came to vitiate normal credit relations, production, and demand. Thus, not only foreign investments and foreign trade but also all domestic estimates and calculations regarding future production and finance were seriously disturbed. One of the statistical measures of the force of these influences is the five billion dollar expansion of brokers' loans. These mounted in a steep curve in 1927 and 1929. 1 7 Simi17 Benjamin M . Anderson, "Brokers' Loans and Bank Credit," The Chase Economic Bulletin (October 31, 1928), p. 9 ; Evans Clark, J. F. Dewhurst,

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larly, bank loans, real estate borrowing, personal loans, and foreign credits piled up in the relatively short span of years to unprecedented figures. The indication of the strain exerted and the vulnerability of the system is seen in its collapse like a house of cards in the four and one-half billion dollar deflation of 1929. 18 This was followed by the slower decline of 1930 and the many billion dollars of defaults in foreign and domestic loans in 1931-1932. The culmination of the financial disturbance and deflation came with the loss of billions of dollars in the banking crisis of 1933 and thereafter. It is probable that later observation of speculative processes and attitudes, supplemented by further analysis of the impressive statistical data already at hand, will justify the high degree of importance given to the second cause of later depression. Speculation of various types has swept through economic life at many times in past centuries. The mental and moral expressions are dramatically plain, but insufficient work has been done in the exact analysis of the economic mechanisms and consequences. It is important, for instance, to see to what extent speculators spend or save, whether industry has too much or too little capital, how initiative and enterprise are stimulated or wasted. Even the recent financial orgies in the land boom and security markets have, for the most part, escaped detailed and factual analysis. There are still unanswered questions as to the way in which speculative influences affect real factors. Such analysis is all the more important because history shows that some form of gambling fever is apt to recur at certain intervals. If this is true, it should at least be possible to recognize it in a fairly early stage and initiate efforts at prevention. This type of cause is manifest in changes in the attitudes of individuals and in the acts of various institutions, A . L . Bernheim, M a r g a r e t G. Schneider, Stock Market Control, Twentieth Century Fund Report ( N e w Y o r k , 1 9 3 4 ) , p. 93. 18 T h i s estimate is based on the disappearance, almost overnight, of this amount of brokers' loans.

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and both are subject to some modification and improvement. T h e force of speculation, so powerful when f u l l y developed, can be repressed if caught in time. It does not rise without warning. Already examination has shown the responsibility that lies partly in fallacious economic theories and partly in irresponsible financial practices and weak banking policies. Combined with these flaws in a vulnerable system, false optimism and greed can wreak great havoc. T h e resulting tide of unreasonable behavior has twisted and distorted economic relationships and swept away much real wealth in the rapid movements of deflation during the final stage of speculation. " N E W E R A " IDEAS AND F A L S E POLICIES

A third cause of the depression, closely related to speculation at some points, and influencing industry on many occasions, has been a group of false ideas frequently referred to as " n e w era" doctrines. 19 These have grown out of an incomplete understanding of the relation of capital to income, of saving to investment, of amortization to overhead costs. It supplied much of the fuel for the speculative fire in W a l l Street, but it spread likewise through all industry and into government finance as well. It affected trends in building and in agriculture, in the advertising, selling, and consuming of goods. It gave a false glow of a hoped-for golden age to a period of crude mistakes and immature economic policy. It is, perhaps, too soon to disentangle all the threads of hope and expectation which made up the psychological fabric of post-war economic life. T h e y reached out in many directions and it is as yet impossible to trace their course at every point. Because of the fact that they involved a serious misunderstanding of the relation of the future to the present, it is difficult to understand their meaning until more time has gone by. So misleading was an industrial boom accompanied by an unusually stable wholesale price index that many ob19 See infra, Chapter V. This idea persisted after the 1929 crash and the following· months of economic distress.

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servers in other countries became confused by the bright pattern which seemed to be permanently woven into the background of American economic life. Optimism following the stress of war increased the funds available to speculation and industryJThe origin of this attitude lies in considerable measure in the unexpectedly rapid post-war recovery and the boom of 1 9 1 9 - 1 9 2 0 . T h e relatively short setback of the 1 9 2 0 - 1 9 2 2 depression was viewed as the fairly definitive adjustment of the more serious disproportions. This recession, followed by a relatively quick recovery, served to enhance a sense of power represented in part by loans and the speculative fever in finance. It was both the changes in policy from a positive point of view, and the failure to anticipate the inevitable reversal from a negative point of view, that caused the serious unbalance—the later severe and disrupting shock. An almost complete lack of cautionary checks and a disregard of ways of reversing business programs increased the vulnerability of the system. It is difficult to synthesize such a many-sided development in a single formula, but one of the controlling and central ideas of what is known as "new era" doctrine seems to be the feasibility of expanding the home market for industrial and agricultural products indefinitely by means of either high-pressure salesmanship or rising wage rates.20 This assumption was strengthened by a prevailing conclusion that prices were relatively stable and that changes could be forecast with sufficient accuracy to protect the individual entrepreneur. These various optimistic ideas blended with others and were reënforced in particular by the favorable expectation regarding credit control through the Federal Reserve. They were accompanied by dramatic evidence of the future potentialities of mass production and engineering improvements in industry. Certain facts outlined in Chapter V help to make more 20

Henry Clay, The Problem of Industrial Relations (London, pp. 1 0 6 - 1 1 4 . He discusses the dangers of these high wage doctrines.

1929),

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definite the general concept and to fill in the picture of the period when it exerted its major influence. Those who undertake the detailed history, as will eventually be done, will be able to write a more complete account of many varied episodes. A l l that can be attempted here is to underline the conclusion already widely held that in this realm, as in foreign markets, financial expansion, agriculture, and construction, there was a wide divergence between fact and expectation, that this divergence continued for so long a time that drastic deflation was unavoidable. 21 A G R I C U L T U R E , A P E R S I S T E N T A R E A OF D I S T U R B A N C E

A fourth major field of deflation and unemployment, rapid collapse of values, and difficulty in restoring normal conditions was agriculture with its increasingly artificial situation.22 A l l the more important price relationships of both products and land values had been pulled out of line. T h e margin of cultivation had been pushed farther in the United States than long-run conditions justified and the result was that millions of people faced a readjustment which they were reluctant to undertake at a time when the possibility of industrial absorption of labor was at a low point. T h e far-reaching disturbance growing out of these conditions was intensified by the fact that the demand for the products of agriculture is, as a rule, inelastic, so that any decline in prices is hard to stop once it has begun. Many have observed the almost inevitable tendency to dump goods irrespective of costs. Since the motives which keep men on the land and increase the area of cultivation are not purely economic, farmers may continue to produce at a loss for a considerable period of time. In fact, the demand for cash to meet debts often leads to a larger offer of crops in the market when the unit value of quantities declines. The effects of unbalanced conditions spread partly through unfavorable price influences and partly through the freezing 21

See infra, Chapters IV and V. Wassily W. Leontief, "Helping the Farmer," Essays on the of the Recovery Program (New York, 1 9 3 4 ) , pp. 1 3 9 - 1 4 4 . 22

Economics

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of credit. T h e banking system of large areas became heavily involved j the value of land began to shrink rapidly j mortg a g e defaults and widespread failures became inevitable. 23 M o r e o v e r , as this downward spiral became evident, the insurance companies and the railroads were seriously threatened by the conditions that impaired the value of mortgages and cut off the productive power of rural communities. In fact, there were many elements in the situation which tended to make a f e w original minor errors become cumulative in effect and spread their destructive influence over wide areas. A l l o w e d to g o on uncorrected, they drew down to economic chaos whole regions of the country and large groups of people. In the western regions of the United States in particular, the unnatural stimulus of the war-time demand for wheat and other farm products had encouraged an agricultural expansion which was carried further by various speculative forces. T h e idea of a new agricultural prosperity was made at least temporarily plausible by the apparent increase in the standard of living at some points, the widespread ownership of automobiles, extensive road construction, the development of the radio, and other things which made rural life seem more attractive. T h e early weakness in the generally prosperous economic situation was met with palliatives and temporary expedients which failed to take account of fundamental market changes. Unfortunately, artificial help to producers postponed some of the difficulties but probably made the decline of prices after 1929 more precipitate. Serious maladjustment in many quarters increased with the interaction of the three groups of causes mentioned above. In addition to these disturbing elements, a significant set of policies in agriculture was developed independently. T h i s would, inevitably, have caused difficulties at some time. Agriculture has many times and in many countries preEvans Clark, The Internal Debts of the United States ( N e w Y o r k , 1 9 3 3 ) , p. 31 ; see section on Farm M o r t g a g e Debts by Frieda Baird. 23

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sented grave problems. It is possible that there is no other branch of productive enterprise in which there are so many personal and incidental reasons which delay or obstruct the adjustment of economic enterprise to the real needs of the nation. T h e desire for independence, the attachment to a particular locality, the division of labor within the family, a dependence on outdoor life, and dozens of other factors tend to complicate the situation. T h e s e forces cannot be weighed and measured on a quantitative scale or appraised mainly in terms of material values. Immediate financial interests are often overlooked until it is too late to make any profitable adjustment. A recognition of these many complications is essential to an understanding of the large part which crop prices and farm problems have played in most of the major depressions. I t throws some light on the fact that there is frequently a failure to make a complete readjustment of agricultural problems and that the overexpansion of some crops, for instance wheat, is prolonged through the new wave of recovery and prosperity. T h u s , old maladjustments lead to a recurrent instability and later price declines in years far removed from the first mistakes. H e r e is found, in fact, one of those typical instances in which an early depression tends to breed the one which follows it. EXCESS IN C A P I T A L E Q U I P M E N T AND C O N S T R U C T I O N

T h e r e is a fifth area of economic activity which has a peculiar influence on general w e l f a r e and economic balance. T h i s realm, the h e a v y industries and construction enterprise, has been subject to unusual disturbance and fluctuation during the last decade. It is made up of a group of diverse enterprises which can be classified under a comprehensive heading to include both the production of capital and of durable goods. 24 T h e importance of this type of production has come 24 F. C. Mills, Economic Tendencies in the United States (New Y o r k , 1 9 3 2 ) , pp. 20, 23, 76, 188, 367, etc. Professor Mills uses the terms producers' goods, construction goods, cafital goods, durable goods almost interchangeably to refer to this general category.

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more and more to the forefront of discussion. During the recent years of prosperity, there was some vague recognition of the very important rôle which it played. During the early phase of the Roosevelt New Deal, it was not given as much importance as many thought desirable.25 Later in 1934, however, this very inclusive area of production came to be a subject of general concern. As time went on, its needs began to influence a large proportion of the major policies as well as many of the more severe criticisms of the administration's program. It is difficult to formulate a satisfactory definition or to choose a distinctive term to apply to this group of industries. T h e important elements to consider and those which set apart this type of enterprise are two. T h e first is the length of time required to make the products concerned available for consumption. Important distinguishing signs, for instance, are those which show how long a time is required to bring a machine into active operation or to make a building or a piece of equipment ready to supply services to the public. Then there are, second, those characteristics which indicate the length of life of the equipment or products under consideration. It is not entirely clear in most discussions which of these elements is the more important. It is clear that both play a part in conditioning production methods, financing, and marketing possibilities. Both affect the market for the commodities produced by the capital instruments since they condition the length of the period through which they continue to operate, even sometimes at a loss. Both are expressions taken from one point of view of the amount of investment concerned and the real cost of the product. It is probable that from most angles of approach it is more important to consider the time and labor which go to make the products available than their probable length of life and usefulness. T h e cost factor is crucial. If the investment were a negligible item, the durable goods could be discarded and forgotten x

Leonard Ayres, The

Cleveland.

!5> 1933) and later bulletins.

Trust

Comfany

Business

Bulletin

(August

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with relatively little net loss to the economy. The mere fact that the equipment fails to perform a useful function for the period originally anticipated is important to individuals but not to the nation as a whole. Even the effect on shorttime market price is not of great consequence. Products may be dumped at low prices, but there is relatively little disturbance if the overhead charges are low. Dumping fer se is not harmful since one gains what another loses, but the loss of the value of past labor through such tendencies may unsettle underlying structural relations of investment, taxation, and income distribution where the investment has been heavy. In most discussions of the construction and durable goods industries, the exact limits of the field under consideration are not clearly drawn, but the general implications, based on a heavy original investment and a long span of time, are implicit in the argument brought forward. Very seldom has a carefully elaborated attempt to formulate precise definitions been made. The result of the relatively large investment in this type of goods in modern society and the spasmodic and fluctuating emergence of the products available to the consumer is that there is an inherent, inevitable discrepancy between the output of capital goods and the output of consumable goods in both the short and long run. This point has been clearly stated by J . M. Clark, both in his book on The Economics of Overhead, Costs and in his recent study of business cycle factors.26 His explanation of a simple and sometimes widely admitted fact, with real force and emphasis, helps to make plain one phase of economic instability. Clark suggests that a relative degree of control.and regularization of the capital goods industries will lessen this discrepancy, although he offers no hope that it will entirely wipe out the difference in the amplitude and timing of the curves in consumers' and producers' goods. As a contribution to the solution of the grave difficulties involved, it is possible that some more careM J . M. Clark, of. cit., pp. 148, 1 5 2 , 176, 180, 1 9 1 , 192. Compare also the theory of derived demand in Alfred Marshall's Princifles of Economics.

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ful formulation of programs or even government efforts to guide the production of intermediate types of goods, especially semi-durable luxury goods, may help to absorb some of the shock attendant on changes in capital goods industries. There are other reasons which make developments in the heavy goods industries especially dangerous to economic prosperity. These are connected with the fact that, because of the large overhead and long production period, many of the cost and demand factors are not clearly seen until a number of years have passed and mistakes may be perpetuated not only in those branches in which the original stimulus is felt but also in others where the false prosperity seems to give a fictitious encouragement. This spread of influences is to be observed in a review of conditions during the past decade. For instance, the development of a boom in one type of building tended to encourage other related lines of enterprise. T h e result is to be seen in the steep upward movement of the curves presented by F . C. Mills 2 7 and others in factual studies of recent conditions. Clearly, the upward movement of durable goods at a rate of several per cent a year introduces very great potential dangers when it is recognized that the goods produced are not, like food and clothing, consumed but tend to pile up month after month to constitute an increasing threat to stable market conditions. In a period when consumption goods are increasing at something less than four per cent, it is obviously abnormal to have many types of buildings, factories, and machine equipment multiplying at a rate of eight or ten per cent a year which results in a net cumulative increase at an even more rapid rate. Unfortunately, both the materials used and, for various reasons, the labor involved are more immobile and inflexible economically in this sort of enterprise than they are in some of those which make commodities nearer the consumer. There has been a general recognition of the high costs, and '"Of. cit., pp. 265 and 2 7 7 ; see curves f o r "total construction, public works and utilities, industrial, commercial, houses, public, and institutional, and apartments and hotels."

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in certain cases, as perhaps in the building industries, the strong bargaining power of labor has furnished an outstanding example of this type of difficulty. T h e resulting rigidity of contracts has been embarrassing in short depressions and tends to be even more serious in a long decline when there is very little opportunity to absorb the investment and when it would be better if labor were shifting into other lines of work. Further analysis will have to wait on a more clear-cut formulation of the theory of capital goods industries28 and on at least a tentative formulation of categories of products which will correspond with this theory. Once this work has been carried to a satisfactory point, the collection of data can be more useful to the practical business man. In some respects this fifth area of strain is different from the four which have been described in the above brief survey of causes. As has been said, it is not clearly defined and distinct and, moreover, it is not possible to point very definitely to groups of individuals responsible for business errors in this field or to show in all cases where and by whom correction could have been initiated. Here, more than in financial speculation or foreign policies, the mistakes were the result of general sentiment and there were few coordinating agencies for bringing about rational restraints of excess. T o a certain extent, the expansion in durable goods was an aspect of "new era" psychology and it was based on inventions dating back thirty or forty years. The discrepancies in rates of change, evident now in the gaps which opened up between curves of basic data in 1926 and later, were not recognized at first nor was there any clearly formulated attempt to reverse the mistaken policies and to withdraw labor and capital gradually from enterprises which had expanded too far. In conclusion, and pending the further analysis of the facts, it may be said that here in the durable goods industries, as in the other areas, the causal influence is found in the lack of adaptation of construction or heavy goods enterprise to the 28

The extension of Marshallian economics, of Böhm-Bawerk's interest theory, and of J . M . Clark's theory of overhead costs must be carried to a point of clear recognition of limits and problems in terms of current business usage.

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general economic environment and in the persistence of initial errors even after the indications of weakness and strain had become available. Mistakes in themselves do not necessarily bring on disaster. When, however, they go unobserved and uncorrected, and when they are even accentuated at the times during which their destructive influence has already become felt, there is reason to expect a severe setback and its inevitable penalties. ERRORS IN J U D G M E N T AND P O L I C Y

A brief survey of the major areas of dislocations in which conspicuous errors can be found shows that they are overlapping and interworking at many points. Nevertheless, it is possible to group many aspects of important enterprise so that they fall clearly under one of the five categories outlined. Even when the "new era" psychology enhanced speculation it can be considered in different guises. Although land values influenced trends in agriculture and in the real estate boom, there were distinguishable lines of policy. The apparent complexity of relations does not entirely prevent the allocation of responsibility. The inconsistencies were glaring and destructive in their effects. For example, a review shows that while various groups of entrepreneurs were acting as if Europe could continue to buy and to borrow, others were pressing successfully to increase international barriers and to maintain an isolationist policy. Similarly, while market prices rose and the annual yield fell in the security markets under speculative pressure, buying continued as if the income on the capital were likely to increase rapidly. In the third place, current consumption and production were expanded under "new era" ideas without regard for the fact that there were certain norms in the ratio of spending, investment, and the distribution of national income which could not be suddenly altered by large percentages. Finally, agricultural production was maintained and prices artificially stimulated at a time when every sign indicated the likelihood of a shrinkage of foreign buying

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and a possible saturation of domestic markets. In fact, there developed an unreal and impermanent position in foreign economic policy, in domestic finance, in industry, in the security markets, and in agriculture. T h e critical importance of each type of maladjustment will be judged as far as is possible by considering the probable nature of the depression if a different course had been followed. Such judgments can never have the weight of definitive proof, but they do indicate a basis for choice of action and for a useful angle of analysis. It is highly probable, for instance, that the smoother curves of prices and production in the post-war decade would have been broken by shorter up and down swings if there had been less intervention in all lines. There is, however, no sign to indicate that the secret of unbroken stability has been found or that the disturbing forces which arise in the course of manifold changes would have ceased to shift the direction of values from time to time. There is reason to believe, however, that many catastrophic occurrences such as the freezing of Central European credits, the suspension of the gold standard, and a suicidal tariff war could have been avoided by a consistent well-coördinated policy on the part of governments, or a more flexible and farsighted line of action pursued by individuals. As far as speculation is concerned, booms can be prevented by early restrictive action if the banks and business community are willing to pay the price for the sake of preventing later severe deflation. Moreover, if there had been no wild orgy of stock buying for a number of years, the banks, the railroads, the insurance companies, and the treasury could, and probably would, have kept their affairs on a reasonably sound basis. T h e ideas which are comprehended under the term "new era" philosophy could be considered mainly as offshoots of financial extravagances and errors, but for purposes of bringing out the importance of changing industrial attitudes they have been associated here with manufacturing in particular

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and then, more broadly, with other phases of the production and distribution of goods. It is held, for instance, that a different point of view in the post-war decade would have led to a more careful distinction between amounts paid in aggregate wages as contrasted with changing and often rising wage rates. Such an emphasis would have given some warning against a continuous rapid increase in luxury goods, would have stimulated a more careful scrutiny of costs, and would have introduced caution at points where there was an uncritical assumption that markets could expand indefinitely. While the disturbing effects of many of these things were being diffused widely through credit in the form of speculative excesses, the long-range influences were being accentuated by the large competitive possibilities of the new productive machinery and powerful institutions. Buildings rose to new heights, massive machines turned out great quantities of standard products, semi-durable goods caught future spending power in the network of debts and credits. The mistakes of the earlier present were the origins of the depression of the future. Distortion and mistaken policy in any one of these five areas would, in all likelihood, have brought on a mild cyclical recession. Trouble in all of them, prolonged by continuing errors in judgment and confusion of action, could hardly fail to lead to an unusually severe decline. In fact, it is easy to account for the occurrence of long years of depression. There is no need to look for mysterious explanations in the face of the mistakes which are now admitted almost everywhere. Even if it is argued that political conditions made reversals of policy difficult, the economist still cannot grant that there is any justification for defying persistently the lessons learned by past experience. It is true that the errors in policy were due in part to conflicts of interests which are bound to emerge from time to time, but it is still important to urge that the ruthless pursuit of a narrow selfishness cannot be counted on to yield rich profits in the long run. There are grounds for reconciling even separate competitive ad-

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vantages with economic principles if the penalty for ignoring these tenets is a catastrophic deflation. Finally, and in summary, it may be said that in the defiance of principles and experience lies the cause of the recent depression. A further elaboration and refinement of ideas regarding business cycles will accompany the progress of the historical and theoretical work now being pushed in many directions. The brief outline suggested here becomes more definite and takes on more meaning in the light of the events in the last fourteen years. Illustrations of the explanations sketched in broad lines in Chapters I I and I I I will follow in Chapters IV to V I I in a brief history of the recent period.

C H A P T E R IV THE WAR

HERITAGE

PAYING FOR WAR ALL the causes of the depression outlined in the previous discussion were generated during the war. They became potentially disturbing even though the force of their impact could have been modified by policy. Finance, foreign trade, agriculture, heavy industries, and industrial standards were pulled out of line. The original distortion created a profound disturbance even though there followed an interval of partial readjustment. W a r itself cannot be considered to have been the cause of the later severe depression, but it established the conditions which pulled supply and demand out of line and which were allowed to spread and develop destructive power as the years went on. Not until some years after the end of hostilities does it become clear that violence has been done to the economic system at many points and that financing war is in a sense impossible. There is a certain paradox in this fact. Obviously war is carried on within the general framework of established finance, but fundamentally the payments are only possible because of a continuous process of confiscation. Vast resources are of necessity destroyed, but the virtual bankruptcy which results at many points does not prevent the continuance of military operations. Only in the period of reconstruction do the obstacles to payment gradually become clear to those who devised the financial expedients which kept things going. Past experience has shown on many occasions that it is possible to mortgage the future and bury the credit system under a mass of unsound debts. War can always be financed in some way though the "standard of war" may be low. By a process of industrial control, borrowing and inflation, the future prospects of those who own property and 80

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the hopes of those who have saved and invested are gradually destroyed without the results becoming immediately apparent. T h e difficulties which every one foresees to some extent fail to prevent the continuance of destructive operations. There is even an appearance of prosperity which gains credence for the views of those inclined to minimize the extent of the cost. T h e reason for such confusion of thought and for the apparent contradiction between reasonable anticipations and actual occurrences lies in the special manner in which the production and consumption of goods takes place during war and in the complicated ways in which modern civilization has subdivided processes and extended them over time and space. It is conceivable, for instance, that if the government completely ignored all property rights and took definitive control of all goods and services, the discrepancy between the real and the apparent ability to finance war would largely disappear. Governments have not in modern times taken this drastic step. I f they did, the result would be that as long as either force or sentiment would persuade men to sacrifice existing properties and claims on the future in the interests of prosecuting the war, the limits to expenditure and destruction would be set by the total real wealth in existence. T h e breakdown would probably come not, as after the recent war, at some distant date when promises were revoked and contracts voided, but at an earlier time when human discouragement and the unwillingness to subordinate personal rights and privileges to the ends of warfare became articulate in a strong protest. The attempt of every government, however, is to postpone as long as possible the public realization of the full cost involved. There is always some hope that the burden can be thrown on future generations. This idea facilitates the fictitious payment at high prices for most of the goods used. It leads to the issue of government promises to pay in return for individual savings j it offers no real certainty that any of them can be met.

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Unfortunately, the more complicated and the more highly capitalized a society becomes, the better able it is to spread the inevitable burden over time and space and to mortgage the future in order to keep the allegiance of those whose help it needs. T h e state must command vast resources in its new business of war-making. Therefore the changes in the material world take the form of government use of most of the available commodities and all the labor it can commandeer. By means of either security issues or new inflationary currency, it gives its citizens, or lending nations, claims to future wealth in exchange for the cash which it spends at once. A small portion of these credits can, of course, be used by the lender for immediate consumption if he uses them as collateral for new loans, but most of them are held until a later date. T h e expansion of government borrowings is usually accompanied by an inflation of the currency or of credit and a rise in the price of corporation securities so that the individual seems often to be richer than he was before. In actual fact, the goods which he wishes to buy with his claims at some later date have been to a large extent destroyed or changed in character. At the time when he comes into the market as a purchaser there may be an acute shortage of real wealth. Thus, while it could be said in a simple, non-capital-using economy that the payment for the war could not be postponed because real wealth would have to be created and used in the present, in a highly organized capitalist society the effects of borrowing and lending on the price structure must inevitably be carried over to the future. One immediate consequence is that past accumulations of capital are exploited by the failure to replace and renew, but the future must meet the deficiency in some new effort or sacrifice. T h e time when the full impact of these overhanging obligations will fall on a world recovering from war will depend on various complicated psychological and production conditions. I f , for instance, immediately after a war, a shortage of wealth is keenly felt, there will be a tendency for those

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83

with large outstanding credits to liquidate them more quickly than would be likely if there were considerable ease and well-being. Such a condition of pressure and want leads rapidly either to destructive deflation or to temporary efforts to stave off deflation with additional inflation. T h e choice between the two courses hinges on political conditions. It is possible that government bondholders can afford to wait f o r maturity dates before using the capital invested. If there is no immediate pressure to use government securities and claims to future wealth to maintain a precarious standard of living, it is likely that there will be considerable pyramiding of investments and expansion of speculative funds, pending some later date of realization. If this occurs, the reversal of the investment process 1 is likely to be initiated by some threat to the security of investments and an immediate stampede to cash in claims for the sake of protecting nominal assets. Such typical war situations are not different in kind f r o m others which lead to cyclical fluctuations in business. T h e r e is a constant tendency in peace or war towards a credit expansion like that just described. Claims outrun wealth and pile up burdens against the future. T h i s fact leads to a dangerous discrepancy between present and potential demand for goods. A n expansion period is followed inevitably by hysterical efforts to gain personal security by quick sales and the hoarding of goods or money. T h e attempt to store unusual amounts of wealth in either f o r m disrupts the normal flow of production and consumption. T h e reversal after a long war is due to the piling up of a top-heavy government debt structure which shakes confidence in credit. T h e resultant liquidation often comes quickly. It is not wise to minimize the importance of war effects simply because they take the f o r m of legal and political influences superimposed on an economic system still capable of functioning in a fairly satisfactory way. Once production T J . M . Keynes, " A n Economic Analysis of Unemployment," ment as a World-Problem, the Harris Foundation Lectures, 1931 >93i)> P· 15·

Unemploy(Chicago,

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RECONSTRUCTION

has emerged from the unspecialized barter stage, a variety of factors, legal, political, and psychological, become extremely powerful, and recent post-war developments have shown that they can very nearly rack to pieces a going productive system. T h e influence of war costs and war payments just outlined has been generalized from a variety of cases and has been made comparable to all inflation-deflation sequences. There is in such a general statement, however, a partial explanation for a situation which has been observed but rarely accounted for adequately, that is, the "primary and secondary" depressions which follow long wars and which seem to be connected but distinctly separate in time. 2 T h u s the slight recession of 1919 was followed by the boom of 1919-1920. T h e severe setback of 1921 was followed by years of relative prosperity. Y e t , in spite of seven years of active production and considerable prosperity, the depression of 1929 has its roots in certain excesses that developed in war time. T h e reason for the attainment of an intermittent and broken prosperity while the basic problems were still unsolved is, perhaps, more difficult to explain from a logical point of view than the reason for the ultimate collapse in 1929. In part, the explanation must be sought in the fact that industrial needs growing out of the temporary restriction of certain types of production stimulated a false prosperity, and in part in the lag of debt liquidation coming several years after the original piling up of claims. T h e constant tendency of action in one direction to bring about an opposite reaction is characteristic both of the credit system and of an economy possessing a large body of capital equipment. Both the use of loans and the increase of capital instruments were accentuated by war finance. It is probable that neither the reason for the 1921 recovery nor the explanation of the later collapse can be expressed in any simple formula, but it should be noted that the pros3 Leonard pp. 15-24·-

P. Ayres,

The

Economics

of

Recovery

(New

York,

1933),

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85

perity which the United States won was to some extent in contrast to the struggles of Europe. T h e main factors which prolonged the short setback into a severe depression were, in the later years of the decade, the complicated internal and external debts and abnormal credit movements originating to a considerable degree in war-time changes. The marshaling of a number of different explanations for these unpredictable changes in business prosperity is not entirely satisfactory to the theorist. The only solid ground on which to base the choice of special factors as having a predominant influence, in the absence of statistical answers and conclusive deductive statements, is to observe the unsettling influences just before and during the depression and then to trace these back to some point at which they seem to lose their identity in general causes. It is clear that in the case of stock speculation and collapse, for instance, in the difficulties of the banks, in farm debts and farm prices, the line of effective influence can be followed back into the war period. Less clearly and definitely, certain speculative impulses, high wage policies, and borrowing habits can be followed back ten years or more through a set of interconnecting links. T h e rise of certain industries that accentuated prosperity excesses as well as the development of certain other disturbing value changes does not seem to have originated in the same set of influences and seems to be only vaguely traceable to the war. 3 It is, of course, difficult to get clear-cut answers to some of the pressing questions about war as a cause because the carrying on of military operations entails the transformation, at least temporarily, of all the major phases of economic life. RECONSTRUCTION

ACTIVITY

Post-war reconstruction also made insistent demands in the years 1 9 1 9 and 1920. It seemed at first to present an urgent but relatively simple problem of effort and coöpera8

Such enterprises as radios and electric refrigeration can be cited. Similarly the stock market boom was not well under way until after 1 9 2 6 .

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DEPRESSION AND RECONSTRUCTION

tion. M o r e houses, more food, more clothes were urgently needed, and the energy n e w l y released from war work flowed quickly into productive channels. H u n g e r in G e r many, devastation in France, poverty in E n g l a n d , and manif o l d troubles in other war-scarred countries all challenged the resources of those nations not yet drained of their wealth. T h e United States in particular roused itself in a l i v e l y boom of productive activity. W h a t seemed for a time to be an emergency situation began to take on some of the characteristics of a new and lasting prosperity. Business activity increased at a feverish pace, while pessimism and fear gave place to hopes of expansion and prosperity, based in part on increased war-time capacity to produce. T h e new spirit was all the more buoyant because it came as a surprise. T h e U n i t e d States at least seemed to be gaining new opportunities and the swift movements of prices and commerce obscured the first signs of serious difficulties which were to bring about a severe reaction. E v e n the collapse of prices in 1920, f o l l o w e d by almost two years of depression, failed to bring a clear understanding of the extent of war losses and the serious nature of underlying maladj ustments. T h e n after the short depression, because the recovery from the low point of 1921 was vigorous and inclusive, many thought that the troubles of 1 9 1 4 1918 had been l e f t behind and that most of the artificial restraints and emergency measures had been liquidated. T h e r e was no widespread understanding of the nature of the permanent changes which had occurred and little awareness of the danger of perpetuating and increasing maladjustment. T h e explanation of the misunderstanding lies probably in the extent of the changes after 1 9 1 4 , which made it difficult to recognize and appraise new conditions. M a n y old landmarks had been swept away. Vast new markets seemed to have opened up for the United States. P o w e r f u l financial instruments were at hand to extend economic influence in unexpected directions. M e a n w h i l e shifts in the influence of cer-

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tain classes and political parties, the use of unfamiliar phrases and altered standards made comparison difficult. In terms of the usual phenomena of business recessions and recovery, the fall in prices in 1920-1921 as w e l l as the subsequent recovery seemed to have brought basic factors into a good working adjustment. It is apparent now, looking back, that a large majority of the fundamental relationships were very much out of j oint. A number of those mentioned above in connection with the changed position of the U n i t e d States 4 were observed and commented upon at the time, even though they were not made the basis for any consistent and forward-looking policy. Others, more conspicuously evident in Europe, were frequently ignored or misunderstood in America. It is now clear that a drastic reordering of productive effort was called for in this period. M o r e o v e r , any long-run economic projects depended f o r their success on some harmony of policy between the stronger nations on both sides of the Atlantic. Postponement of an intelligent and aggressive attack on world problems made the need f o r cooperative effort more urgent and at the same time much more difficult. FAILURE

TO R E C O G N I Z E

READJUSTMENT

PROBLEMS

T h e changes g r o w i n g out of the war should not be underestimated. I n the first place, the loss of man-power and the destruction of wealth during hostilities was often measured in purely quantitative terms rather than with respect to the way such losses upset the customary balance of supply factors and demand conditions. It was not realized to what an extent the uneven impact of destructive forces called for a sequence of profound adjustments in commerce and finance as well as in many other areas of political and economic life. Rough appraisals made in 1 9 1 9 and 1920 for purposes of war indemnification were misleading as guides to the extent of the internal realignments of enterprise in both debtor and 1 See sufra, C h a p t e r I, pages 4 and 5, population, cultivation, position, mass production, n e w aims, growing· interdependence, etc.

creditor

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DEPRESSION A N D

RECONSTRUCTION

creditor countries. Shifts in production at many points laid a basis for rapid mechanization and the extension of production in new directions, without bringing any clear consciousness of the need for a careful balancing of the new proportions between different factors. Replacement of lost property called for expansion in industry, not only in those goods which were directly demanded but in various kinds of capital goods which lay further back in the complex process of specialized production. Inevitably, capacity in some lines was stimulated to meet temporary demands and the new equipment was often kept in active operation after the special requirements had been satisfied. In production the situation may have been obscured by many confusing changes, but in finance the main outlines of the new situation were very conspicuous.5 Some corrective effort was instituted here and there after the war, but even in finance the long series of after-effects were imperfectly realized. Obviously the United States was placed in a new position of power. England had lost much of her dominance as the one great financial center and the flexibility of London as a money market was seriously impaired. She found herself faced with large debts at the moment when the quality of her credits with other countries had deteriorated in a distressing manner. France had lost heavily from her foreign investment portfolio and was threatened with internal financial collapse on account of an unbalanced budget. Most of the other countries were seriously crippled as capital markets and were not able to meet their own most urgent needs. The gold reserves behind bank credit were unevenly distributed because of the persistent drain of metals from warring countries. The new demands for funds were made on the basis of dire need rather than because of any assured prospect of repayment of capital or interest in the future. In addition to the many artificial factors in finance, political interferences in economic life had resulted in very great changes. Many of the controls set up during war time had ε

Sir Arthur Salter, Recovery, The Second Effort (New York, 1932), p. 6.

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been continued in the same or in altered form. Some temporary measures, such as inclusive price-fixing regulations and railroad control, had been thrown over quickly, while others, such as foreign exchange regulations and import restrictions, lasted for a considerable period. T h e change f r o m pre-war conditions was so marked that it led many to suggest the passing of a familiar but v a g u e l y defined system called laissez faire6 and the entrance on a new age of more conscious control. Others, stating the matter in a different way, and looking to certain less institutional aspects of economic life, stressed an increasing rigidity in prices and control of production. 7 T h e r e is a significant degree of truth in both these points of view, but they have sometimes been exaggerated as a basis for false theories of economic trends. A careful interpretation of the facts indicates that the picture cannot be drawn in the sharp contrasts of black and white which indicate sudden and dramatic change. It is true that a new familiarity with government intervention had been established, but it is also true that it had aroused strong opposition in some quarters. M o r e o v e r , it has been observed over many decades that in times of economic pressure and distress, political instruments are frequently used to redistribute wealth, to regulate a diminished output of goods, and to assure the means of subsistence to the mass of the people who have been pushed closer to the starvation level as the nation's surplus declined. T o the extent that many countries were in difficult straits after the war, the tendency to increase political intervention became operative and considerably affected public thinking. T h e increased desire to use political powers f o r economic ends and to avoid the effects of reduced national income often lasts through the early stages of an upturn and is sometimes given credit for a major part of the recovery. A s soon as prosperity has become marked, however, there is apt to be a reversal of these tend* G. D . H. Cole, "Laissez-Faire," The Encyclofaedia (New Y o r k , 1 9 3 3 ) , Vol. 9, pp. 15-20. 7

F. C. Mills, Economic

P· 557·

Tendencies

of the Social

Sciences,

in the United States ( N e w Y o r k , 1 9 3 2 ) ,

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DEPRESSION AND RECONSTRUCTION

encies and a renewed pressure for individualism and competition. There were clear signs of this tendency in the postwar decade. Here and there in the United States, of course, institutions and administrative machinery established to direct industry or commerce continued to function, while higher wages and special conditions, artificially established for a temporary emergency, continued to lessen the flexibility of action of producers and necessitated the acceptance of new standards. These more rigid elements were offset, however, in certain cases by the increased rapidity of movement and transformation of enterprise which freed producer and consumer from the full restraining influence of the special regulations of political origin. The greater expansibility of credit, for instance, gave new and uncontrolled power to financial leaders which may have counterbalanced the efforts of Central Banks or governments to exercise control. A rapid growth of small enterprises occurred in certain industries.8 This development inevitably lay outside the framework of established standards of wages and conditions which had been built up gradually and won at great cost in other kinds of enterprise. The railroads were under some restrictions, but in contrast to them, motor traffic brought an unprecedented freedom of action into transportation. Wages were held at high levels, but manufacturers established new processes and introduced more machines which may have lessened the net effect of stronger collective bargaining on labor costs.9 Any attempts to balance the new forces of control, on the one hand, and the increasing scope of freedom, on the other, are difficult, if not impossible, to achieve. The complications of the question are many. A careful reëxamination of the evolution of various forces, however, shows that the general result of the changes in this period was not so much a net movement in either direction as a radical difference in the kinds 8 Some enterprises connected with automobile servicing a n d bus transportation are examples of this tendency. ° A further study of rigidity in this period w o u l d supply v a l u a b l e material.

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of change that could be expected in various enterprises. A condition amounting almost to anarchy prevailed in many fields of enterprise, while others were subject to increased regulation. At the very moment when some observers stressed the rôle of government as a new and decisive element and announced that laissez faire was dead, others saw new power in the hands of business men and financiers and urged that the lawlessness which was based on unbridled competition was increasing rather than diminishing. T H R E E O T H E R C H A N G E S IN D E M A N D

These four main groups of factors—the loss of wealth, the transformation of production instruments and methods, financial changes, and the increase of political intervention — a l l worked themselves out through a variety of specific instruments and are to be observed in the form of various changes in prices, in products, in commerce, and in investments. In addition to these four, there are three others which are of equal importance in influencing the years to come. One of these m a j o r influences is the shift in the power and importance of various classes and groups in practically every country. T h e others are changes in the demands of some of the large markets of the world and the collapse of various currencies. T o a considerable extent, the rigidities and restrictions which came with government intervention in business were the outgrowth of attempts to express changes in the power of different groups. T h e means urged by those who held a new authority or fought for new rights were taxation, inflation, special laws and ordinances, and in some cases revolutionary movements. B y reason of an aggressive use of various weapons, new riches were thrown into the hands of some of the more active industrialists, trade union leaders, financiers, and politicians. T h i s redistribution was usually to the detriment of the middle classes, the weaker groups of wage-earners, the professional groups, and the leisure classes. Some of the legislation held over from the war reflects these changes.

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DEPRESSION AND RECONSTRUCTION

Certainly the attitude towards saving, international commerce, living standards, and government finance indicates the establishment of a new balance of power within many countries. T h e United States was probably one of the last of the industrialized nations to recognize that these changes were taking place. T h i s slow realization was partly a result of the fact that there was a much wider margin of real wealth to be absorbed in wages on the upswing and more reserve spending power in the credit system and in individual savings through the w h o l e period. M o r e wealth in the f o r m of real wages was in the hands of labor on the downswing after 1920 than in any other country. I n contrast, labor leadership was less articulate than in most other industrial societies. T h e result of these changes in the relative importance of various elements in the population, at a time when the smallincome receivers tried to gain new advantages and the rich tried to h o l d their positions, was in part to shift the emphasis away f r o m lowering production costs to attempts to increase the v o l u m e of sales. T h e idea held by some manufacturers as w e l l as by labor of maintaining wage rates was reënforced by observing the difficulties encountered by those who tried to reduce them. T h e displacement of men by machines was to a certain extent a result of high wage rates. A rapid development of sales pressure was one outgrowth of the rising importance of the lower income groups, and rapid mechanization was another. 1 0 T h e latter tendencies went hand in hand in building up an ever greater capacity to produce. T h e y laid the foundation f o r " n e w e r a " thinking and speculative excess as w e l l as for the later collapse. Other important developments affected markets for commodities in these years. A s far as the United States was concerned, the opening up of large European areas to her goods was the outstanding commercial development during and immediately after the war. T h e importance of this enlarged 10

E m i l Lederer, " T e c h n o l o g y , " Encyclofedia

York, 1934), Vol. 14, p. 556.

of the Social

Sciences

(New

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outlet for commodities was probably much greater than was that of the expanding domestic market, but it also held greater dangers since the rapid increase of exports was unnatural and misleading. E v e n before France and Germany and other western countries began to cut down their imports, the drying up of certain eastern and southern markets tended to offset the new opportunities for sales elsewhere. T h e repressive effect of the shrinkage of foreign purchasing power in terms of gold which cramped those largely dependent on fiat money was disastrous to some branches of American industry. E v e n though most of the results were not obvious for several years, the gradual revival of European production began immediately after the war to limit and repress large-scale buying and to stimulate easy credit and high-pressure selling in America. These were natural, if somewhat mistaken, efforts to postpone the day of drastic decline. Russia, China, India, and Japan all had difficulty in paying for their customary purchases of western manufactures after the war. South America, a fairly steady buyer of staple commodities, became a less attractive field for American expansion. A t the same time competition and chaos in many parts of Europe served to reduce the consumption of American goods. T h e rapid disappearance of market demand in many areas and the hurried attempts to exploit new territories introduced many uncertain elements and turned some commercial ventures into a gamble. In the light of swift changes, appeals for intervention by means of tariffs, subsidies, loans, etc., were inevitable, but they grew out of contradictions of policy rather than out of clear-sighted knowledge. Moreover, they led to destructive tampering and eventually to nationalism and reprisals. Nationalistic tendencies were in evidence soon after the war ended, but they were not clearly manifest until much later, when a realization of the meaning of the tariff law of June 1 9 3 0 swept over Europe with a feeling of bitter disillusionment. Only then did the f u l l logic of the intense com-

DEPRESSION AND RECONSTRUCTION

petitive struggle and the cost of errors in computing future trade prospects become undeniably clear. A final major heritage of war influence is found in the disordered currencies which came with other upsets in finance. T h e desperate efforts of a dozen governments to finance their armies by borrowing, taxation, and inflation all weakened the substructure of circulating money and made depreciation almost inevitable. Some of these difficulties were recognized as early as the Paris peace conference in 1 9 1 9 - 2 0 . Others emerged during the struggle over Reparation, and still others came to light later in various countries as the conflict between classes, waged largely over issues in the fields of public finance and taxation, led to disastrous inflation. With inflation there came unbridled speculation in money and exchange. T h e seeds of the later monetary trouble had been sown during the war, of course. In some cases, the results could have been predicted as inevitable, but in others they were multiplied almost beyond belief by a long series of avoidable political and economic errors. Many unanticipated inequalities, uncertainties, and erratic movements in value grew out of disorders in money and exchange. A certain number of these could have been nullified or discounted if they had been recognized more quickly. T h e minor fluctuations in value might have been prevented from becoming maj or swings if some loss through temporary sacrifices had been preferred to the greater risk of a struggle for large potential gains at the cost of possible failure. E v e n though a part of the currency depreciation was the inevitable aftermath of the war and must be set down as an unavoidable part of its cost, it made a heavy addition to the destruction of wealth from other causes. T h e world was much the poorer because its money and banking systems were temporarily derailed, and there was need for additional effort in the realm of finance. Other notable changes were wrought in the economic world by the war, but these seven must be set down as the most conspicuous and the most far-reaching in their effects be-

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cause of the way their influence spread to all types of economic endeavor. F o r the purposes of the present discussion changes in territories and boundaries, new alliances, and shifts in public opinion and morals are subordinate to, or reflected in, the main economic forces here outlined. T h e loss of human and material resources, the changes in various industries, the shift in financial balance, the changed nature of political interference, the alteration of class structure, the shrinkage of some markets offset by a temporary expansion of others, and monetary weakness—these new conditions occurred in seven major fields of economics and sociology. T o understand them f u l l y one would have to take account of the research data and ideas that have developed around production, credit, politics, labor problems, distribution of income, and money. Nevertheless the outstanding facts are easily recognizable and few will deny the general nature of the events and processes which left the world in 1 9 x 9 a very different place from what it was in 1 9 1 4 . F A L L A C I O U S H O P E S OF K E E P I N G S P E C I A L A D V A N T A G E S

Obj ective manifestations of the war heritage appear in the stirring events of the early twenties. Booms in production, hard-fought strikes, enormous loans, revolutionary movements, and financial catastrophes marked the early post-war years. T h e curves of prices made wide sweeps; wholesale price indices finished a rapid climb in 1 9 2 0 and fell in an almost vertical drop to little more than half the high point. Curves showing wage changes followed in slower motion and cut a wide arc against the background of more stable incomes. Security prices moved erratically. T h e volume of production of many things moved sharply above the long-time upward trend and led indirectly to the piling up of huge inventories by manufacturer and wholesaler and to lively speculation in commodities. At the beginning of the new decade of recovery from the war, the 1 9 2 0 presidential campaign in the United States was the occasion for alluring promises to producers already

g6

DEPRESSION AND RECONSTRUCTION

tuned to a rapid tempo of war activities. The prevailing interpretation of the idea of a return to normal was a consolidation of all past gains along with an elimination of the disturbing features left over from the boom. The hopes for further expansion of European demand for goods entailed no corresponding willingness on the part of the United States to yield any important points in international cooperation. Both finance and commerce were encouraged to carry on an energetic drive for larger enterprise while pressure for the collection of foreign debts was definitely envisaged. Similarly, during the first part of the post-war period, labor tried to hold its gains by a number of aggressive strikes. Wage levels were well maintained at many points in spite of the expectation of lower commodity prices. There was comparatively little real saving as a counterpart to the unprecedented expansion in capital equipment. A net gain in the standard of living was to be seen in the wider enjoyment of certain luxuries, especially in the increased uses of automobiles, in varied and widely patronized amusements, and in rising quality and quantity in the consumption of food, clothing, and household goods. Taxation had not encroached seriously on real wealth, although there was some hardship because the cost of living was high for those with fixed incomes. The national losses incurred during the war had been offset in part by the gains of a very active industry and also, from the point of view of the government, by levies on the depleted real incomes of the salaried and bondholding classes. With all the contemporary movement and activity, the general appearance of life in these times of reconstruction was varied and stimulating. New opportunities for wealth were apparent and the ambitions of many were roused to a new intensity of economic struggle in the hope of rich gains. Both individuals and the industries and groups that made up the corporate life of the nation were stimulated to unprecedented efforts. Even though the revolution in Russia and chaos in China were regarded as significant episodes by many, in some quar-

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ters they were minimized as remote happenings that merely threw into relief the financial and commercial struggles of western Europe. Foremost in most people's thought was the rebuilding of France and the restoration of peace-time business conditions in Germany. These, together with the effort to return to normal industrial conditions in England, seemed at this time much more important to industrial America than the eastern troubles. As a rule, the high degree of interdependence of nations on each other was greatly underestimated. It was possible during several years for the organic nature of world commerce and the many links between price structures to be ignored in the formulation of the foreign policies of one of the greatest exporting nations. In fact, the United States had accepted its new opportunities in finance and trade with an incomplete realization of the risks and obligations involved. The ease with which the demobilized soldiers had been absorbed into an expanding industry was a surprise to many. Almost at once after the war an active speculation in staple commodities such as sugar, leather, and silk began to push up prices at a speed reflected on the charts in a steep curve. The foundation for many of these swollen values was patently unstable. It was only necessary for a far-away disturbance, such as the Japanese earthquake, to occur to precipitate troubles in the markets of silk, cotton, leather, and other commodities. Disturbing rumors of the excess in speculative holdings were sufficient to send the structure crashing downward. The 1 9 2 0 depression must be counted as one of the more severe recessions among the cyclical fluctuations of the past fifty years. When put beside the decline of 19301934, it now seems relatively mild, but the months of severe unemployment in 1 9 2 0 and 1 9 2 1 brought a great deal of real distress. T h e surprising thing to note is not so much the sharp decline as the quick recovery. During the brief period of low production and unemployment little was accomplished in the way of readjustments between agriculture, industry, and commerce. It is probable that some part of the post-war

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DEPRESSION AND RECONSTRUCTION

correction and. reform could have been accomplished in a fairly well-balanced and orderly liquidation if European conditions had not roused uncritical hopes of a rich market for American exploitation. Unfortunately the stimulating influence of an immediate demand for raw materials abroad prevented any early reduction in agricultural enterprise or in the heavy industries. M o r e o v e r , most of the construction, metal, and other durable goods industries came out of the depression quickly. W a g e s were still high in pre-war terms and exaggerated expectations on the part of investors and exporters gave a rosy g l o w to the rapid recovery f r o m a severe recession. T h e history of the prosperity and decline of 1 9 1 9 - 1 9 2 2 will always be important to an understanding of the years which follow. L o o k e d at f r o m one angle, they are a tribute to the energy and courage of those who survived the war. F r o m another point of view, the mistakes which came with rapid recovery constitute a warning against hasty efforts to accomplish inconsistent results. It is now clear that v e r y f e w understood the extent of the changes which had occurred 5 almost every one underestimated the real costs of the war. N e w instruments for gaining wealth and many half-understood opportunities in new fields were the basis f o r an unjustified optimism and for a quick turning away f r o m the consequence of war. T h u s , the momentum of reconstruction carried the United States through the first depression without accomplishing the readjustment of the m a j o r factors of production and without bringing an understanding of the most pressing problems of the moment, such as the importance of a flexible price structure, the significance of varying costs, or the meaning of changes in the distribution of wealth. MANY

QUESTIONS

STILL

UNANSWERED

E v e n this rough sketch of the main forces and events which shaped the post-war world indicates that further study of the eventful time after 1918 is urgently needed. A good

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many of the more important facts have become evident in the jagged movement of curves which show the course of prices and volume of goods produced. Others are still obscure. T h e statistics of the period form a rich store of material from which much can still be gleaned. Studies of various sorts, recording significant episodes, and memories of the early post-war years are still needed to interpret changes in the decade which followed. It is possible, however, that even with the knowledge of events as fresh as it is now, the memories of those fateful months have already been distorted somewhat by the more vivid impressions of the tumultuous years that followed. T h e existence of an interim period of first readjustments has been so taken for granted that many episodes which were in a sense turning points have been insufficiently analyzed in the light of later knowledge of the results which grew out of them. Moreover, some forms of adaptations in production and prices which were assumed to have taken place actually never occurred. 11 In fact, it is almost certain that the clue to many of the later errors of business policy is to be found in the months immediately after the armistice. Even though the definitive action which was to hem economic life about and deprive it later of free development had not yet been taken, even though the debt structure was only moderately extended, and thinking flexible, there was a distinct bias in estimates of the economic future and certain superficial but widely accepted ideas had exerted already a determining influence. It is probable that the power of a number of popular theories, such as the ideas regarding wages, to circumscribe economic action will be more fully realized when this period is further explored. T h e cultivation of a state of mind easily susceptible to propaganda and the influence of war emotions on uncontrolled hopes of peace-time may come to bear its share of blame. It proved to have played a conspicuous part and gave an opportunity to many unfamiliar tendencies in 11 As certain relations came into adjustment, others, notably wages for certain kinds of skilled work, and land values, remained far out of line.

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politics. Clearly publicity, and advertising, and demagoguery had new and effective weapons at their disposal. The comprehensive study of the depression will probably endeavor to answer in a definitive way a number of questions which have come in retrospect to take on special significance. The study of causes in the five areas of activity already outlined will be made more precise in the light of historical facts and careful quantitative measurement. Some of the questions regarding these years which should guide further investigation may be suggested here. In the first place, the changes in the capacity of heavy industries as the result of war activities call for more comprehensive examination. The attempts to convert some war firms into concerns producing capital equipment adapted to a peace-time world throw interesting light on the question of over- and underinvestment. Such influences were to affect the amount of available productive power in the next fifteen years. Both the facts and the plans that characterized the turning points of 1 9 1 9 - 1 9 2 0 are significant in a study of the events which followed. In the second place, a further analysis in the shift in the relative volumes of different types of goods produced would be highly enlightening. T h e ratio between necessities and luxuries, between consumable, semi-durable, and capital goods would indicate whether changes characteristic of the new era, and other speculative periods, had already become apparent in the earlier years. In the third place, more facts are wanted with regard to the volume of wage-earners' incomes and the uses to which they were put. Some of the material which would have been useful in such a study has already disappeared 5 some will become more difficult to obtain with each passing year 5 some has already been embodied in research reports which merit an early reëxamination. A sufficient span of years is now available to give perspective to the post-war readjustments. There is some ground for clear-cut statements regarding earning, spending, and saving. Gaps in knowledge which heretofore have permitted

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loose reasoning and unfounded theories with regard to cost and purchasing power may be closed by a reappraisal of some of the research already completed. O n l y by an unbiased study of wages, living standards, and consumption problems can the economist wisely assist in the formulation of constructive policies to influence the distribution of wealth. T h e n , in the fourth place, the transformation in various kinds of enterprise which resulted from increased exports calls for careful research. T h e r e has been much vague speculation as to the importance of exports in increasing the profits of industry. T h e possibility of finding new, and in some cases expanding, outlets for goods had a very real bearing on the development of mass production. T h e s e possibilities were enhanced by increased standardization and mechanization. L i t tle has been done to appraise the influence of foreign trade on the quantity and the organization of domestic production. Material is lacking at present for a sound judgment regarding the cost to society of high tariffs or of the sudden growth of nationalism in the U n i t e d States and elsewhere. Finally, studies already undertaken in the movement of various groups of prices within the complex fabric of general values call for further interpretation. T h i s should aim to disentangle monetary phenomena from those which reflect changes in method or efficiency. T h e r e is a mass of highly significant data regarding this post-war reconstruction period which calls for reinterpretation. T h e findings are at present so complex as to be confusing to the business man, and so far they have lacked the finality of interpretation which may be possible now that both the end and the beginning of several post-war cycles of business fluctuations are available to the student. Some of the investigations here suggested must wait until the urgent questions of the first stages of recovery in 1934 and 1935 have been answered. M o s t of them, however, have a direct and immediate bearing on the nature of plans for the next few months and years. T h e pressure of growing discrepancies and the inevitable continuity of economic influ-

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enees become more apparent as the span of vision widens to include the recent and more distant past. The further passage of time bringing a broader perspective is bound to ripen judgments and show how the results of past mistakes reach far into the future. It is important to recognize that the frequent repetition of the assertion that conditions are novel and unprecedented is in part its own refutation. There are new combinations of familiar factors, there are new elements to be found among the mass of time-worn principles, but there can be no complete reversal of economic trends even as the result of political revolutions. These trends are the product in part of physical conditions, of population changes, of world influences, and deep-rooted habits of thought and action. In a very real sense, the war heritage of the past is still determining the course of affairs in the present. The questions of internationalism versus nationalism, of freedom versus control, of balanced expansion as compared with short-sighted exploitation, are ever-present. The forms in which these problems present themselves may change, but the substance remains the same.

C H A P T E R

V

THE SIGNIFICANCE OF THE "NEW ERA" A P A R T I A L BASIS FOR N E W

IDEAS

RARELY has economic life been so directly modified by conscious theorizing as during the post-war decade. In these years there is a segment of time between 1922 and 1929 which was dominated to a greater or lesser degree by a body of doctrines associated with the term "new era". T h e y were years of genuine prosperity. T h e y were marked by a richly productive industry and a rising standard of living. Even the two short depressions in 1924 and 1927 did not greatly reduce the volume of production. A feeling of power dominated the financial centers, while rising investments and daring ventures in untried fields indicated the vitality of a strong creative impulse. In the material world, in building activity, and in business and finance, new types of organization marked the increasing complexity of capital structures. They were taken to be dramatic representatives of a new dominance of man over his environment. 1 T h e intangible changing nature of an idea makes it a difficult subject of scientific analysis, and yet the idea or group of ideas which altered the currents of economic life at this time have been manifest in many concrete forms. T h e y appeared in widely separated fields at approximately the same time and were expressed by many different types of people. Their power cannot be doubted ; their influence carried through two minor cyclical swings and modified the policies and theories of the depression and recovery years. T h e essential thought behind the tendencies of the period was that markets could be expanded almost indefinitely, not by reason of the power of lower prices to call out wider ' R . T . Ely, Outlines

of Economics

( N e w Y o r k , 1923 edition), p. 27. 103

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market demand but by the expansion of consumers' moneyincome and the absorption of that income by high-pressure salesmanship. A frequent appeal was made to employers to shift the emphasis of industrial policy in such a way as to increase workers' incomes by setting higher wage rates. This policy was urged with some expectation that further disbursements to labor would be spent in the purchase of goods in such a way that the volume of sales, of production, and of employment would all move up together. T h e acceptance by many people of a social philosophy with regard to discrepancies between business income and outgo which recognized the growing importance of mass purchasing power indicates the effectiveness of the line of argument advanced at this time. It is striking to observe that the essential idea behind these conservative, Utopian theories was a vital part of the Marxian doctrine almost a century ago. There was a serious attempt to reconcile the selfish advantage of the manufacturer with a larger distribution of wages. At the same time a number of observations and theories with regard to price stabilization and credit control were associated with this general body of thinking. 2 Only rarely, however, was the new point of view expressed in terms of definite theory. During the period of its first development and strongest influence it was more conspicuous as a general state of mind than as any closely reasoned body of doctrines. For the most part, the abstract formulation of the central ideas came later than did the material results of general activity and public sentiment which it encouraged. The hope that prosperity could continue without interruption was transformed into a fixed conviction. T h e notable stress which was placed on wage-earners' and mass purchasing power was part of an increasing participation of the general public in economic affairs. T h e wide interest in in3 U. S. Senate Hearings: A Bill to Establish a National Economic Council, S. 6 2 1 5 , 71st Congress (Washington, D. C., 1 9 3 2 ) , hereinafter cited as Senate Hearings 6 2 1 5 , statement of E. A. Goldenweiser, pp. 6-7; see also pp. 239, 240; S. E. Harris, Twenty Years of Federal Reserve Policy (Cambridge, Mass., 1 9 3 3 ) , vol. I, pp. 86-90.

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vestment, which became later a speculative mania, also indicated a confident assurance in the increasing productivity of the country. The power of this group of ideas was sufficient to set them apart as an important influence and make of them a distinct line of cause leading to the depression. In their extreme form they were peculiar to the United States. The sustained wave of optimism which made it possible for the volume of manufacturing and many security values to rise high above their traditional norms was unique in America and only affected other countries indirectly. The forces which were set in motion flowed out through speculative channels, and then played a part in the general disturbance of world economic conditions through erratic capital movements and the conditions of financial anarchy in the operation of the gold exchange standard. The briefest possible description of the motivating force of this epoch could probably be made in terms of a belief in an easy increase in the standard of living and the achievement of a flexible economic stability. Poverty was held by some to be disappearing rapidly 5 depressions were considered to be in large measure preventable 3 and the lesser fluctuations which might occur from time to time were held to be predictable with a reasonable degree of accuracy. The strength of the general "new era" idea is to be seen in part in the many different kinds of action stimulated as well as in the numerous types of explanation which emerged to account for the flaws in the unfolding of business and financial policy. T h e period of dominance of these ideas was fairly long in terms of a usually fickle public opinion. During the years of prosperity, the professional economists were divided in their views and, for the most part, refrained from appraising what seemed to be a new situation. A few had laid hold on certain sound implications to be found in the vague body of theory brought forward in these years and had attempted to give them scientific expression. Others had refuted minor points while they avoided a frontal attack. Still

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others considered a cautious and reserved attitude a sufficient safeguard to their reputations and underestimated the growing influence of popular theories on practical affairs. Meanwhile, for several years, production moved on an upward sloping curve to yield unprecedented wealth to a nation already living on a high plane of general comfort. In attempting to weigh and interpret these ideas it must be acknowledged that no body of thought which has won the allegiance of millions of intelligent people can be dismissed lightly. Neither can it be judged to be entirely devoid of truth. T h e wisest assumption is that there can be found somewhere a partial correspondence between the ideas and actual experience which has made them acceptable. Moreover, there is almost certain to be some effective response to any widely felt need. This response will bring practical policy and fundamental truth more closely into harmony as human effort gropes its way slowly among the confusing problems of economic life towards a vaguely imagined goal. So strong was the motive force generated by the philosophy of the new era that the quick revulsion of feeling which came with the various crises in the security markets in 1929 and thereafter, and which spread in a wave of pessimism over the entire surface of economic life did not submerge it entirely. E v e n though there was a hasty rejection of many sound conclusions regarding both the new era and the old, much of the thinking has not yet been completely refuted or confirmed in any important respect. There is, in fact, some basis of truth and a significant expression of a widespread public demand in the thinking which characterized the period ending in the year 1929. The main concepts continued to influence both thought and action during the later years of deep depression. They were made the foundation of a group of fallacious theories which were to delay recovery. A l l this is admitted now by a maj ority of the experts in this field and yet there has been no clear and emphatic statement either of the foundation stones on which

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"new e r a " thinking rested or of the misleading deductions to which it led all too frequently. T h e solid basis of fact in the realm of production on which many of the misleading notions rested was not really new but had come to be realized with increasing force in the postwar decade. Unfortunately, and because of much superficial analysis, it was taken as a reason for overthrowing certain other and more long-standing assumptions. Never before in economic history had intellectual and propaganda agencies combined to such a degree to demonstrate the evident fact that man had succeeded in many countries in conquering hunger and building up the possibility of substantial comfort. This material advance was an important characteristic of all those countries that had attained a stationary population, but the many practical applications and corollaries had not been brought forward with dramatic emphasis before. T h e fundamental contrasts, and the points where misunderstanding developed, were the wide differences between the rich potentialities of industrial production and the inevitable increase in costs that would limit their realization at many points. T h e r e was also a gap caused by the slowness of the rate of increase of total production as compared with that of special kinds of production. It is natural, therefore, that the new and special prominence given to the effectiveness of human effort led to exaggerations in many directions. T h e optimistic note which was carried into many highly responsive departments of economic life led to a kind of financial delusion of grandeur in some quarters and to the overoptimistic expansion of capacity to produce in others. Credit transactions were activated by a new stimulus 5 capital structure was reorganized on more ambitious lines 5 spending habits were altered so as to stimulate new luxury trades 5 and men's vision reached out to new economic goals never before considered attainable. T h e determinations and desires which were strengthened by this sense of conquest led many to urge the early possibility of the complete elimination of poverty. T h e first step

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in this direction was taken to be the practical accomplishment of a relatively stable but slowly rising price level accompanied by ever-rising wages and standards of living. H e r e again old ideas were brought forward in new terms. T h e static state of J. S. M i l l 3 and the Utopias of many writers were not associated with the post-war philosophy, but they reappeared constantly in altered form so as to constitute a description of controlled price levels and increasing income accompanied by a f u l l and continuous use of all known productive resources. E v e n the more conservative judgment of scientific observers must take account of a rational basis for those hopes that have come to command universal attention. There can be no serious quarrel with the intention to win this greater degree of prosperity. Differences can arise only over the methods to be used, the confident expectation of early success, and the nature of some of the intermediary goals. I n spite of such reasonable doubts, it is apparent that the hasty dismissal of "new era" ideas by some has led to a neglect of certain basic truths 4 and to confusion regarding a persistent current in human intentions which made of these ideas a ready vehicle for immediate practical reforms. Moreover, after the first sharp recession in business in 1929, this superficial attitude in some quarters led to an unreasonable reversal of interpretation, using in its revision the intellectual raw materials of the earlier opposite statement. W i l d assumptions regarding the extent of the displacement of human labor by machines and the imminence of unlimited price declines led to a kind of hysteria. In fact, the pessimism of 1933 was clothed in familiar phrases regarding mechanization, spending power, productive capacity, and persistent price trends which, despite superficial differences, were similar to the misconceptions of 1922, to 1929. T h e results were 3 J. S. M i l l , Principles of Political Economy, Book I V , Chapter V I , "Of the Stationary State." 4 Reference is here inade to principles determining rates of growth. See infra, Chapters V I I I and I X .

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almost equally distressing in that they obscured many important relationships. There was the same kind of fallacy implicit in the hope of abolishing poverty by means of reducing production after 1929 as there was in the investment mania combined with an anti-saving doctrine. Moreover, a serious contradiction between a policy of increasing labor cost and increasing mass consumption grew out of the complete disregard of the imminence of diminishing returns in many industries. There are always some firms which, if confronted with rising labor costs, must reduce the volume of activities or inaugurate labor-saving devices. Some of the more naive expressions of these confusions regarding cost and purchasing power were merely statements of a desire to "eat your cake and have it too." The more complicated explanations were expressed in terms of complex financial operations which tended to conceal real investment facts. It is impossible to build sound structures on the shifting sands of such contradictory hypotheses. If it is an accepted fact that the power to produce is more than equal to the normal needs of the people of the United States, it is also true that prosperity is won only by reasonable use of this power. If production is the aim, destruction cannot be the means. If stability is desirable, rapid artificially induced price movements cannot be expected to safeguard a delicate equilibrium. Granted the social importance of a higher standard of living for the wage-earner, it is still true that some incentive in the form of profit must be left to motivate enterprise under our present system. Of course, if other aims are put in the foreground, it may be possible to use other means, but the search for a state of society rich in material wealth must be made by means of an active employment of all the most efficient tools. Whatever may be the correct expression of all the various conflicting and balancing influences, the "new era" has indeed been built on technical proficiency. This gain has reached a very high point in the present and calls for a relatively

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high wage level consistent with the new effectiveness of labor. Because of these tendencies, and not in spite of them, there can be no wholesale disregard of the sources of economic wealth or the accumulation of stores of commodities out of which labor in the final analysis is paid. A closer examination of the f o r m and origin of some of these concepts may indicate the reasons for the confusion existing on a number of fundamental points. F O U R G E N E R A L F O R M S OF T H E I D E A ( 1 9 2 1 τ ο

1925)

In the years after the 1921 depression, important developments occurred in four different branches of economic life. T h e s e were closely interconnected and were all directly or indirectly related to the notable industrial growth of the period. In fact, it is useful to put them together under the single term " n e w e r a " and consider that together they constitute a m a j o r cause of the depression, but for the sake of later verification and of more detailed analysis the differences of their separate manifestations are important. T h e significant representatives of the general philosophy are to be found, in the first place, in the fields of personnel and scientific management. T h e y emerge, in the second place, in connection with forecasting services and the advance in the statistical measurement of economic phenomena. A third instance is to be seen in the new efforts at credit control and therefore in indirect attempts at price control. F i n a l l y , there is an expression of these attitudes, already referred to, in the f o r m of a group of theories and policies advocating high wages as a means to stability. T h e linking together of these four different approaches to contemporary problems of poverty and wealth under one h e a d i n g — " n e w e r a " thinking—introduces certain complexities into the analysis, and yet it is essential to a proper emphasis on the evolution of economic policy. It is not possible to segregate these ideas either in time or in space. T h e y were not confined to industry; in fact, they influenced action to some extent in all the broad fields of enterprise listed in

SIGNIFICANCE OF THE "NEW ERA;

III

Chapter I I I , that is, agriculture, foreign relations, heavy industries, and security speculation. Moreover, they were not limited to the years here set apart but had their origin earlier and continued to shape ideas in the later period. T h e earmarking of this group of influences under one heading is subject to qualification and special interpretation but has been attempted here to give special emphasis to significant production tendencies. F o r the sake of setting apart these currents of influence from others, it has been considered wise to indicate the years just before 1 9 2 6 as the high point in this reasoning. These areas of disturbance were overlapping in time and in type of enterprise, but it is possible to point out that the most significant actions in international affairs occurred early in the immediate post-war period and again at the critical turning point in the sharp downward movement after 1929. T h e problems in the area of international finance have, therefore, been considered chiefly in Chapters I V and V I I , which describe the periods 1 9 1 9 to 1 9 2 1 and 1 9 2 6 to 1929 respectively. T h e mistakes in finance were most conspicuous in the later period, although the steps taken during these chaotic months were to a considerable extent the outgrowth of earlier decisions. In contrast with financial extravagances, agricultural and real estate overexpansion ran their course, for a while, parallel with the industrial excesses. T h e y reached their peak at approximately the same time, that is, around 1 9 2 6 . T h e complex interplay of one force on another makes categorical subdivision unwise. Only those who have the whole picture clearly in mind can afford to fix their attention on the separate parts without risking the loss of perspective. I t is clear, however, that there was a separate and distinguishable force which flowed through different channels and aroused a similar spirit in several different departments of economic life. One stream of influence reënforced another· the increasing effectiveness of labor and of labor management was accompanied by more knowledge of business facts as a

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guide to predictions of the future. T h i s clearer knowledge made the hope of credit and price control seem feasible, while wages, as one of the more important divisions in the general flow of income, became, in the opinion of many, a logical point for intervention. O n l y w e l l on in the period of optimism, however, was it generally realized that there was need for a theoretical justification of prevalent assumptions. It was at this point that the inevitable crop of explanations by both amateur and professional economists attempted to give abstract expression to a changed point of view. D u r i n g these later years many radical modifications of the theory of distribution, and of wages in particular, were brought forward. THE

PERSONNEL

MOVEMENT

M o s t of the notable changes in labor policy, including scientific management and the personnel movement, had their origins in the years before the war. 5 T h e increased demand for workers and the pressure to produce more goods which came with the war acted in the United States as a marked stimulus to turn attention to all phases of labor management problems. M e a n w h i l e , immigration restrictions, multiplying steadily after 1 9 1 6 , altered both the quality and the quantity of the labor supply. T h e r e was a sudden focusing of attention on the importance of training skilled workers, on the cost of labor turnover, on employees' grievances, and on other forms of waste. T h e double-headed attack on these obstacles to efficiency aimed to improve the motivation, eliminate friction, achieve a greater smoothness in the flow of materials and semi-finished parts through the plant, and bring about a well-coördinated harmony between all the elements in production. T h e effort resulted in special innova" H. S. Person, "Scientific Management," Encyclopaedia of the Social Sciences ( N e w Y o r k , 1 9 3 4 ) , Vol. 13, pp. 603-608; see also the writings of Henry L. Gantt, F. B. Gilbreth, Frederick W . T a y l o r , Harrington Emerson, and others; Ordway T e a d , "Personnel Administration," Encyclopaedia of the Social Sciences ( N e w Y o r k , 1 9 3 4 ) , Vol. 12, pp. 88-90.

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113

tions in individual factories and also in a change in the public attitude towards labor and industry. A rapid development of technique and method in the study of psychology which made possible in dozens of firms the use of elaborate tests for selecting workers laid a basis for various methods of improving plant relations. One of the early discussions of what was happening in industry is found in the article of the late Magnus Alexander of the National Industrial Conference Board, published in 1925.® The title of his article represents one of the first uses of the term here taken as a keynote. It holds the same meaning as many later phrases which were used to characterize the decade. It reads, "America's New Era of Economic Power." Dr. Alexander finds a solid basis for new opportunities in a number of favorable conditions which he sets forth briefly. Some of these alleged improvements were increased stability, more stationary population, contented labor, benefits from industrial combinations, foreign markets, increased plant capacity, and industrial leadership. In his general description of the nature of the contemporary industrial world, he gives considerable prominence to an increased ability of employers to improve working conditions and to the response of labor to new opportunities in the form of productivity. The term had not been used very often prior to this date, but it began to be taken as a slogan, as were other phrases such as "the Golden A g e , " " O u r Era of Prosperity," " A New Economic Revolution," " T h e Wonder Economy of America," and other suggestions that there had been farreaching changes in the face and nature of the material world. Moreover, many books and articles written during these years stressed the extent of losses arising from fatigue, friction, and lack of proper incentives and implied that most of 6 Magnus W. Alexander, "America's New Era of Economic Power," Current History (October 1 9 2 5 ) , pp. 56-605 "Vital Problems Now Confronting American Manufacturers," Industrial Management (April 1927), pp. 193-201.

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these were avoidable. 7 Experiments in profit-sharing, the sixhour day, labor copartnership, and various welfare endeavors were urged on the attention of both the philanthropic employer and the more acquisitive manager who was anxious to secure, by all legitimate means, the best return for the total wages paid. T h e possibility of combining a generous and humane policy with an efficient engineering program was urged with more vigorous persuasion than ever before. At the same time a considerable increase in stock ownership by employees was taken as a sign and as a means of a new "spirit of cooperation." 8 Implicit in most of this discussion was the assumption of an underlying harmony of interest between labor and capital. This thought was occasionally reminiscent of the earlier mystical doctrine of the physiocrats, although it was expressed more widely and more concretely in this later period. It seemed plausible to many that if expanding markets could be made to absorb both higher prices and higher wages there would be a gradual improvement of efficiency as the volume of output increased. T h e idea was extremely attractive and was accepted as sound by many of those who were impressed by the recent increase in domestic and foreign buying of American goods. In any case, the drive to cut unit costs and increase aggregate incomes went on, and the part which labor played in the process was widely stressed. New magazines were issued to explain the technique of labor management 5 professional associations were established to hasten the "rationalization" of industry. T h e cessation of aggressive unionism in many quarters9 as real wages held their own in a time of fairly steady employment gave support to many of the ideas which were brought forward. No movement which carried into so many departments ' See P. Sargant Florence, Henry C. Link, Boyd Fisher, Lord Leverhulme, Ordway Tead, H. C. Metcalf, W. D. Scott, and many others. 8 T . N. Carver, The Present Economic Revolution in the United States (Boston, 1 9 2 6 ) . 9 The policy of the A. F. of L. and the carry-over of a war-time attitude towards certain problems are significant in this connection.

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115

of economic life and which showed tangible results in efficiency and profits can be discarded as inconsequential even though it may f a l l into temporary disrepute with changed conditions. T h e saner conclusions and findings of the employment management movement have been added to the permanent equipment of industrial engineering. T h e importance of certain overlooked features of plant management and of the more delicate adjustments of labor relations, the extent of avoidable waste in the form of delays, inefficiencies, and lack of standardization were, fortunately, recognized more clearly than ever before. In rare instances, the results of tentative experiments have been embodied in new standards of professional ethics in business and in changed methods of organization. A definitive history of this phase of economic development is still to be written. 10 It is best that it should be delayed until both the extravagant claims and the premature criticisms have been forgotten. A better knowledge of the attempts to improve labor relations and conditions in the recovery period will add perspective to the earlier situation. N o ideal situation, no Utopia, could develop from an attack on the problem which was limited to a few of the more obvious difficulties. T h e r e was a gain in the elimination of the more conspicuous errors in industrial practice, but this did not guarantee justice or industrial peace. N o fundamental harmony between capital and labor could be assumed to exist because of a more generous policy growing out of a temporary expansion of markets and increase in real wages. FORECASTING

Meanwhile keen attention to industrial affairs and the gradual development of statistical technique had given a new impetus to the attempts to forecast economic change. ω T h e new concern of certain business men with these problems can be examined in the books, articles, and speeches of such men as Henry Dennison, E . A . Filene, Gerard Swope, Samuel Fels, T h o m a s Watson, and others who have exerted a wide influence.

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Even before the war, research bureaus and service letters to investors or merchants were becoming familiar as agencies which could act as guides to business decisions, but none of them had gained the great prominence or the respectability which was to come in the "new era." In this new emphasis, the further development of the Harvard Economic Service11 in 1921 and after may be taken as a landmark. For the first time a university noted for its stress on the classical approach to economic studies attempted to develop a widely available means for making practical recommendations on current decisions. T h e fact that this kind of investigation and analysis was distorted in the hands of some of the agencies to yield a false dogmatism and to give a false support to definite prophecies indicates not at all its true worth. There had been a real forward step in the analytical approach to a complex set of relationships. In any case curve-reading became, in these years, a national pastime. There was a tendency for the subtleties and cautions of the more careful scientist to be ignored as many turned to the more readable charts of rising values which various types of promoters offered. T h e unstable interrelationship of significant elements was overlooked as emphasis was placed on the upward pitch of lines representing changes in physical volumes of production, in net sales, in electric power consumption, in bank clearings, and in other rising curves of economic indices. T h e fact that one rising curve as it approached another might be taken as a warning of a dangerous competitive tendency of selling or production to squeeze out profits was often overlooked. With general expansion there was a real threat of inflationary excess, and the danger in the disappearance of motivating differentials was ignored by those who expected to buy at low levels and sell at high. There was a curious blending of different types of analysis —a use, on the one hand, of refined mathematical treatment u

See Weekly Letters, H a r v a r d Economic Service (Cambridge, Mass.).

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of complicated data, and on the other, of crude deductions based on events over a relatively short span of time. T h e lessons to be learned from former crises were not used as checks or warnings since they were thought to be characteristic of a different period with different problems of production and exchange. Evidence regarding former monetary swings and dangerous signs of inflation or deflation were discounted by those who assumed that financial leaders had passed beyond the early clumsy efforts at checking fluctuations and had achieved an unprecedented degree of control over prices. A survey of some of the more conservative publications of universities or business research groups indicates that some recognized the existence of uncertainty and the imminent need of readjustment but that many made the unjustified assumption that they had developed quick indicators of significant changes and could identify any upward or downward tendency. T h e expectation that the individual could protect himself by buying or selling at the strategic moments was equivalent to a claim that the worst phases of instability had been conquered. A s one looks back on these analyses, the striking impression made is of surprising cheerfulness in the predictions of minor recessions and in the confident forecast of quick recoveries after a healthy readjustment of factors to each other. T o a considerable extent the nature of the guidance which careful research can give was misconstrued in the general rush to take quick advantage of the fragmentary results available. T h i s false concept led to uneconomic buying and at times to a stampede in the direction of common stocks. T h e warning of declining stock yields as prices rose to fictitious levels went unheeded. T h e true function of research, to give the relative advantage of developing one thing or another, or of pushing towards one margin or another, was partially overlooked. Scientific investigations were shaping instruments to aid in comparing relative opportunities so that

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RECONSTRUCTION

the more expensive, less effective effort could be avoided. W h e n , later, the time for the more critical use of many facts arrives, it can be recognized that there are vast differences between the apparent opportunities of these years, and that some temporarily underrated were really better than others that seemed to offer the richest promise. T h e wrong valuation was in part the result of a failure to take account of the competitive push in some directions which would make permanent gains impossible. Eventually, as a more intelligent use of facts is attained, the diffusion of funds and energy will be more even and will be guided by a balanced consideration of profit expectation relative to volume of enterprise. 12 T h i s later stage of achievement in research was far from realization in the decade 1920-1930. T h e contributions which result from the energetic and painstaking accumulation of data and the careful statistical analyses of these years may eventually prove to be much greater than later criticisms and the obvious errors in prophecies would lead one to suppose. Moreover, the effort which the research worker was making to embody his findings in clear-cut recommendations to act in definite ways was, on the whole, an honest if sometimes unsuccessful attempt to be of service to business. In fact, it was judgments made on the basis of these findings and not the serious research studies themselves which were to blame for the reputation for false leads which the latter earned. I n the years that followed there has been an inevitable collapse of many expectations and claims. T h i s reversal has obscured the underlying basis of real worth in economic research. Its importance will be clearly recognized when the false prophecies and extravagant ideas of foretelling future prices and events are left behind. M o r e sober estimates show that it will be a notable accomplishment if it becomes possible to make an intelligent interpretation of the immediate 12

See infra, Chapter XI.

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past. The achievement of this new degree of understanding will constitute a much needed advance in the interest of formulating policy. I f statistical material can be representative and up to date, so that the economic situation of the previous week or month may be fairly generally understood, much will be gained. I f significant relationships of the previous year could have been put before the business man quickly, his power to act intelligently would have been greatly enhanced. Whenever he is armed with this knowledge, the entrepreneur is probably better fitted by temperament and by virtue of his pivotal position to plan future business programs than is the man with an exclusively academic point of view. The natural caution of the good research worker, appropriate to a study of scientific generalizations of averages and of trends, is not always helpful in the launching of new enterprise or in the swift reorientation of commercial policy. It is inevitable that practical programs should unfold slowly from day to day in the spirit of the market place and on the basis of a subtle union of many opinions, while the statistician's and student's task is to see that these opinions are guided by accurate factual information and well-rounded interpretation. In this important decade, however, business forecasting gave a false flavor to an important phase of the development of economic science. It created an illusion of personal security and power and a preoccupation with short-time price changes. It deflected energy into confusing byways and distracted attention from long-run principles. A more temperate appraisal of future prospects would have hampered the immediate prospects of profit-making through speculation. Thus, the "new era" had powerful instruments in the forms of statistical charts, service letters, promotion talks, and a new habit of thinking in terms of upward-moving indices. One of the most natural and direct fruits of this forecasting development was the rapid increase in public speculation in securities. This participation in financial affairs was encour-

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aged in some quarters by a heightened awareness of the new possibilities of elasticity in money and credit. C R E D I T AND P R I C E

CONTROL

There were, in fact, in these years new and powerful banking instruments as the result of the development of the Federal Reserve System. T h e relatively quick recovery from the 1 9 2 1 depression had increased financial optimism. Moreover, there had been at that time an absence of panic conditions in money markets such as was familiar heretofore in depressions in the United States. Those who were watching the signs of progress were much impressed by this fact and, as time went on, they were struck also by the unusual degree of stability of commodity prices. A very natural conclusion in these circumstances was that the institutions and customs which had developed in banking, in forecasting, and in the field of investment had brought a real financial improvement. T h e successful operation of the Federal Reserve System during the ten years after 1 9 1 3 was taken as the basis for a far-reaching hope of constructive credit control. T h e heavy responsibilities of building up a technique of working methods for financing the war and for adapting a credit system to rapid industrial expansion in the years just after the war had been well taken care of. T h e new banking organization had become a smoothly functioning department of economic activity in a very short time. Its efforts to equalize money rates between widely separated geographic regions were remarkably effective; the gold settlement fund seemed a highly satisfactory device; there were wider markets for commercial bills, and there was a more sensitive response of money markets to short-time demands. The rapid expansion of credit, more or less directly the result of increased gold reserves, and the activities of commercial banks in the investment field were a part of a general inflationary movement which the Federal Reserve would not restrain. Neither this

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situation nor the opposition in a number of quarters to the clearing system and the reluctance of some banks to join seemed to hamper the general usefulness of so powerful an institution. In the opinion of most financiers, the worst dangers of either a money stringency or of runaway credit movements seemed to be wiped out. 13 A very much greater freedom of action in finance also resulted from the newly attained creditor position of the United States and from the resultant large accumulations of gold which were piling up in the banks as monetary reserves. These seemed at first to some to hold threats of inflation, but as time went on these fears were quieted by what was held to be an effective sterilization of these monetary influences.14 It was significant that a considerable share of the gold was quietly put into circulation by means of gold certificates instead of being made the basis for a large expansion of money and credit at a rate which would be some multiple of the amounts held in reserve. Thus, the potential expansion of currency and credit was restrained in some measure. This fact may not have had a high degree of influence on economic conditions, but it did affect the political and psychological aspects of the situation. It is probable that the inflation which was potential in both the credit and the gold was delayed or diverted from the commodity field into other investment channels. There is some reason to think that the transfer of the stimulus from goods to securities led to much misunderstanding and a false sense of stability. The warnings of Governor Strong, Dr. Walter Stewart, 15 and others failed to impress those who were confident of the increasing ability of the Central Banks to control price levels. 13 W. R . Burgess, The Reserve Banks and the Money Market (New Y o r k , 9¿7)> ΡΡ· 1-8. 4 The alleged sterilization of gold reserves is still a debated question ; see sufra, Chapter I I I , p. 6 1 . 15 Hearings, Stabilization Committee ; Price Level for Commodities in General, U. S. House of Representatives 7895 ( 6 9 : 2 ) , 1 9 2 6 ; H. R . 1 1 8 0 6 ( 7 0 : 1 ) , 1 9 2 8 ; see also J . M . Keynes, A Treatise on Money (London, 1 9 3 0 ) , vol. ii, P· 344· 1

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T h e more optimistic relied upon the joint effects of improved statistical measurement and a growing centralization of credit control to maintain the relative degree of steadiness which was characteristic of the years after 1 9 2 3 . The narrow movements of the index of wholesale prices during this period were reassuring. It was not possible to disentangle all the varying influences and it is only recently that one has been able to observe by a study of past data that a downward movement of prices, due to improvements in technique and large scale production, probably offset a fairly persistent inflationary tendency during a five or six year period. Uncertainty on this point was inevitable because only the net effects emerged clearly in the curves which supported the arguments of the stabilizers. Other by-products of a time of active lending both at home and abroad and a lively interest in stocks brought a sense of power which flowed into many special branches of financial activity. It seemed to be comparatively easy to launch new enterprises and float more securities. T h e demand for goods enhanced by the speculative activity radiated out from the financial centers and tended to quiet the alarm of those who distrusted the apparent prosperity. A few warned in vain of the recurrent tendency to reaction in production and of a probable downward price movement. Some even indicated the possibility that a postponed reaction would be more severe than one encountered earlier. T h e net result of these separate but related facts in the realms of lending and buying was that an increasing confidence in financial leadership outran the solid improvements in knowledge and actual ability to control. T h e apparent price stability was more a result of a happy conjuncture of circumstances than of any clearly thought out policy or of the power to enforce general banking and investment cooperation. Lags and differences between expectation and accomplishment developed a number of significant discrepancies in prices which were blurred and hidden for a time by the synthesizing influence of general averages. In a list of

SIGNIFICANCE OF THE "NEW ERA:

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56 commodity prices cited by D r . Mills, 1 6 27 registered a net change of more than 20 per cent between 1922 and 1929. This divergence of prices from the general average suggests a purely fictitious statistical stability which did not bring a stable equilibrium. Clearly changes of this magnitude cannot occur without affecting many delicate relationships. T h e reasons for the appearance of prosperity in finance grew out of such superficial descriptions of conditions as these averages afforded and also out of temporary and abnormal credit movements. F o r instance, the quick recoveries from the depressions of 1 9 2 1 , 1924, and 1927 were made possible by the inflow of funds f r o m E u r o p e on private and public account. T h e expansion of short-term credit in the form of instalment selling, 17 brokers' loans, and bank deposits served in some cases to postpone a constructive refunding of long-term loans. T h e r e was elsewhere a tendency on the part of business to issue bonds and to increase fixed obligations as compared with short-term borrowings. 1 8 E a s y money and a speculating public made this new financial policy seem attractive. Most of the credits behind these operations were created without any demands for thrift or postponement of consumption. T h u s , the true state of affairs was disguised and the public was disinclined to save for the future by sacrificing some of its habitual spending power. Despite the later emphasis on farm debts, financial borrowings of a speculative character far outweighed borrowings on land and crops both in volume and importance. A t the very moment when stock market speculation was becoming most vigorous, serious difficulties in capital markets were upsetting the conditions which make possible the steady replacement of capital funds. M F. C. Mills, Economic Tendencies in the United States ( N e w Y o r k , 1 9 3 2 ) , PP· 336, 337. In production costs, for instance (p. 394-), there was a fan-like moving apart in the years 1923 to 1929 that amounted to a difference of more than 20 per cent. 17 M . T . Copeland, " M a r k e t i n g , " Recent Economic Changes in the United States (New Y o r k , 1 9 2 9 ) , Vol. I, p. 398. 18 Evans Clark, The Internal Debts of the United States (New Y o r k , 1 9 3 3 ) , pp. 175-180.

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As a sign of this difficulty, long-term interest rates were disturbingly out of line with short-term rates. 19 It was true that many weak points in the money and credit system had been eliminated by the development of the Federal Reserve Banks. It is unlikely that the money panics familiar in past crises will ever occur with the same severity again.20 It is likewise true that the gradual increase of cooperation in banking had been accelerated and that attention had been directed as never before to problems of stabilizing prices and conditions. Despite those improvements, however, many grave dangers remained. T h e careful descriptions of the changes in banking technique given in the books of W . R . Burgess, C. O. Hardy and others 21 who wrote on the Federal Reserve System at this time gave a place of prominence to the vigorous efforts to achieve further money market control. These studies made available to the careful student a new knowledge of the strength and weakness of Central Banks and their efforts through open-market operations to expand or contract purchasing power, their use of the discount rate, gold transactions, and warnings to restrict or stimulate credit. Many, however, took these first beginnings of control as indications of a very rapid progress in the art of directing the flow of funds. They assumed that there would no longer be any danger from erratic changes in the volume of funds available. T h e fact that debts—and credits—were rising fast during the nineteen-twenties was taken as a sign of a satisfactory correspondence between money factors and productive activity. Neither in regard to foreign nor domestic investment was there a keen awareness of a critical aspect of the problem, 19 J . M . Keynes, " T h e Future of the Rate of Interest," Index (September, 1 9 3 0 ) , Svenska Handelsbanken, pp. 1 7 8 - 1 8 6 ; W . W . Riefler, Money Rates ani Money Markets in the United States ( N e w Y o r k , 1 9 3 0 ) . 20 T h e banking· crisis of 1 9 3 3 was not actually a money panic, but it does lead one to wonder about the validity of a statement such as this written in 1932. 21 Note especially L . D . Edie, Money, Bank Credit, and Prices ( N e w York, 1 9 2 8 ) ; R . G . H a w t r e y , The Art of Central Banking (London, 1 9 3 2 ) ; H. L . Reed, Federal Reserve Policy, 1921-1930 (New York, 1 9 3 0 ) ; P. M. W a r b u r g , The Federal Reserve System, 2 vols. ( N e w Y o r k , 1 9 3 0 ) .

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that is, the ability of the debtor to repay and the willingness of the creditor to receive. These difficulties were to take on extreme importance at a time when the pace of activity began to slow down and the value of money in goods and foreign currencies became notably altered. Thus, institutions, scientific analyses, general impressions, and easy credit practices combined to bring about a sense of new-found security. It was realized that the banker's position would be stronger if the possibilities of forecasting could fulfill early hopes and if the increasing harmony between capital and labor could weld motives together and bring about a real partnership in production. In 1926 it seemed possible that the volume of output would continue to grow under these good auspices j it seemed possible that statistical technique would give a new definiteness to economic programs. It was hoped that money and credit could be kept in line with plans for economic expansion. Attention turned naturally, with greater insistence than before, to a consideration of the characteristic divisions of the entire mass of purchasing power into various streams of income and to the ways in which these different incomes, and wages in particular, were used. T H E T H E O R Y OF H I G H

WAGES

The first expressions of the characteristic "new era" wage theories probably developed out of the attempt to explain certain unanticipated post-war conditions. There had been a very rapid rise in wage rates and earnings during the year. The sharp up and down price movements of the next few years left real wages in some instances well above the prewar levels. T h e additional labor costs which industry was called on to meet did not seem to cause any serious embarrassment.22 On the contrary, the increasing demand of low income groups for certain commodities in the years after 1 9 2 1 , especially such things as low-priced automobiles, 22

F. C. Mills, of. cit., p. 232.

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radios, and many semi-durable goods, gave a welcome stimulus to certain industries. High pressure salesmanship, instalment selling, easy credit, security and real estate speculation all tended to create a special frame of mind which fixed attention on marketing possibilities. Expansion abroad had been a notable feature of the period, but a belief in the high standard of living in America as compared to foreign countries made it plausible that, for a time at least, the newer luxuries could be sold better at home than elsewhere. T h e obvious conclusion of the merchant and advertiser testing out new fields was that the income of the consumer would help determine and condition his future success. Some manufacturers, impressed by the possibilities of a higher living standard, studied the incomes of certain groups of wage-earners and discovered that those in the intermediate brackets, after they had supplied themselves with the necessities of life, still had a considerable margin of spending power which could be drawn out by suitable low-priced goods and ingenious efforts in persuasion. They were convinced that a drastic reduction of such incomes would mean a curtailment of these new demands.23 Meanwhile a number of discussions of the practical questions that were in the minds of many appeared in theoretical form. T h e essential ideas in the analyses were not new. It is true that they were advanced with interesting modifications and a considerable degree of originality, but many of the ideas had been expressed before. There was, in fact, a real similarity at some points with the wages fund doctrine of the nineteenth century. Never, however, had the setting been so conducive to a ready acceptance of the main propositions being urged. T h e employer had to choose either to rely on an increasing consumption of his wares or to turn to a difficult struggle to reduce wages. T h e promoter considered ® W . A. Berridge, Emma A . Winslow, and Richard A. Flinn, Purchasing Power of the Consumer (New York, 1 9 2 5 ) . This volume occasioned by the J . Walter Thompson prize contest is significant of a new emphasis on consumers' buying· power.

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127

that he would be on unstable ground unless buying power kept up. The advertiser urged active buying in terms of a universal prosperity, a prosperity which could only come with more money in the hands of the mass of the people. The whole structure was considered by some to be poised on this one financial foundation stone. Henry Ford was an outstanding example of those business men who urged production for the mass of the population and a deliberate effort to keep up spending power by a high wage policy. The economists here and there took up the question and a number of them urged the necessity of a high labor income to support large-scale production. Many names are associated with the unfolding of this idea. J . A. Hobson in England, Wadill Catchings and W . T . Foster in America are outstanding exponents of it in certain forms.24 T h e arguments brought forward were, in some cases, highly convincing. Many overlooked the fact that the advocates of this line of reasoning and policy took for granted the existence of a more or less static set of relationships. Few observed that the validity of their arguments depended on an almost mechanical and unvarying transfer of a given number of units of purchasing power from some groups to others. 25 Since funds were not spent until they became incomes or working capital for some spender, this group of theorists argued that wages should increase as fast as production in the interest of stability. For the most part the proponents of this argument ignored the possible effect of a declining unit cost for consumption goods as well as the important part which credit played in supplying an increasing money demand to various groups of consumers. There was a surprising lack of awareness of the incalculable factors, of the dynamic nature of economic life, and of " See also P. W. Martin, Unemployment and Purchasing Power (London, 1 9 2 9 ) ; F. A. Hayek, " T h e 'Paradox' of Saving," Economica ( M a y , 1 9 3 1 ) ; D. H. Robertson, " T h e Monetary Doctrines of Messrs. Foster and Catchings," Quarterly Journal of Economics ( M a y , 1 9 2 9 ) . 26 Or an equally calculable failure to transfer purchasing power.

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the influence of cost and credit on prices. But more serious than these gaps which occurred in most of the thinking was the failure to recognize the relation of labor costs to the demand for labor and therefore to the volume of employment. Those who argued that high wages were important in maintaining prosperity assumed that a high wage policy would increase spending and so maintain business activity along a wide front. They were apt to stress wage rates and to overlook the possible inverse correlation between the rates and the aggregates paid to labor. Unfortunately, many employers were forced to cut down the number of men employed when real wages rose. They substituted machines or contracted their output. In so doing, they were apt to set in motion a narrowing spiral of declining consumer purchasing power. In setting forth the more optimistic view, those who urged deliberate attempts to increase incomes left out of account, for the most part, the keen competition between men and machines at the margin of costs where the employer watches his expenses in order to hold his own in a fierce industrial struggle. In any case it is evident that other streams of income might expand or contract so as to increase or cancel out wage changes. Failure to take account of the first effects of increasing mechanization contracting the market for labor and an underestimation of the risks of unemployment may have been to blame for some of the later troubles. An extreme reaction against these original errors was expressed in 1932 in technocracy. The technocrats caught hold of some of the dangers in the purchasing power arguments and tried to show that the competition between men and machines had already become disastrous. The facts available have not borne out their contention. The true state of affairs lies somewhere between the two extremes. Large increases in wage rates would probably lead to disturbing declines in wage-earner income by increasing unemployment. Moreover, wage changes of familiar magnitude have been very small compared with the dol-

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129

lar value of changes in bank credit which is a potential demand for commodities.26 During the earlier years of the "new era" philosophy, however, only the brighter side of the picture was stressed. The failure of wages to fall during a time of increasing mass production seemed to hold a possible key to lasting prosperity. There were hopes that the fourfold attack on economic uncertainty, through labor management, forecasting, credit control, and a generous wage policy might bring about a well-coördinated adjustment of essential factors and gain a productive stability. THE

"OLD

ERA"

Most of the ideas discussed in the preceding sections are associated in their general implications and stand in sharp contrast to the thinking in pre-war days. There was, in a certain sense, an old era which seems to be a more definite continuation of the ideas of the nineteenth century, whereas the war constitutes a break in a number of important traditions. The attitude toward poverty and toward marked inequalities in wealth was a notable instance of this change. T h e literature of 1 9 1 3 and the years preceding shows a fairly general acceptance of social stratification and enduring poverty. Even articles in the economic journals advised the poor to husband their resources and save for emergencies, even though such thrift meant real sacrifices and a meager way of living. The insistence on wise spending and careful saving, on conservation of national resources and on individual thrift to provide for accidents and old age now sounds strangely out of date after years of widespread arguments in favor of high wages and quick spending. It is astonishing to compare the pre-war discussions of charitable assistance given to the more or less permanent poor and the descriptions of "how the other half live," with M Some further study of the relative importance of producers' and consumers' purchasing power is urgently needed.

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the later slogans urging the worker to own his own home, the claims that a two-car garage was needed by most families, and the assumption of the possible attainment of a luxury standard for almost all wage-earners. In the same way one finds a sharp contrast between the warnings regarding the exhaustion of forests, oil, coal, and other basic materials, and the later "keep-your-shelves-bare" and antihoarding, anti-saving drives. There were after the war definite signs of a change of attitude and of an almost uncritical faith in the ever-increasing wealth at the disposal of the average man. T o a certain extent, this swing of the pendulum was a normal thing and does not indicate a complete or permanent reversal of former trends. In a few respects, however, as has been indicated already, the point of view of the twenties went further than usual and led to a serious dislocation of production and consumption. For one thing, with the "new era" there developed a widespread belief that a rising price level was essential to prosperity. This idea did not work itself out in a commodity price rise at this time, but it did affect production and security markets. In pre-war days there had been a strong agitation to keep down the cost of living. T h e recognition of improved industrial technique in 1 9 1 0 and thereafter had encouraged the idea that the improvement in living conditions could come through the gradual spread of the benefits of progress by means of lower commodity prices. T h e opposite point of view after the war brought serious dangers and was in a considerable measure a trap which caught economic and industrial leaders in a very difficult position. Its danger lay partly in that it made more articulate those groups that gain at least temporarily by inflation. T h e difficulties were enhanced also by the failure to develop checks on potential price movements through active competition, by pressure of public opinion, or through government action. This lack of restraining influence tended to speed up the movement of buying, selling, and production in an unprecedented manner.

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131

It is true that even though for a time prices, costs, wages, and various items moved up together, the effect was to stimulate many sensitive parts of the industrial organism and this increasing speed of movement tended to disturb all familiar signs and indices and to open up gaps which could not be easily closed. Thus the more closely coordinated, delicately balanced adjustment of the slower changes of pre-war days became almost impossible in the later period. A further and equally serious problem which grew out of the change in ideas was the great prospect of professional and material advancement held out to the average man that tended to make him impatient of small gains. Never before, perhaps, was there such a determined drive on the part of retail stores to grant credits, by brokers to lend, by industrial leaders to discourage savings. Never, perhaps, had large numbers of people pledged so much of their future earnings for present consumptions. The explanation that the lowincome groups were adding to their capital goods such things as radios and household equipment, was made with little regard to whether they earned sufficient surplus to justify such claims on future income. Many of these articles were durable in nature but failed to increase the income-getting power of those who bought them on credit. The result of a widespread tendency of this sort was to create a potential vacuum, the threat of a later buying famine, and to endanger the future stability of prices and production. Many people found their current income depleted by charges for loans and for instalment purchases at a time when their personal credit suddenly dried up. It is true that the first collapse came in the security field, but it was rapidly contagious in many other directions. The demand for consumers' goods held fairly well, but it was at the expense of the stream of funds used to buy capital goods, and the uncertainty introduced into many markets was the greatest enemy of recovery. It is almost certain that something of the old spirit must be blended with the new hopes. On the one hand, it is clear

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that the worker cannot long continue to consume more than he produces currently. On the other hand, if the modifications coming with the "new era" make it possible to reorder the productive machinery in such a way that he can turn out more goods, it is to the interests of society that, through the proper adjustment of wages and commodity prices, a larger real income should be available to him. It may be that the best way of distributing the gains will be by means of falling rather than of rising prices. It is probable that the policy best designed to attain a reasonably stable economy will move more slowly and in the direction of altering the nature and proportion of income streams than is desirable on some other grounds. T h e dangers of unemployment because of a deficiency of purchasing power as expressed in "new era" terms would come, if at all, mainly because of a disturbance of the balance of saving and spending. Such upsets are probably much more serious in the modern world than the repressive influence of gradually falling prices. Less speed and better balance are needed for the healthy functioning of a complex specialized productive system. T H E N A T U R E OF PROGRESS

T h e phenomena discussed above suggest that a reappraisal of the real nature of economic progress is needed as a base for future decisions. This demands more knowledge. But the known facts already suggest that progress depends not only on advances in material prosperity but upon balance and stability. T o achieve this balance there must be a recognition of a misleading tendency to dramatize various phases of life by representing them as new and unprecedented. Thus, the prosperity of the years after 1 9 2 1 was considered new and revolutionary and the later crisis a catastrophe such as the world had never known before. A modicum of truth beneath such assertions has given specious plausibility to a number of new conclusions and leads also to a questioning of

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the ready acceptance of many previously accepted but untested principles. Only a statistical inventory and a careful economic examination of many objective facts can give a satisfactory guide and show how much the world has changed. Some of this work has been done by F. C. Mills in Economic Tendencies. More material is to be found here and there in the reports of other research workers. There are still, however, many important questions awaiting answers as the world passes from one stage to another of changing economic organization. For example, it is important that price tendencies be clarified so that the declines due to improved effectiveness of effort in production and increases due to the increasing expansibility of credit and other monetary factors can be separated from each other and made the basis for the development of clear-sighted policy. Again, more must be known with regard to the standard of living of the lower-income groups. Wages must be measured not only in the better known industries but also in casual and sweated occupations, so that the averages will take on new meanings and be applicable to a larger number of individual cases. In this connection wage-earners' budgets must be examined in times of rising, falling, and stationary prices to indicate more significant facts regarding both the quantity and the quality of goods consumed. 27 Furthermore the exploitation of natural resources must be measured in connection with the rate of industrial operations. Population trends must be considered in connection with both the supply of labor and the demand for goods.28 By means of a further analysis and synthesis, attempts must be made to discover what rate of progress seems to permit healthy adjustments of interrelated parts to each other. The astonishing amount of progress achieved has been 27

See the Reports of the Heller C. W. Thornthwaite, Internal phia, 1934). 28

Committee, The University of California. Migration in the United States (Philadel-

DEPRESSION A N D R E C O N S T R U C T I O N

described by Professor M i l l s in impressive terms. 29 " O v e r an eight-year period the American economy was moving forward at a rate perhaps never surpassed, a rate which represented a potential doubling of the physical income of the average citizen once every 29 years." Certainly important advances in the material world cannot be denied. Gains in the intelligent attack on problems of wealth and income can also be discerned here. There had been no conscious coordination, however, of the advance in different fields; engineering technique outran banking control; consumption standards out-stripped budget knowledge and statistical measurement. Ideas of equality surpassed the willingness of those with large incomes to support taxation or to give up any substantial part of their share. It is in the nature of progress to advance unevenly against the resistance of various factors, but this lack of balance is a real obstacle to achieving stability and must be taken into account. In labor relations, wage policy, credit control, and forecasting, hopes have been aroused which can only be fulfilled by a cautious and critical awareness of the complex adjustments of different parts of the industrial machine. Rapid change must yield at some points to the need for balance and stability. " F . C. Mills, of. cit., p. 310.

CHAPTER T H E

T U R N I N G

VI

P O I N T — 1 9 2 6

T H R E E P H A S E S OF D E V E L O P M E N T :

1920-1929

THE consecutive survey of events in the post-war decade brings the discussion now to a period which with respect to the orientation of policy may be called critical. After this time one points with increasing frequency to lost opportunities and widening discrepancies. Even though the shifting relations in 1926 were very like those in other years, when the spirit of the times and the direction of the curves is further examined it may take on the importance of a turning point in economic policies. In any case, it has been chosen here because of a few signs already evident to illustrate one of the central propositions of this study. The hypothesis which it is taken to illustrate is that when a large group of important enterprises expands at a rate faster than the rate of expansion in the years immediately preceding it, there is trouble ahead. Some such pulling out of line was noticeable in 1926 and grew more pronounced in the years that followed. The main outlines of the situation in the early post-war years, 1 9 1 9 - 1 9 2 1 , the reconstruction period, indicate that prices, credit, production, and consumption were dominated by an attempt to divert economic life very quickly into peacetime channels. T h e resulting pressure on resources and manpower and the articulate demands of consumers pushed prices up. The funds used just after the war were the result of several years of large-scale government spending which had led to a widespread activity and a large volume of output and employment. A second period here set apart, from the peak of prices in May 1920 to the recovery of 1922, was more like a typi135

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cal business cycle in the nature of the economic movements which occurred. H i g h prices, which had been pulled far out of line as measured by pre-war comparisons, fell swiftly ; production declined, but not to the same extent as prices; wages were pulled downward, but retained a considerable part of their war-time gains. A l t h o u g h the fall of some prices and quantities was severe, the rates of movement differed so much as to bring some factors more closely into adjustment than they had been during the war. Judged in terms of the situation which had been familiar before 1914, production conditions in 1922 were sounder than they had been for many years. T h e third phase in this time of swift economic evolution from 1922 to 1925 has become associated with " n e w era" thinking and was characterized by upward moving indices in almost all fields of activity. M u c h of the point of view and some of the conditions covered a considerable span of years and carried over into a fourth phase of economic change, that is, collapse and depression. It is possible to follow this fourfold division in terms not of ideology and theory but of concrete factors and visible things. A study of the curves of economic data, for instance, tends to show that within the " n e w e r a " period there was a time of legitimate expansion when many different economic variables moved up at r o u g h l y similar rates of speed. There was a time of natural but scarcely recognized readjustment which closed some of the gaps opened up in earlier years, a period of excess when all those elements which exert a wide influence began a steep climb and l e f t some of the more sluggish behind, and a time of sudden reaction and steep, uncontrollable declines. A D E P A R T U R E FROM N O R M A L R A T E S OF C H A N G E

E v e n though some facts are masked by confusing and divergent interpretation and others are hidden in a wealth of statistical detail, it is still possible to find many significant signs of fundamental maladjustments as early as 1926 and

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137

there is some reason for indicating this year as one of the critical turning points for the United States. Emphasis on one moment of time as having peculiar significance in shifting the current of events implies some theory of the nature of sound development. It is a problem difficult to analyze and freighted with controversy, but, from a pragmatic point of view, certain hypotheses may be made the basis for further research pending more exact definition and wellestablished evidence. T h e nature of the argument rests on a realistic understanding of long-time tendencies. Economic activity over the whole sweep of history has been characterized by an increase in volume of output as well as in the money value of the world's wealth. Advanced methods in recent years have made possible a slight acceleration of a fairly regular pace of expansion, but this slight increase in the pitch of the trend represents a very small net gain. In short, there is some reason to assume that there exists a normal rate of increase in wealth and that departures from this rate will take place only for relatively short periods or only in small amounts. This alleged normal line of production increase can be a useful guide in judging the sound rates of expansion in particular factors. T h e comparison of many curves with this one line can give an approximation of when the turning point in expansion occurred. It would probably be a safe working principle to assume, for instance, that changes in highly important and widely effective influences such as money, credit, and wages must in the long run show a fairly close correspondence to this one very important rate of change. Furthermore, it can be assumed that those industries, for there will always be some, which outstrip this speed of development by a wide margin can do so only if balanced in a general way against others which are becoming obsolescent. In other words, this upward sloping curve holds, in all probability, the key to estimates of the amount of real wealth available and, therefore, to policies aiming at more equitable distribution of income, future prosperity, and the achievement of

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stable economic equilibrium. T h e graphic presentation of the general concept takes the form of a straight line trend of production—for this period mounting at a rate of 3.8 per cent per year—and of other curves of special types of production, prices, commerce, and so on, many of which rose above this line and reached a peak in 1926. Some of the important curves dropped, at least temporarily, from this line of growth and indicate a point of hesitation and reorientation in 1926 and in 1927. A number of the curves then continued to rise and others never crossed the line at all. At this time, however, a sufficient number changed either their direction or pitch to warrant special attention and explanation. No rigid application of a general rule can be made in the short run, but even in the short run it can serve as a warning and as a guide. As time goes on, the results of many studies made by dozens of economists and recorded in scores of documents must be taken as a foundation on which to build new assumptions and from which to push further explorations. The need for an analysis in general terms of the importance of production curves as guides has been suggested in Chapter I I . In the discussion of causes, it was indicated that the explanation of a severe depression was found in every case in the maladjustments resulting from changing rates of change. In pursuance of this general idea, the tentative use of the line of physical production as a base and as a guide to the probable normal of the present and future is made a central thesis of this argument. T h e reliance on a moving standard of comparison to test soundness of changes, up or down, gives no easy clue to the solution of the problem of stability. This standard is particularly difficult to apply because it must comprise a considerable number of important items. Nevertheless, such an average or trend line can be used to locate a zone within which movements are moderate and beyond which they are dangerous. T h e suggestion here offered is not novel, but it puts a new emphasis on the rate of change in that it makes it the core and central guiding

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139

principle of policy. It is an attempt to give proper weight to buying and selling habits, standards of living, and slowly changing mental attitudes. Such institutional and human factors are the logical basis for a pragmatic standard. T h e y account in large measure for the sluggishness of the response of the production trend to short-time changes. Any marked divergence of the more volatile elements of economic life such as bank credit, security prices, or the activity of the more fluctuating industries, any rapid swing of prices from the curve representing the average growth of real wealth, opens up gaps and strains and accentuates the ever-present discrepancies in rates of change. T h e consequent push and pull of short-time adjustment causes profound disturbance in production and exchange. Further, any sharp turn up or down in the line of physical production itself is a warning of the need of fundamental readjustments to institutional factors and customs and is a warning of the imminence of sudden reaction. There are two special characteristics and partly accidental aspects of this particular standard which give it a narrower, and perhaps a more definite, application to the general problem. These are, first, that by the very nature of the case the composite expression in an index number of production conditions does not and cannot change quickly and so remains a central tendency in the midst of a complex of fluctuating variables, and second, a notable characteristic of the production trend is that it gives a preponderant emphasis to tangible wealth and subordinates monetary values to physical realities. It is possible to indicate in a general way the nature of distortion and why the consequences were serious and lasting. It is not possible at this time to prove the universal validity of the comparison here suggested nor to make the rules precise and the tests exact. A great deal of further work is required and a careful examination of the relations between many factors in a series of depressions before the evidence can be conclusive. It is feasible, however, even now to set up tentative standards and broad principles.

DEPRESSION AND RECONSTRUCTION PHYSICAL PRODUCTION, A M A J O R

SIGN AND

CAUSE

T h e key to the problem of balance lies in the proper interpretation of the pace and direction of past production. T h e practical guides to specific decisions w i l l develop out of a constant improvement of trend lines, averages, and standards that represent an inclusive list of economic phenomena. T h e importance of this aspect of economic change becomes evident in comparisons of the years 1925, 1926, and 1927. It is clear that since many things are included in an index of general business activity and yet complete collection of facts is impossible, the selection of items w i l l introduce a bias which w i l l v a r y f r o m time to time. It is also true that differences in value per quantitative unit call for care in assigning the proper weights to different elements and introduce many possibilities of error. Nevertheless the inclusion of many separate items moving in different directions gives grounds for the hope that some errors cancel out and that there remain only the larger, more conspicuous biases resulting from conditions in outstanding industries and that these can be reckoned with before they have gone very far. In any case, indices of physical production exist; they call for constant improvement and yet even now they possess a meaning universally understood and acknowledged. T h e importance of the curves of general production in the appraisal of economic conditions is obvious when it is recognized that they represent the real income of the community. T h e y stand for raw materials, goods in process of production, and consumable wares. T h e y are a synthetic expression of different time elements which condition and limit the further progress of economic development. L o o k e d at from another point of view, they represent the total effort exerted by current labor plus some of the results of past labor in the form of equipment. If they are compared with many other indices it w i l l be found that the others are more subject to sudden large and unpredictable swings caused by erratic movements in money, credit, or speculative prices. These

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141

other forces have a constant bearing on the curve of production data, but they do not exert a predominant influence because production is conditioned by tangible things, raw material, human effort, capital equipment, space, man-power, and various real needs, as well as by the more arbitrary and volatile factors such as subjective valuations, changes in style, and the volume of money in circulation. A point of very great practical and theoretical importance is, necessarily, the length of the period which shall be taken to serve as a standard or the "normal" line. A definitive answer to this question cannot be given because of the shifting span of cyclical waves which set a minimum. A t least one cyclical swing and perhaps two are needed, however. T h e period which is selected should take some account also of the average length of life of capital and consumable goods. It is certain that no absolute or perfect expression of this time factor can be made, but experience and pragmatic attempts to use different periods in considering past trends and cycles will, with further research, yield increasingly useful results. It is clear that the immediate past—this year and last year—gives no sufficient basis for estimating excess or deficiency or the adjustment of producing to investing. Society must pay by continuous savings out of current production for the capital created and used over a period of ten, twenty, or thirty years. T h e time element will continue to demand consideration and the replacement of costly capital goods by cheaper forms does not obviate the necessity of saving. Effort has been frozen into equipment and if this is wasted or superseded because of unwillingness to keep it in repair, those groups—the security holders—who hold the title to the capital goods try to claim a share of the now diminished total of consumable goods available as a substitute for the nonexistent surplus produced by the capital goods. These claims continue to link the future with the past. Any attempt to ignore obsolescence is misleading, and an underestimation of its importance is very dangerous.

DEPRESSION A N D R E C O N S T R U C T I O N

Fortunately, once business leaders and economists have determined to use as a production guide a period covering at least one of the larger cyclical swings, theoretical differences as to the precise number of years to add to this minimal span become somewhat academic in importance. These additional years exert a diminishing pressure on the slant of the line because the variation of each item counts less as the number of items increases.1 On the whole, too many years is apt to give a truer picture than too few in efforts to establish a slowly changing norm. For practical purposes it is therefore probably wise to use at least twenty years for averaging short-time fluctuations. Further experiments with other periods may suggest modifications, but the main idea need not be rejected because of the possibility of later revision. T h e argument, then, set forth in specific terms, is that any considerable divergence of value factors and goods factors from a theoretical line of change represented by the long-time rate of growth of physical production is a presumptive sign of excess or deficiency and a warning of probable maladjustment. It is maintained above that the movement of a number of important economic variables away from this line or zone brings a threat of serious disturbance and that if a majority diverge for any considerable time there will follow, inevitably, a prolonged depression and possibly a state of political and economic chaos. T H E CRITICAL YEAR

T h e year 1926 stands out in terms of the above analysis as a pivot and turning point in the evolution of many economic tendencies. It is marked by a number of important shifts in relationships. Several fundamental elements of economic life which had been undergoing an unusual expansion tended at this time to contract. In contrast, many enterprises, stimulated by what seemed to be an unprecedented time of 1 T h i s corrective tendency holds according· to the laws of probability because of the random nature of movements of a large number of observations, a fact which is cometimes offset in part, however, by the application of certain mathematical formulae which exaggerate extreme items.

THE TURNING POINT—1926

143

prosperity, moved forward with increasing speed. It was at this time, therefore, that there emerged the first serious discrepancies in values and volumes. In general, irrespective of some declines, overconfidence spread through strategic areas in business and finance along with a failure to realize that the end of post-war industrial recovery had brought grave consequences which would have to be absorbed in changed production and distribution of wealth. This time in general, and this year in particular, was characterized by production errors rather than by financial errors. T h e later phase after 1926 was dominated more largely by speculation and inflation; the earlier period up to and including 1925 by overconstruction and a business program based on expanding markets for goods. T h e rare combination of fairly steady but downwardtending commodity prices and low money rates with rising stock and bond values and an unusually active production, observable in 1926 and thereafter, seemed to postpone the necessity of a critical appraisal. T h e signs of strain which can be seen now on looking back were buried deep under the surface phenomena of the moment. T h e more evident fact was the increase in productivity of both men and machines and a rising standard of living accompanied inevitably by an increasingly cheerful outlook on life. Most of the economic dangers that lay ahead were ignored. T h e large exports of goods and credits during post-war years had given an impetus to production which lasted long after the reasons behind them vanished. In many ways, therefore, the best period of American economic existence was the most perilous. F. C. M i l l s in Economic Τendencies indicates these dangers. H e shows in a number of striking diagrams that the expansion which occurred was accompanied by an ominous divergence of rates of change. H e warns in his exposition that small percentage differences in the coordination of factors must be added to each other to understand their full significance. T h o u g h he does not direct special attention to 1926, many of the facts he presents warrant special emphasis

DEPRESSION AND RECONSTRUCTION

on this year. Similarly many of the exhibits of Leonard P. Ayres show widening discrepancies in 1927 and thereafter. T h e striking rapidity with which equipment enterprises and heavy industries were expanding, for instance, was conspicuously dangerous to future industrial expansion because the length of life of capital goods makes investment errors hard to rectify. Whatever strain was exerted from this source was bound to be persistent, perhaps cumulative, and to place a very heavy burden on the future. T h e comparison of the pre-war and post-war periods is particularly impressive if one realizes that even before the war there had been a rapid improvement in manufacturing methods and in output per man. T h e net differences from high to low in the rates of change between the industries here cited amounted, on the average, to eight per cent per year before the war and to fifteen per cent after the war. 2 That is, if extreme items are disregarded in both cases, rates of change before the war concentrated between minus one and plus seven per cent, while after the war the declines spread to minus four and the increases in production to plus eleven per cent. If all the extreme cases except the automobile industry are included, the difference between the earlier period and the later years would show the same increasing divergence of rates of growth. T h e increase in the upward trend of production and the discrepancies between this general upward trend and the contraction of movement in certain cases is the more significant when considered in connection with the leveling off of the population curve. In fact it is notable that the rapid increase in production as well as the differences and shifts in the relationships of these rates to each other occurred in spite of evident signs of decline in the birth rate as well as in immigration. 3 2 F. C. Mills, Economic Tendencies in the United States ( N e w Y o r k , 1932), pp. 9, 257, 294.. * T h e divergence of tendencies from each other is more significant in view of the fact that they indicate a net change for a period of about six years. T h e y can be taken to account f o r a considerable series of maladjustments at the end of that period.

T H E TURNING POINT—1926

145

The difficulties which rapid changes involve cannot be fully understood without a study of many intangibles. These lie in the fields of sociology, quantitative comparisons, speculation, and industrial management. The general reasoning involved has already been suggested above. Some further effects of these lags and discrepancies may be suggested in connection with a description of this particular period. A brief comment on the complex relations of different stages and aspects of production that make balance difficult to achieve is appropriate in connection with the assumption that the discrepancies observable in some measure in 1926 were not corrected at this time, but became in 1927 and 1928 increasingly more disturbing. These relationships were to a considerable extent misunderstood. In the first place, many of the industrial projects and even more of the salesmanship prominent in the years 1 9 2 2 - 1 9 2 9 , and typically evident in 1926, were undertaken on the assumption that there would continue to be a widespread increase in the use of luxury goods and a wiping out of many differences in living standards. Real wages were increasing, and so was the extension of credit to the man of small means. At the same time there was no clearly discernible willingness on the part of those with large incomes to accept a greater equality of wealth. There was, in fact, in the postwar decade in the United States a vigorous resistance to any guarantees of the improved position of the worker by means either of a strong trade union position or of intervention on the part of the state.4 This contradiction of philosophies is an expression of a familiar situation. Mental habits and aspirations cannot usually be changed as rapidly as can the mechanical instruments by which they are maintained. I f , therefore, the environment changes very fast, there will be lags in other directions where less aggressive efforts have been applied. T h e speed of social and therefore of economic "National election returns in 1 9 2 4 and 1 9 2 8 as well as the unsuccessful struggles for social legislation in many states offer some evidence on this point.

14Ó

DEPRESSION AND RECONSTRUCTION

change is decreased by the extent and influence of these slow-moving institutional factors. In the second place, there were new difficulties apparent in the setting up of standards and points of reference. It was at first assumed that the gains in some production were probably net gains and that the increased output of steel, or cotton, or buildings enriched the nation by an amount approximately equal to the added volume. This concept was partly valid during periods such as that after 1 9 2 2 when no serious marketing problems confronted manufacturers and salesmen. It was only when various signs of excess production or a deficiency of demand became apparent that the more complicated instruments of statistical research were applied to discover whether the pulling away of some factors from a general line of movement was apt to generate serious difficulties. The delay in understanding shifts in relative positions prepared the way for the third general type of strain emerging in 1926, that is, the false influence of professional and amateur speculation in the valuation of goods and securities. In the period under consideration there had been a real advance in statistical technique, but there was, despite this, a failure to lay sufficient emphasis on the increasing range of movement and an excessive reliance on the favorable implications of rising production trends. Some factual evidence of grave maladjustments could have been found in the intricate pattern of divergent lines, showing a network of conflicting movements, which lies behind the indices and which shows the first clues of unbalanced changes. Because of the incompleteness of most expressions of economic tendencies, many curves which rose at a rapid rate were projected by optimistic expectations into the future at the same steep incline. In these estimates some factors which were able to reënforce each other, such as the increase in physical production, expanding credits, and rising securities values, were given full consideration in the calculation of future profits. A few changes were absorbed by shifts to hand-to-mouth buying which made it necessary to accumu-

THE TURNING POINT—1926

147

late inventories of commodities at different places. There was no extensive search for compensating action to balance the increases since the "new era" ideas encouraged the general impression that there had been a very real change in economic limits. Similarly, in the fourth place, the mechanical frictions, the internal lack of adjustments arising from the inadequate organization and lack of adaptation of distributive methods to basic changes meant that deficiencies occurred here and there which were scarcely realized until they had begun to raise serious problems. These were complicated by overvaluation of land and equipment and by changed relations between machinery and man-power, between various types of goods, between city and country. 5 T h e development of new trades, the multiplication of middlemen, and the fictitious stability of certain prices, notably wheat and steel, accompanied the expansion of business, and were made more dangerous by the increased diversity of movement. There were few shock absorbers in credit or commerce to lessen the strain of the ultimate readjustment. T o a certain extent, the most striking new developments were factors which tended to increase the range of action and make more prevalent many concealed strains and incalculable claims on an uncertain future. Emphasis now on the gaps which opened up between different factors in the years 1926 to 1928 and the assumption that there should have been a correspondence between the changes occurring at different points is justified in part at least by the observation of the close organic interconnections of producing and consuming, of saving, investing, manufacturing, and retailing, and of all other phases of material life. The flow of funds through the economic system is in every instance the result and the cause of proper functioning in all contiguous parts. T h e intricacy of the relations and interdependence of each element on every other calls for no 5 C. W . Thornthwaite, Internal phia, 1934).

Migration

in the Uniteci States

(Philadel-

148

DEPRESSION A N D R E C O N S T R U C T I O N

demonstration, since it is universally acknowledged, but, in spite of this knowledge, there has been no development of reliable instruments for making sure that the balance of changes, so urgently needed, does in fact occur. It is interesting to observe that until recently comparatively little attention has been paid to the general nature of this difficulty and even less to the detailed demonstration of where the discrepancies occur. T h e equilibrium analysis of the classical economists which assumed an almost automatic readjustment from period to period calls for some modification when used in connection with elaborate studies of time series by modern methods. 6 T h e extensive work of those who have developed time series analysis does much to fill the gap, but there is still a notable incompleteness both in the statistical exhibits and the interpretation of the known facts. Perhaps the post-depression period ahead is the moment comparable in its risks and opportunities to 1926 when one should press forward those comprehensive studies which will include measurement and analysis of all stages of production and selling and which will take account of all major products, of all markets, and of the means of financing economic processes at every point. N e w machinery tried out in 1933 for the purpose of coordinating industry makes plain both the need and to a certain extent the agencies and channels for collecting necessary data. T h e thought behind most plans gives a new emphasis now to the interrelations of the various parts but little attention was paid to such matters in 1926. Useful service could have been rendered at this time if research had shown clearly the consequences of increased activity in an intermediary stage of an industry on stages before and after. N o practical use was made of the common knowledge that the enterprises engaged in the extraction of raw material or its transformation into finished products may be put to intolerable strain by the expansion or contraction of some other stage of production. Such an expansion, if not 6 S. S. Kuznets, " T i m e Series," Encyclofaedia Y o r k , 1 9 3 4 ) , vol. 14, pp. 629-636.

of the Social

Sciences

(New

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149

offset by some decline, inevitably puts new pressure on the stages just before and just after to adjust themselves to this change.7 If, as was the case to a certain extent, the earlier and the later stages do not adjust in a flexible way but are called on to absorb the difference in demand or supply, severe strains result which become in many instances destructive. To clarify this point it is possible to set up an imaginary scheme of stages such as that suggested by Professor H a y e k and others. If one assumes six, then it is possible to demonstrate that a marked change in a production stage, called for the sake of illustration three, will necessitate compensating adjustment in two and four and that, if this adjustment is not made, serious and perhaps cumulative distortion will result. Moreover, marked expansion or contraction at the beginning of a productive process or at the end, in the extraction of raw materials or in consumption, may tend to persist and occasion further changes all along the line. Intermediate changes are often artificial and unreal and require temporary offsets or checks rather than a permanent modification of all related facts. In any case, no important stage in the flow from raw material to consumption can be neglected in a constructive policy. Careful selection of first facts to study is impelled by the multiplicity of data, but must afford representative and well-balanced figures in order to make clear the processes which are significant. Differences in rates of increase are less conspicuous when most curves are moving upward as they were during 1926. Such a condition prevailed during much of the post-war period. Whenever these curves were flattened by smoothing processes or by reduced scales of values tending to minimize the rate of expansion, the growing discrepancies between curves were obscured. W h e n e v e r the curves were made steep by setting up scales of measurement which emphasized rapid development, the rise in the lines made the divergence hard for the layman to understand, though it was clear to the 7 F. A . Hayek, Prices and Production (London, 1 9 3 1 ) , pp. 29-64; and E. F. M . Durbin, Purchasing Power and Trade Defression (London, 1 9 3 3 ) , pp. 115-121.

DEPRESSION A N D R E C O N S T R U C T I O N

mathematical economist. O n l y later in the period 1927-1930 when the turns and changes of direction made lines cross and recross at sharp angles were the real differences clearly indicated. It is possible that the more careful scrutiny of different factors during this period, particularly around the pivotal year, will indicate that the secret of the apparent stability of production, wages, prices, and money rates was the result of the temporary substitution of artificial domestic markets for declining foreign markets. M o r e o v e r , careful search may reveal signs discernible even in 1926 of the failure of economic society to adjust to an unusual situation. T o a considerable extent this failure may have been due to the temporary lessening of competition between commodities and between concerns that came with an increased monetary demand for goods and easier credit at many points. A T I M E OF O P P O R T U N I T Y

It is useful perhaps to attempt a summary of conditions in the year 1926 and leave to other investigators the further testing of the assumption that this year was actually a moment of transition and a time of special opportunity. There is some reason to think that at this point in time it was still possible to avoid the worst mistakes of the years to come, but by 1927 certain characteristic errors were fastening themselves more firmly on economic life. A t this time industry seemed to be prospering at almost every point. T h e unbalances which were beginning to develop had not yet affected the practical situation in any large group of enterprises. M a n y of these unbalances were already serious in nature but are only now clearly discernible. In fact, such an eminent economist as M r . Keynes stated in 1931 that he did not think there had been any serious disturbance of equilibrium during this time. 8 Further material has come to light since this statement, especially with regard 8 J. M . Keynes, " A n Economic Analysis of Unemployment" in Unemployment as a World-Problem, Harris Foundation Lectures (Chicago, 1931)1 pp. 10, i l ,

THE TURNING POINT—1926

to conditions in the United States, which might lead him to modify his statement. Agricultural products and cereals in particular were overextended on the basis of almost any comparison which might be made.9 Exaggeration of land values, acreage under cultivation, crops, and expenses of cultivation, as well as mortgage debt, led to a situation which seemed dangerous to many, but which was obviously difficult to cure. T h e very large cotton carry-over in this year was a conspicuous and dramatic indication of the general problem already becoming acute. In the realm of finance, conditions seemed favorable to a further advance in prosperity; money was readily available for investment; the Federal Reserve System seemed to have a fair degree of control over the situation. Large sums of gold were lying in vaults of the Federal Reserve Banks 10 and yet did not seem to affect a reasonably steady commodity price level. Confidence in the future was substantial. In the monetary field, especially where it touched foreign exchange and foreign investment, there were still many unsolved problems, but, on the whole, conditions were much brighter. England had returned to a gold standard in 1925 with what seemed to be a remarkable lack of strain and disturbance. T h e Dawes Plan in 1924 had restored borrowing and buying power and brought a real boom to Germany, and the restoration of European currencies, disrupted temporarily by the depreciation of the French franc, seemed to go on in a satisfactory way. Trouble in real estate, partly influenced by excessive land booms,11 and an uncertain agricultural future had begun to be evident, but many types of building went on at a rapid rate, and the evident difficulties were minimized by speculators. "There was probably a shortage of milk and 10 Statistical Abstract of the United States pp. 246, 248, 258. The course of the Florida land boom and is an interesting example of recurrent speculative

green vegetables. 1929 (Washington, collapse—1925 and "bubbles."

1929), 1926—

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DEPRESSION AND R E C O N S T R U C T I O N

T h e wage-earner seemed to be in a relatively favorable position j he had gained in wage rates while prices were steady, and the installation of machinery had not as yet made conspicuous encroachment upon the demand for labor. H e r e and there relatively high rates were beginning to eat into the volume of employment, but the situation was not acute. T h e "new era" philosophy was well designed to cover up sizable discrepancies and to push expansion even further. W h e n it was noted here and there that Europe was burdened with heavy debts, frictions and hostilities of many types, this observation merely served to throw American prosperity into high relief. F u l l credit was taken for creating a new set of relationships, new goals, new methods, and an unprecedented activity in production and consumption. In fact, there was in the United States a dangerous illusion of power. Just at this point, however, it can be observed that the influences which have been noted as causal mistakes in policy began to work upon the complex fabric of economic life. The cumulative error growing out of failure to readjust agricultural realities to the falling off of war-time demand is a conspicuous example. It is not unreasonable to suppose that the false orientation of policy could have been more widely understood and acknowledged at this time. In any case, a number of measures to subsidize or peg agriculture were advanced in this critical period and continued to modify government programs for at least seven years to come. " N e w era" industrial policies and expansion hopes were not seriously questioned at this time although it was in 1926 that many wage rates began to move up in contrast to a declining volume of employment. Similarly real earnings of those employed probably rose more rapidly than factory payrolls because prices were falling slowly. 1 2 T h e potential rise in labor costs coincided with a time of notable machine 12

1931

National Industrial Conference Board, Wages (New Y o r k , 1 9 3 2 ) , pp. 67-69.

in the

Onitei

States in

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153

development. A t about the same time the shrinkage of foreign demand for commodities led to increasing sales pressure to exploit domestic markets. Although, as has been said, the outlook in Europe in 1 9 2 6 was fairly bright on the surface, signs of grave dangers were noted by more careful observers. Reparation difficulties were far from settled, and the effects of the first actual payments of German Reparation and interallied debts to the United States were beginning to be felt in further strains in the world's credit relations. Austria had attained no real recovery after the dismemberment and economic losses growing out of the war. T h e gold exchange standard caused the piling up of abnormal balances here and there. T h e widening gap between long- and short-term rates was beginning to reveal peculiar conditions in most money markets. Investment was booming, but the ability to repay speculative debts was subject to serious question. Tariffs, debts, exchange restrictions, widespread uncertainty, and distrust hampered commerce at many points. In short, economic sanity had not replaced the hostilities and rivalries of war. Meanwhile speculation was quick to catch up the good features in the situation and ignore the bad. It gained momentum with the stimulus of more gold, new exports, and new ideas. Trade in securities mounted on the rising volume of public participation that continued through the next three years. The public seemed more responsive to buying suggestions of all kinds than it had ever been. T h e new attention to appreciation in the day-to-day quotations of those security values which offered possibilities of a trading profit obscured the steady decline in the yield on stocks and the abnormal rates on bonds and long-time borrowing. Here, if anywhere, was a point of possible control after 19265 here as nowhere else, except with respect to foreign debts and reparation payments, were avoidable mistakes destined to bulk large as causes of future trouble. In fact, if one admits that some of the agricultural and industrial errors were difficult to avoid politically, it is still

DEPRESSION AND RECONSTRUCTION

possible to argue, subject to the corrections which history will offer, that the failure to develop enlightened leadership in foreign policies, particularly with respect to debts and tariffs, as well as the lack of clear-sighted, aggressive banking controls, may come to be considered the greatest of the lost opportunities of a century. All of these influences can be considered qualitatively as causes, and statistically as discrepancies of rates of change. The general proposition must be established or modified by careful testing and demonstration. Any proposed sign of disequilibrium must be subjected to further examination. If the temporary swing of the production curve out of its normal track of advance is a warning, and if prolonged divergence like that after 1926 brings inevitable collapse, then the existence of danger can be detected by the examination of quantitative measures of growth and trend, and by a careful interpretation of differences in direction in the light of the relations of various stages of production to each other and to institutional factors in a complex economic situation. T H E N E E D FOR F U R T H E R A N A L Y S I S OF

1926

The foregoing analysis of the critical events of 1926 is admittedly tentative. T o verify this diagnosis and to understand the significance of the phenomena here noted we need much more information. Before going further, it is appropriate to indicate in outline form the kinds of information required. T o the studies which have already been made by F. C. Mills, S. S. Kuznets, Arthur Burns, and others, must be added further attempts to condense as well as to expand investigation. It is of the highest importance to try to develop by trial and error, as well as by abstract reasoning, simplified expressions of possible norms, trend lines, and maj or indications of strain. Definite bases of comparison must be set up and sequences outlined which can serve as guides. Some of the questions with regard to 1926 and the years just before and after it which should be explored further are the following:

T H E TURNING POINT—1926

χ. Can certain types of industrial and agricultural enterprise be chosen as representatives of a more complex situation, to show the interrelationships between a. raw material, b. machine equipment, c. semi-processed goods, d. durable consumers' goods, e. semi-durable consumers' goods, f. perishable consumers' goods? 2. Can certain sequences of production and consumption be outlined so as to indicate where in the process of making and distributing goods a shrinkage in the margin of profit first exerts a depressing influence and where the flow becomes clogged and buying delayed? 3. Can production and finance be represented in parallel curves so as to indicate at what times savings, investment, construction, and industrial activity get out of line? 4. Can the time intervals of the more important analytical curves be broken down so as to associate certain types of business decisions with certain speculative and psychological forces that have induced expansion or contraction? Can one discern a concentration of such destructive or constructive decisions at the time of specific political changes or economic events? 5. Can the curves of expansion of durable and semidurable goods be corrected by taking account of length of life so as to make them strictly comparable to the curves of perishable or quickly consumable commodities? 6. Can industries be distinguished by statistical signs or direct knowledge of conditions so as to show which are in stages when rapid expansion or decay is natural and are abnormally stimulated or depressed by inflation or deflation? Some of these further steps in the study of times of special

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DEPRESSION AND RECONSTRUCTION

importance to theoretical analysis are being undertaken at various places by well-qualified students of the problem. Some of these questions are already recognized as important} others are still unformulated and call for further clarification before they can be made a framework into which data can be fitted. When these and other points are cleared up, it will be easier to show the moments of excessive strain and to indicate where the flow of money income becomes deficient, where the goods stream is blocked by the decline in purchasing power, and where stoppage is caused by a destruction of confidence and a falling demand for products. It is almost certain that even a short list of significant indices must include typical raw materials, minerals, agricultural products and such things as the volume of output and consumption of coal, steel, oil, wheat, cotton, and dairy products. They will have to take account of goods in process such as cloth, leather, and steel ingots. They will measure changes in electric power, construction, building permits, machinery, railroad earnings, car loadings, and other basic data. Consumption of goods will continue to be studied, in retail sales, in budget analyses, and in careful examination of basic wage data. T h e place of one country in relation to other countries will be appraised as reflected in the movement of gold, goods, and investments in and out, as well as in price level comparisons. Financial factors will be taken as a necessary parallel to all these various endeavors. The study of investments will be undertaken along with that of industrial expansion} interest rates will be linked with the movements of goods and employment; deposits, clearings, bank debits will be referred to a general line of trend in production as well as to short-term swings. Then finally, the general economic and institutional setting will be sketched in terms of fiscal policy, political aims, population tendencies, and social programs. T h e influential part played by the stock market will be recognized as having a broad, over-all influence. After a diversified description of conditions is available, it may be possible to present three broad sets of curves

THE

TURNING POINT—1926

showing changes in production, finance income, and speculation. T h e real points of danger would emerge in differences between three major categories—first, commodity production including both consumers' and producers' goods, second, credit with the more reliable measures of earnings and incomes, and third, prices with emphasis on those indices that reveal inflation and deflation in goods and securities—major tendencies to be represented as smooth curves with the minor fluctuations cut as dents in the broad trends of the more persistent movement. T H E S E A R C H FOR D E F I N I T E N O R M S AND Q U A N T I T A T I V E STANDARDS

In many important respects, 1926 may be considered a peculiarly important phase in the expansion of the decade. Up to that time the errors in policy, the exaggerations of production and consumption had not gone far. T h e strain and stress of the years preceding it were natural to the postwar readjustment. T h e major difficulties seemed to many in America to be conquered with the recovery from the 1921 depression. Because of and notwithstanding evident prosperity, the errors beyond this point were, according to some opinions, continuous and cumulative. There was no notable adjustment of industry or agriculture to the major policies of government at home and abroad. There was no consistent effort in finance to keep the means of payment in harmony with real long-term values. There was no clear-sighted attempt to set the mounting curves of economic activity against a line which would represent permanent and unchanging conditions. T h e growing inequalities of money rates, as well as the erratic use of investment funds, hung over many markets without bringing about any vigorous remedial action. It is possible that further investigation may show the changes in this one year to have been less important than is here assumed. It is possible that those who are familiar with the continued prosperity in the later years of the decade may question the existence of serious disturbance in a time which

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DEPRESSION AND RECONSTRUCTION

already seems remote. T h e facts at hand, however, show that significant pressure on production and distribution dates far back of the period of actual distress, and that some of the depression causes generated in war time remained dormant in the midst of favorable and yet confusing tendencies after the armistice. The nature of the difficulty has been referred to here as a series of discrepancies. This abstract expression of differences and strains amounts to little more than a truism, but it takes on more meaning when illustrated in curves of actual changes in the period under consideration. T h e data for this analysis are found in a rich accumulation of material in recent books and can be further elaborated by using different spans of years to show the nature of the divergence from an assumed time of adjustment and by bringing together comparisons of three or four obviously related factors which express different stages of production. The reasoning behind the description of the nature of the difficulty runs usually in terms of intricate institutional interrelations and of value relations. T h e comparisons given imply that there is some validity to an already established set of connections and that it is desirable to maintain normal profit margins. T h e r e is reason to criticize the existence of large profits at some points, but it is still true that the necessity of a return to human efforts and material outlay in each stage of the economic process is a partial defense of the thesis that interrelated elements must be kept in line. Disequilibrium so expressed becomes more than a vague statement of abnormality and runs in terms of actual volumes of goods produced and sold and in changes of prices and of income. One of the important steps in the understanding of the depression will consist, then, in proving or disproving the validity of some one standard of comparison, some base from which deviations can be measured. If this standard or base line can be, as is here suggested, the volume of physical production over a considerable period of years, the task is

THE

TURNING

POINT—1926

159

relatively easy. 13 If it is to be some more complicated norm arrived at by combining various general factors relating to demand, investment, incomes, or financial media, it is urgent that such standards should be developed soon and checked carefully against present and past experience. It is possible that the further development and exploration of ideas suggested here will give support to unpopular but constructive efforts to restrain hasty and ill-coördinated expansion in the interest of sustained and steady progress. 18 It would be unwise to assume that the proper expression of changes in physical production is a simple accomplishment, but it is probably a do-able task.

C H A P T E R

VII

THE BREAK CONCLUSIVE

ERRORS

THE survey of the post-war decade covers many critical phases of economic change, but there are none so dramatic as the events which culminated in the crash of 1929. In the years 1927 to 1933 there emerge conspicuously two types of causes: those mistakes in policy which were to bring financial catastrophe, and that combination of precipitating events which was to overthrow the unstable schemes of an expanding business activity. A downward reaction in security values and a decline in physical production shook the rising structure of artificial values in 1927. T h e resultant hesitation continued to be apparent in some quarters through 1929, but there did not occur the severe reaction which some were beginning to predict. T h e reason lay partly in the sharply divergent interpretations of financial trends and partly in the excitement which came with quick profits in stock market speculation. This confusion of interpretation led, in some quarters, to underemphasis on the need for readjustment and loss taking. During this period the credit relations of the United States with the rest of the world were extremely confused. England was struggling with serious problems in commerce and finance. Germany was still a promising borrower with high money rates as a bait for American capital. French conditions were much improved, but there were swift and disturbing financial changes. Currency stabilization had been accomplished in a number of countries and the piling up of short-time balances in N e w Y o r k and London laid a broad basis for new security operations. T h e deliberate efforts of the Federal Reserve Banks to encourage the outflow of gold by lowering discount rates were followed by conflicting re160

T H E BREAK

i6i

suits and uncertainties. 1 A money policy engaged in without widespread support and with an incomplete realization of the difficulties and apprehensions which might follow the loss of gold could not be pushed vigorously. It was, therefore, almost of necessity a short-time influence of doubtful importance. It may even have led to more confusion than clarity in financial action since it ran counter to the desires and theories of the bulk of the financial interests in the United States. It is neither wise nor necessary to rehearse all the important events that led from a period of relatively stable prosperity in 1926 to a time of drastic decline in 1929. Most of the major episodes of those years are well known; some of the notable disturbing factors have been mentioned above in Chapter I I I . It is useful, perhaps, to characterize in a general way what was happening and to mention one or two points of difficulty not always given due weight in current appraisal of major conditioning factors. Although some of these influences whose significance has been minimized are to be found in the field of foreign affairs, they had many and powerful repercussions on domestic problems. T h e y were relatively unappreciated by most business men at this time. Others which were closer to American production and investment were masked by misleading statistical data, or by prejudice which substituted hope for knowledge in certain instances. At the risk of oversimplifying a complex situation, it can be said that from 1927 on two general influences dominated all others. These were the reparation-debt problems and stock market excesses. T h e y were to emerge alternately and together in a series of dramatic episodes during the next few years. T h e y were working continually through secondary factors on the general level of well-being and they were not completely liquidated even in the dark years of 1932 and 1933. In any case, both the group of problems growing out 1 S. E. Harris, Twenty vol. II, p. 437.

Years of Federal Reserve Policy

(Cambridge, 1 9 3 3 ) ,

IÓ2

DEPRESSION AND RECONSTRUCTION

of reparation-interallied debts and foreign investments on the one hand and the repercussions of the security speculation in the United States on the other led to continuous and growing distortion in finance. T h e chain of events leading out of the German situation to American economic conditions was not at all times obvious. Certainly, it was not until 1930 that pessimism and disturbance originating in that source became widely evident. Nevertheless, there was continuous strain on the loan markets, 2 a g r o w i n g predominance of short- over long-term funds, 3 and a widening discrepancy between national gold reserves. A t the same time the downward pressure on international prices caused in considerable measure by German efforts to export and make payments abroad f r o m 1 9 2 5 - 1 9 3 0 threw the money markets of the w o r l d into disorder. M a n y kinds of uneconomic loans and transactions followed in the train of those connected with Reparation. H i g h stock prices came with the other investment changes, unstable credit was built on a basis of false hopes, and money market conditions in the United States reflected the unnatural financial manœuvres in Europe. So far-reaching were the effects of the abnormal financial operations that many of them were still unliquidated at the time of the disastrous banking crisis of M a r c h 1933. T h e cumulative collapse which followed has many very obvious characteristics. T h e weight of the heavy burden of public and private debt was partially liquidated as prices bore down the whole edifice in an irresistible decline. T h e w a y in which this liquidation was to influence every remote corner of economic life was not realized until the growing list of bank failures made evident the fact that funds of all kinds were involved, and that neither bank deposit liquidity a M a n y of the loans to Germany were made because of high yields, falsely thought to be a sign of high productivity and accepted by Germany because of the abnormal need f o r foreign exchange. 8 T h i s is true though the bonded indebtedness of corporations also rose rapidly. See Evans Clark, The Internal Debts of the United States (New Y o r k , 1 9 3 3 ) , p. 1 7 5 ; see also Senate Hearings 6215 ( 7 1 , 7 2 ) , pp. 22, 23.

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163

nor industrial productivity could be counted on to aid recovery immediately after the first months of readjustment were over. T h u s , over a span of ten years from 1 9 1 9 to 1929 it is possible to observe the gradual increase of strain and stress. First, after the war, for many months, there was a series of obvious distortions and maladjustments bringing about the severe crisis of 1920. T h e n in the period from 1922 to 1926 there were certain varied and persistent causes of disturbance in finance, in agriculture, and in industry which continued to exist during a period of v e r y real prosperity and which were not wiped out during the minor reactions of 1924 and 1927. F i n a l l y , in the years 1927 to 1929 there were those growing financial excesses at home and abroad which prevented the readjustment in production and consumption otherwise possible. E v e n at the time it was evident that the confused currents and unsound relationships of 1927 to 1929 were mainly financial. T h e final stage in the chain of causes is that characteristic sequence of events in which a prolonged decline of prices is the necessary cause of further decline. In fact, it has long been recognized that deflation initiates a vicious spiral f r o m which an early escape is impossible. T h e momentum of the movement offers sufficient explanation for its continuance. If it were not for the fact that some episodes have worked themselves out differently and that some panics have been quickly checked, one would not have to look far for explanations of severe depressions. Value changes that are spread so quickly by the institutions of credit and changes in purchasing power w o u l d overshadow all others. A s it is, the existence of some cases in which recovery has set in at early phases of a precipitate downward movement leads one to push economic analysis forward into the later stages of the depression in the second and third year after a panic, just as one is forced to trace it back for a number of y e a r s — i n this case at least as far as the war. T h e r e were also, in the years after the stock market crash,

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recovery measures which were really depression causes in the sense that they carried further and made more intense those inconsistencies which brought about the original difficulties. It can be shown in some cases that the efforts to restore confidence in stocks accentuated the later troubles. Similarly, the attempt to peg wheat prices4 piled up later obligations and increased pressure for government intervention. Even the halting attempts to clear away the wreckage left the economic system weaker rather than stronger. Some of the measures might have succeeded and could not have been condemned prior to actual experience. Others were confused and ill-coördinated and definitely served to intensify the depression that they aimed to cure. A description of the evolution of the depression influences, even after the first decline, is, therefore, a study in causes so far as these later events explain both the length and the depth of the industrial collapse. It is usually at this later stage after much harm has already been done and not in the period of incubation that public opinion is effective in the direction of reform and concerted action is at last possible. L A C K OF C O N S I S T E N T A G G R E S S I V E P O L I C Y ,

1927

As the focus of attention shifts in 1927 from the industrial and commodity fields to the financial, one of the outstanding episodes was the lowering of the rediscount rate of the New York Federal Reserve Bank from 4 to per cent on August 5 , 1 9 2 7 . ® This act was an indication of the recession of business which had already become marked during the spring and early summer, but it was even more a sign of the increasing desire to aid in straightening out the tangled financial affairs in Europe. T h e amount of gold which had accumulated in the United States reached a new peak of over three billion dollars in May. This was not quite as high as the figure 3,168 million dollars for July 1924, but it was 4 The National City Bank of New York, Monthly Bank Letter (New York, Jan. 1 9 3 1 ) , pp. 9-13. B C. O. Hardy, Credit Policies of the Federal Reserve System (Washington, 1 9 3 2 ) , pp. 95, 107, 235.

THE BREAK less justified by conditions abroad than it had been in the period of currency confusion of 1922 to 1926. A number of countries had been able to restore stable monetary conditions by 1927.® T h e r e was, therefore, f r o m a w o r l d standpoint, no sound economic reason for the United States to have such a large share of existing g o l d stocks in its custody. T h e immediate cause was the nation's somewhat artificial creditor position, which, as a f e w realized, would cease to be an asset and might become an embarrassment unless its price l e v e l should come more into line with w o r l d conditions. In any case, the lowering of the discount rate may have been one factor in the quick revival of domestic trade and of security speculation. T h e movement that got under way in the stock market in 1928 culminated in the sharp peak of exaggerated values and the vertical drop of 1929. T h e rapid rise of brokers' loans f r o m about three billion dollars in 1927 to over eight billion in 1929 reflected the feverish state of the buying public. 7 T h e steady decline of bonds which began in most groups at the end of 1927 signified a serious malady affecting all credit and investment. Industry could, of course, readjust its capital structure temporarily so as not to be inconvenienced by the unpopularity of long-term fixed interest issues, but even so, funds on short term, subject to the vagaries of the market, could not properly nourish the highly capitalized productive machine of the twentieth century. 8 T h e increasing difficulty in long-time borrowing was bound to be felt unless monetary conditions here and abroad were righted. T h e confusion with regard to stock values was increased by certain new practices which were subject to general misinterpretation. T w o of these were the extensive substitution of stock dividends for cash disbursements to the holders of securities and the wholesale plowing back of earnings by rein' E . L . Dulles, The French Franc 1Ç14-1Ç28 ( N e w Y o r k , 1 9 2 9 ) , p. 409; see also chronological list of events in E . L . Dulles, The Bank for International Settlements at Work ( N e w Y o r k , 1 9 3 2 ) , pp. 509-522. 7 Senate Hearings, 6215 ( 7 1 , 7 2 ) , pp. 34, 35. 8 T h i s tendency was even more marked in Europe.

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vesting profits in the business. These post-war developments were destined to increase productive capacity. 9 Meanwhile, large corporation surpluses were invested in stocks and the growing tendency to issue scrip and rights to stockholders further complicated an already confused situation. Security values were maintained at fictitious levels by the unwillingness of holders to take profits because of the income tax levies on capital gains. Financial observers differed widely in their interpretation of these tendencies. A policy of building up equipment, undoubtedly sound in industries which were still in their infancy, or in new lines of enterprise, became disastrous when pursued in more highly competitive fields. T h e inevitable result in the long run was almost certain to be the dumping of products on the market whenever at a later time capacity should come into full use. In actual fact this development was coincident with and partially caused by a sharp decline in money demand and a progressive decline in prices. T h e substitution of stock dividends and rights for cash constituted a somewhat special aspect of the general economic policy. T h e contrast lies in the fact that one tendency is important because of the growing legal claims to future income ; the other because of the intensification of industrial competition. T h e increasing mass of claims in the hands of security owners was essentially inflationary because other things failed to keep pace. In fact, despite some hasty generalizations to the contrary, physical production lagged behind money incomes—the growing claims meant excessive demands and precipitate liquidation later. T h e y bore down on a relatively narrow base of tangible assets. In other words, a new form of stock watering took place, different in form but comparable in effect to that which was widely practiced before the 1907 panic. Meanwhile all the "new era" ideas which have been discussed in Chapter V were brought forward, along with other vaguer explanations, in order to justify to the skeptics the unprecedented rise in security values. T h e r e seemed to be 'Irving Fisher, The Stock Market

Crash—And

After

(New York, 1930).

THE BREAK

no clear reason for rejecting the more plausible analyses. There was emerging at the time a new kind of buying based on a higher standard of living and consumer credit which stimulated industry. It seemed to make possible the production of larger volumes of goods with increasing economy of operation. It is clear that over long periods of time these changes were gradually taking place. T h e desire to speed up the process was natural and was justified by a number of signs dramatically evident of the changing spirit of the decade. The short downward movement of prices which came with 1 9 2 7 was considered by many to be the healthy readjustment of certain important relationships that had pulled temporarily out of line. It was difficult, if not impossible, to see at that time that the decline had not gone far enough, that exaggerations still existed, and that some unsound conditions, notably in agriculture, had not been touched by the changes which had brought some of the other factors into line. It now seems probable that a more vigorous domestic policy in this year accompanied by major international readjustment would have prolonged somewhat the 1927 depression but would have been the means of avoiding many of the worse disasters of the later collapse. 10 The year 1 9 2 7 , however, was characterized by serious conflicts in theory and practice. There was a notable discrepancy between rapidly rising stock values and the sharp decline in business in the latter half of the year. There was a similar lack of coherence between the falling off of production and the low money rates which might easily have brought an increase in general activity. Moreover, the lowering of the bank rates did not readjust the abnormal gold situation as much as had been expected. This lack of harmony between forces, due in part to the lure of rising security values for the investor, tended to counter the more direct effects of low yield on investments. The active buying of 10 See Weekly Letters, Harvard Economic Service (1927, Jan. 8, May 14, June 4, 25, and others).

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DEPRESSION A N D

RECONSTRUCTION

domestic securities lessened the expected outflow of the standard metal, i. e. gold, which might otherwise have eased financial strain both here and abroad. These unexpected events and relationships led to prolonged controversy. Both the permanence of existing price levels and the wisdom of current policies were questioned. The direction of future trends was widely disputed. Economists as a group gave no clear verdict, but tipsters with an interest in the promotion of particular securities reaped a rich advantage which was to continue for many months. A writer in the Annalist11 noted the declines in the steel and automobile industries as being peculiarly significant. H e warned of insidious inflation and of false appraisal of incomes, and questioned the ultimate dependability of instalment selling. H e commented on the confusion introduced by the lack of the usual seasonal movements and by perplexing money market and stock market conditions. H e noted the rapid development of chain stores and the displacement of workers from industry because of technical changes paralleled by an expansion of service and luxury employment. Even in retrospect it is not clear at all points what should have been done to straighten out these complicated tangles and shifting currents of value. It is obvious that a more consistent policy designed to bring international indebtedness to a more usual and less one-sided condition would have made financial action at home more constructive. A vigorous attempt to check speculation might have been successful and would have been worth the cost. It is not quite clear, however, just what instruments would have been used to accomplish these purposes, nor just how they should have been applied. The industrial reaction seemed at the time severe enough to disturb confidence and halt runaway movements. The large number of failures might have made the production basis of financial life more solid, but for reasons not yet entirely evident, these healthy tendencies did not become 11

Benjamin Baker, "The Business Outlook for 1927," The Annalist 14, i9 2 7)> PP· 39-4°·

(Jan.

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effective and inflation and speculation unjustified by real production conditions continued. Since calculations were misguided and economic institutions were ill-prepared to face contemporary problems, it is important to temper criticism even when it is granted that corrective tendencies could have been started in a score of directions to accomplish a joint result. If either government or business could have cut through the maze of conflicting influences they could have taken more vigorous action in regard to farm debt and agricultural production, or could have strengthened the banking system and linked it more closely with the Federal Reserve System. T h e y could have faced the dilemma of international debts in a more generous spirit and could have detected inflation in loans, in a few wage rates, and in many industrial hopes. On the contrary, the more conspicuous signs of departure from familiar conditions were being explained away by professional optimists, some of them preaching a new economics. Unfortunately, rich opportunities for personal gain did not leave much room for heroic and farsighted action. F I N A N C I A L EXCESS,

1928

It was not until the recovery from the industrial setback of 1927 had gathered momentum that the astonishing rise of the bull market got under way. T h e easy money policy of the earlier months was a stimulating factor, no doubt, but equally important perhaps was the apparent ease with which general industrial recovery was accomplished and the apparent threat of an old-time business cycle avoided. N e w fuel was added to the fires of those who thought banking and industrial control in a world of ever-widening markets was being accomplished. There had been for a considerable period no real money stringency such as those experienced frequently before the war. Commodity prices seeme¿ to have attained a stability never witnessed before. T h e fact that the sluggish movement of the indices was a result not only of conditions in the commodity markets but also of

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the growing refinement of mathematical treatment and a blending together in averages of offsetting and balancing items was an explanation not brought forward as a caution. Employment more than regained the 1 9 2 7 losses, while wages, judged by all the readily available measures, rose in terms of both dollars and goods. This was a time when a small but significant amount of employee stock ownership was actively stimulated by satisfactory reports on earnings, by the rising prices of securities, and by deliberate sales efforts. Again talks of a real partnership between capital and labor were urged in many quarters and encouraged the hopes of those who were eager to see the savings of all classes absorbed in increasing capital equipment and industrial machinery with an enlarged national wealth as a result. T h e promoters of stock had ideas which were true in essence but exaggerated in application. As J . M . Keynes and others have pointed out, the smooth flow of savings into investment is of the first importance, but the principles on which investment can wisely be undertaken call for a very great ability to plan the relation of factors of production to each other. Moreover, anticipation of the exact nature of the complicated adjustments of different kinds of instruments to each other at some later time is beyond the capacities of the leaders of economic life. Certainly the general public is largely ignorant of such future problems. Meanwhile, with a decline in real savings, the potential disinvestment spoken of by M r . Keynes was hanging over the market. New lenders were not likely to refrain from consuming the apparent profits which they had made as the result of the earlier sacrifices through savings. This paradox of saving was bound to be increasingly evident at times when there might arise serious doubts as to the certainty of realizing the later gains. T h e flood of money which poured into Wall Street was directed there essentially by those who had a short-time point of view and had neither the resources

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nor the habit of foregoing present consumption to enjoy the later fruits of the long-run development. On the basis of the almost limitless desire to speculate in securities, clever men who knew more about corporate finance than they did about industrial and social conditions developed attractive mechanisms to facilitate the participation of the smaller trader in a large number of industrial enterprises. There was an almost inevitable pyramiding of one claim on another. T h e participation of the ultimate investor in financial enterprise was often based on buying shares of concerns which bought other shares, and these manœuvres resulted in the multiplying of either profits or losses by an unknown and essentially unknowable figure. In a time of rising prices, however, the potential losses were largely ignored. 12 During these months of 1928, production curves seemed to follow the forecasts and to justify the hopes of the more ambitious financiers. T h e upswing in automobile output, for instance, was impressive, particularly in view of the fears entertained by many that the market would become saturated quickly. Construction contracts 13 fluctuated so erratically that there was little possibility of discerning the fact, obvious later on, that a downward movement had already set in. Exports were still on the increase, while department store sales rose impressively. T h e decline in the price of wheat in the same year was the occasion for advocating many new schemes to help the farmer. These suggestions were at first mainly considered to be bloc efforts of limited importance and at this time failed to receive any serious support. T h e steadily growing force behind them was little recognized amid the general preoccupation with financial and industrial tendencies, and for the most part the first portentous signs of the more disturbing dislocations were passed over as inconsequential. In 1928, for the third time since the war, industrial proThe participation of a large number of small investors was in part an outgrowth of the sale of small-denomination Liberty bonds during the war. "Senate Hearings, 6215 ( 7 1 , 7 2 ) , pp. 51, 52> 594· 13

D E P R E S S I O N AND

RECONSTRUCTION

duction rose sharply above the long-term line of trend. This time the improvement was taken as a sign of a permanent increase in well-being. In 1922 it had seemed to be a natural rebound from an abnormal post-war low. In 1925, it was taken to be more significant of future wealth and was thought by some to hold a promise of a new and lasting prosperity. In 1928 this spirit of optimism had gained more ground and many spoke as if the solution of age-old economic problems had been achieved in the United States. The decline in the gold reserves to a low point in July 1928 1 4 and successive increases in the discount rates gave some clue to a confusion of sentiments in the banking world. There was a hesitating reaction from the easy money policy of the previous years. It was no indication of really vigorous efforts to halt speculation, but rather a sign of conflicting opinion and of occasional fears which could not be expressed in a strong repressive policy for political reasons. Corrective action was hampered also by the uncentralized nature of the banking system. T h e sentiment of bankers in the United States varied greatly and could not be brought into harmony. A branch banking system was sorely needed. Even though Federal Reserve rates were raised a number of times, 15 they lagged behind the swift upward moving curve of call money rates and failed to contract the rising volume of loans. Never before had there been anything in American credit comparable to the rapid rise of brokers' loans, which doubled during the year. T h e presidential election in the fall of 192g increased the feeling of uncertainty. Because of the speculative fever, the turn of the tide in the gold movements which permitted about a billion dollars to seep back to Europe, most of it to France and England, was short-lived. T h e year 1928 was characterized by a specious prosperity in many countries and was signalized by the increasing difficulties experienced by many of the European debtors in continuing the one-sided payments grow14

The Federal Reserve Board, Twentieth Annual Refort, 1933 (Washington, 1 9 3 4 ) , P- 138. 15 Statistical Abstract of the United States, 1929 (Washington, 1 9 2 9 ) , p. 255.

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ing out of the war. B y the end of the year, the tide of gold was again running the other way. Meanwhile, other financial difficulties were accentuated by the marked decline in the bond market, a sign of the increasing unwillingness of America to lend on a fixed interest basis and the drying up of this source of funds for the European debtor. T h e meaning of many of these changes was not evident at this time. Reactions which now appear as the turning points in maj or lines of trend seemed at the moment to be merely temporary setbacks not to be taken seriously. There was no very carefully developed technique for interpreting the up and down movements of the curves in the light of knowledge of the more permanent changes in the economic world. For instance, the falling price of wheat was not taken as a timely indication of the growing capacity of Russia and other countries to produce, and the turn of the gold current back in the direction of America was not recognized as a different kind of influence from the original war-induced movement in that direction. T h e second flow back was the result partly of the operation of a speculative prospect of gain and was exaggerated by the working of the gold exchange standard. T h e r e was also a continuous and increasing pressure to pay America in money, since various mercantilist measures conspired to prevent payment in goods. A t this time Germany and France were both producing goods in great abundance and many countries were competing with a new intensity in foreign markets. T h e problem of merchandising certain raw materials such as rubber, cotton, copper, coal, wheat, sugar, and silver was becoming greater because of the persistent delay in adjusting tariff and credit relations. It is almost impossible to reduce the complex actions of many influences during this time to any compact statement. Many people were dealing with financial matters with which they had little or no previous experience. Obviously the American lender was an uncertain quantity in the field of foreign investments and loan-supported speculation held a

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constant threat of an eventual cumulative decline. For these and other reasons, all the saner-minded authorities admitted the imminence of a sharp reaction, but few anticipated a reversal as severe as that of 1929. THE

SECURITY PANIC,

1929

T h e struggle between conflicting opinions in April and M a y 1929 was almost as critical in its importance as the subsequent October collapse. T h e situation in the spring of the year was outlined in sharp contrasts of black and white. It was obvious to most thoughtful men that many security values were selling at inflated levels. 16 It was equally clear that any strong repressive measures, sufficiently aggressive to bring about a rigorous control of the money markets and the liquidation of unsound loans, would affect not only speculation itself but also the production substructure on which inflation rests. T h e burden of responsibility for deliberately halting the expansion of production seemed much less acceptable to those in strategic positions than that associated with a selective repression of stock market activity, yet the two possible effects of higher money rates could not be isolated from each other. W h i l e bankers were hesitating over this problem and economists were attempting to explain conflicting signs, the search for the means of curbing the obvious speculative excess was making little headway. It is probable that it could not have been done without upsetting the more normal expansion which was going on in industry. Some held that there were ways of continuing the steady upward progress and that the only serious danger to this progress was the sudden stalling of machinery, such as might result if any artificial deflationary measures were attempted. A t this critical time call money soared to the very unusual figures of 20 per cent and over on March 27, 1929 and the Federal Reserve authorities disputed the matter of raising " J o h n Foster Dulles, Speech before the American International Chamber of Commerce, Washington, A p r i l 30, 1929.

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their rates, with resulting confusion in the minds of the public. 17 T h e lack of the emergence of a clear policy at any point, and the continued announcement of encouraging words by Secretary M e l l o n , President Mitchell of the National City Bank, and other men in strategic positions, sent the value of stocks rushing upward again during the summer. 18 In this instance there is observable one of those signs of the serious dangers of basing decisions on the analysis of the movement of curves. It is obvious if one looks at the full span of months from the beginning of 1928 to the low point of 1932 that the downward movement in production for many commodities began before July 1929. It was, however, impossible to j u d g e this marked change in direction at the time. W h a t now appears to be a sharply defined peak, was then a small dent in an upward moving line. It is apparent, looking back, that the drop in automobile production, construction contracts, pig iron production, electric power consumption, and many other such basic factors was already pronounced in the summer and fall. But it was so slow to appear on the charts that when the stock market break came it seemed to be unrelated to those recent changes not yet clearly evident in the series of quantitative data. For this reason the collapse seemed to many in the first instance to be purely financial. A shock to confidence had been given by a number of actions. T h e increase in the N e w York Federal Reserve rate on August 9, 1929, the raising 17 T h e problems raised by high money rates and active stock market speculation made acute the controversy between the Federal Reserve Board and the N e w Y o r k Bank with regard to the advisability of raising the discount rate at this time. Some commentators do not emphasize sufficiently the fact that the influence exerted by Secretary M e l l o n and other officials as well as the emphatic declarations by President Mitchell of the National City Bank and others were as important in causing a false optimism as were the actual decisions on discount rate policy. C . O. Hardy, Credit Policies of the Federal Reserve System (Washington, 1 9 3 2 ) , pp. 1 4 8 - 1 7 8 ; R. G. Hawtrey, The Art of Central Banking (London, 1 9 3 2 ) , pp. 74-83; S. E. Harris, Twenty Years of Federal Reserve Policy, (Cambridge, 1 9 3 3 ) , vol. ii, pp. 473-487 ; see money rate charts, Leonard Ayres, The Cleveland Trust Comfany Business Bulletin (July 15, 1 9 3 0 ) . 18 Franz Schneider, "Some Observations on Recent Federal Reserve P o l i c y , " The American Economic Review, Supplement ( M a r c h , 1 9 3 0 ) , p. 1 0 4 ; see also sufra, Chapter III, pp. 60-62.

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DEPRESSION AND RECONSTRUCTION

of the English discount rate, September 26, 1929, the Hatry failure, the American copper price change, the decline in the market value of certain popular investment trusts and other similar events shook the high pyramid of stock quotations and brought it tumbling down, along with the loan structure on which it had been reared. In reality, however, the decline in production and employment which had occurred as an inconspicuous accompaniment to this more dramatic situation was in many ways more significant. It was the more urgent because of the increase in competition throughout the world and the unprecedented capacity to produce goods at a time when markets were narrowing in all directions. Moreover, the difficulty in securing long-term funds, reflected in the decline in bonds, led to a weakening of the structure at many points. The crowning misfortune of the year 1929 was to underestimate the damage which had been done. The deflation, which was to a considerable extent inevitable, had gone too far to be easily repaired. T h e attempts of the bankers' pools to steady stocks and avert a money panic were justified by the needs of the moment, and cannot be condemned even in retrospect, since they may be judged to have given an opportunity for rescue work not actually taken advantage of. In the light of the failure to take advantage of a respite with constructive measures in finance or production, and because of confusion of thought and delay in action, they did more harm than good. T h e temporary recourse to emergency measures could be counted as a wise thing if on top of that there had been a serious effort to remove the fundamental causes of maladjustment. If agriculture, foreign debts, banking conditions, and tariffs had been readjusted with a view to long-run development rather than narrow competitive gains for the immediate future, much of the later trouble would have been avoided. If on top of this bankers had made an effort to raise the ethical standards in the financial professions generally and attempted to allay the speculative fever, and if the hopes for constantly rising stock prices had

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been put aside, the outcome of the events of these stormymonths would have been different. A s it was, the liquidation of billions of dollars worth of credits, an unparalleled deflation in October and November 1929, served to weaken rather than strengthen the financial system. It undermined many banks and seriously delayed many business commitments. Meanwhile, false hopes of the efficacy of low money rates and a continued sickness in the bond markets delayed recovery. In this year and in the months to come, the failure to guard against the evils of unemployment by the enactment of farsighted relief measures piled up the danger of future crises which were bound to force the hand of the moderate groups at times when hasty action was dangerous. T h e sins of omission and commission cannot be laid at the door of any one group. It is probable that it takes longer to deflate hopes and expectations than it does to pull down a hastily reared financial structure. T h e ideas of a decade could not be rejected overnight. " N e w era" thinking withstood the devastating attacks of the stock market crash. Professor Irving Fisher published a book justifying the 1929 stock levels in the winter after the decline. 19 M a n y others came forward to discuss bargains in securities. Ideas of bolstering up weak places, of subsidizing the farmer, and of nursing along weak banks were more acceptable to many than the heroics of far-reaching reform. In all these calculations, the decisions were made mainly irrespective of the European situation, and the dangers of further disturbance from that direction were ignored in the excitement of following swift changes at home. T h e optimistic statements of economists and bankers of seven of the leading nations regarding the expectation of continuing prosperity incorporated in the Y o u n g Plan of June 7, 1929, which had been framed mainly by American experts, are peculiarly interesting since these ideas were not easily abandoned in 1930. T h e world had never experienced deflation on as large 1 8 Irving

Fisher, of. cit.-, see also sufra, p. 166.

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DEPRESSION AND RECONSTRUCTION

a scale as that which began on October 24, 1929. It had never seen values swept away with such a catastrophic swiftness in a country overflowing with riches. It is not surprising perhaps that the saner impulses were paralyzed for some time and that the dominating personalities in the days after the collapse were to a considerable extent the same adventurers who had led in the upward climb. It is surprising, in looking back, to see to what extent the methods of the boom were the methods of the early period of deflation. There was no vigorous demand expressed in the press, in directors' meetings, or in government circles to shift the leadership to new political or business groups. There was no apparent effort to strengthen the saner tendencies in banking and to restrict the power of large commercial institutions that continued to sponsor doubtful securities. Moreover, there was no clear recognition of the fact that deflation, though inevitable in certain quarters, should be checked and regulated at those points where it endangered insurance companies and imperiled the entire banking structure. T h e possibility of scaling down mortgage payments was not seriously considered and there was no concerted attack on banking problems to lessen the number of failures. T h e liquidation of past mistakes was carried on for many months in the same spirit of survival of the strongest which had characterized the upswing. Finally, despite many dramatic episodes and instructive experiences during a decade, there was no plan to halt the contraction of European credit, which was bound to depress world prices and restrict international trade. T h e work of restoring credit and budgets, already begun by the League of Nations and other organizations, was forced to stop. Even economists of the most conservative school are forced to criticize ruthless deflation of this unselective type and the failure to recognize and counteract the effects of bankruptcy at strategic points. T h e prolonged sufferings of several years were necessary to bring about an understanding of the fact that losses incurred should not be allowed to cumber the

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credit structure and upset confidence, but that credits should be scaled down to permit a new start and a vital readjustment of productive forces. FOUR

STAGES OF D E P R E S S I O N P O L I C Y ,

FIRST,

1930

T h e l o n g months of depression that followed were marked by four different phases according to the nature of the attempts to bring about recovery. T h e first year was probably the most aimless and unavailing of the whole period because very little of an aggressive or reforming nature was undertaken and many of the statements and forecasts which were issued merely served to confuse public opinion. T h i s period immediately after the crash marks a first and distinct phase of the depression in the U n i t e d States. T h e quick rebound of stocks in the winter of twenty-nine, which carried t h e m w e l l above the November lows, seemed to give support to the cheering statements from the President and f r o m others in high places. T h e idea sponsored in Washington of maintaining wages through a depression kept up the spirits, if not the income, of many people. It was widely urged that there were bargains to be had, that the United States was essentially sound, and that the panic would soon give w a y and permit a return to normal business activity. T h e avoidance in 1929 of the chaos which had accompanied many previous financial reversals also encouraged the v e r y natural tendency to expect an early improvement in conditions. T h e r e was no credit stringency such as had been experienced in a number of previous crises. B y February 1930 many competent observers said that the decline was over, and the announcement that the bankers' pool of N o v e m b e r 1929 had been liquidated was taken as a bullish sign. Stocks moved upward until A p r i l 10, the high for the year. T h i s last point of resistance was destined to stand out as a peak in the almost continuous downward sweep of price curves which carried securities to an extreme low point in July 1932. T h e year 1930 was a critical period in the orientation of economic policies, even though corrective measures were con-

i8o

DEPRESSION AND RECONSTRUCTION

spicuous mainly by their absence. During four months of comparative respite following the catastrophic deflation, there was no sign of a clear recognition of the changes which had taken place. There was no widespread feeling that the gravity of the situation called for vigorous efforts. T h e r e was no indication of willingness to accept temporary sacrifices by cutting long-term indebtedness for the sake of achieving balance. T h e stock market was still a place of active gambling ; few impressive economies were introduced into business; no broad relief measures for the growing numbers of unemployed were urged on a government reluctant to adopt such measures. Foreign affairs were being handled, for the most part, in the spirit that had prevailed from 1924 to 1929. Agricultural interests were being nursed along by the Farm Board, which bought wheat in considerable volume, and high tariff plans were insistently urged in Congress. In short, it is impossible to find any comprehensive and clearly thought-out measures which were designed to protect the banks, to bring about an orderly adjustment in agriculture, to lower levels of value, to lessen the destructive effects of unemployment, or to lighten the burden on E u rope in such a way as to remove the threat of repudiation that hung over foreign obligations. Mentally, the world had not progressed far beyond the thinking of 1926. A n easy money policy, 20 ill-judged attempts to restore confidence, and support granted to special interests here and there were the measures usually adopted. These attempts to subsidize and to interfere with natural tendencies were more appropriate to the previous decade than to this time of unusual stress and strain which called for fundamental reconstruction. T h e change in the business outlook in April 1930 was scarcely noted until a number of events were piled on each other to arouse general uneasiness. T h e price of copper was 20 T h e simultaneous lowering· of discount rates in N e w Y o r k and by three European Central Banks in the first week in M a y while financial representatives of a number of countries were conferring on the launching of the Young Loan was taken by sorr.e to indicate a constructive effort at Central Bank cooperation. E. L. Dulles, The Bank for International Settlements at Work ( N e w Y o r k , 1 9 3 2 ) , p. 514.

THE

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reduced 5 at the end of the month the United States Steel Corporation reported unusually low earnings. Meanwhile, physical production was declining in many important industries and stock values and brokers' loans were moving steadily downward. In June the unexpected difficulty of finding subscribers to the $ γ 2 per cent Young Loan, 2 1 floated simultaneously on nine different markets, was a dramatic indication of the degree to which the abnormal condition of the bond market was misconstrued. It is true that the loan was unusually large and was complicated by a number of special characteristics, but there is no doubt that the first preparations were made with the expectation of a ready sale. The failure of this loan and the passage of the HawleySmoot tariff in June 1 9 3 0 were the occasion for a black wave of pessimism which swept over Europe and darkened the horizon for many months thereafter. From this time on, the second crisis which was superimposed on the stock market break began to exert a cumulative depressing influence on American conditions. It is true that the probable quantitative effects of the tariff law may have been exaggerated in some quarters. T h e direct harm to European exporters in dollars and cents was not necessarily destined to be large, but the moral effect was tremendous. Nevertheless, it seemed to most of those who had been trying to patch up a difficult situation for years that escape to more normal conditions through foreign trade and by means of freer cooperation in finance was definitely cut off by this measure. From now on it was concluded in some quarters that there must be a recourse to narrow nationalist efforts in the face of keen competition. Hopes of international concessions for the sake of mutual advantages were excluded, and along with these much of the tentative reconstruction work of the League of Nations had to be scrapped. The summer of 1 9 3 0 marks the transition to a second phase of depression relations and policies. During the months to 21

E. L. Dulles, The Bank for International Settlements at Work York, 1 9 3 2 ) , pp. 364, 365.

(New

182

DEPRESSION AND RECONSTRUCTION

come the problems were taken more seriously and a blind groping effort to find a means to turn the tide in the other direction was made in the United States. T o those who were close to European conditions at this time, the feeling of despair born in the spring of the year was made manifest in dramatic fashion in the sweeping triumph of the Nazis in the German elections of September 14. 2 2 T h e echoes of this event were less loud in America than in Europe, but even in America many saw the serious menace latent in a new vindictive spirit and were apprehensive of the possibilities of a new reign of terror. There were thus further reasons for the shrinkage of credit and the widespread collapse of confidence. This new panic in credit which began in October in Germany 23 was to bring on later, in 1 9 3 1 and 1 9 3 2 , the third and monetary phase of the great depression which reached a crisis when England abandoned the gold standard. T h e flight of money from Germany, the decline in the value of Young Loan bonds, and the gallant struggles of D r . Bruening to keep a moderate government functioning in Berlin were followed by the virtual end of reparation payments and there opened a new chapter of dictatorship and nationalism in the political history of the world. 24 America, however, was too concerned with its immediate financial problems to give due weight to these events. The stock market decline, which had continued almost unbroken since April, had brought with it some very disconcerting bankruptcies and, toward the end of the year, a distressing wave of bank failures. There was still no strong effort to institute new lines of policy. For the most part, the government played a negative rôle. A budget deficit of 180 million dollars was admitted and the President's message to Congress called for 1 5 0 million dollars in relief. These figures 22 The National Socialist Party became widely known as Nazis in Germany and later, after 1930, in other countries as well. 28 There was a bad wave of bank failures in the United States at this time. Statistical Abstract of the United States 1931 (Washington, 1 9 3 1 ) , p. 293. 21 In December 1 9 3 0 Dr. Bruening queried various governments as to the possibility of taking official action among creditor nations regarding the increasing resistance in Germany to reparation payments.

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were not insignificant at the time, though they are dwarfed by later expenditures of unprecedented size. T h e r e was no public recognition in the face of these facts of the need for working out a comprehensive government plan to lessen distress among the unemployed. 2 5 T h u s the first year of the depression ended on an exceedingly pessimistic note and little progress can be counted to the credit of either public or private agencies during these twelve months of business recession. T H E FREEZING OF C R E D I T , 1 9 3 I

T h e year 1 9 3 1 , like the one which preceded it, began with a small measure of recovery in both security markets and industry. T o a certain extent this was a typical rebound of sentiment after the unusual gloom at the close of D e cember. In a small degree it was the reflection of small but definite improvements in political and economic relations between European countries. One should note, for instance, the meeting of the Council of the L e a g u e of Nations in Geneva with new efforts at cooperation and adjustment of grievances. France, Germany, and E n g l a n d seemed closer together than at any time since the war. 26 T h e improvement, f r o m whatever cause, however, did not hold under the increasing strains which continued to bear down on sensitive values, and there was a continuation of the earlier rapid decline in March. T h e year was characterized in America by such measures as low money rates and the institution of the National Credit Corporation. T h i s organization tended to stimulate inflationary expansion, 27 although the intention of outright in26 The magnitude of unemployment relief needs was not realized at this time and plans to meet it were not formulated in any comprehensive manner. Failure to meet this problem, either by direct or indirect methods, is evidenced by growing· unrest and also by the increase in the numbers of persons involved. It was estimated in 1934 that one-sixth of the nation's population was on relief; The New York Times (Dec. 3, 1934) ; see also Senate Hearings 6215 ( 7 1 , 7 2 ) , p. 260. "'Premier Briand's friendly visit to Berlin was planned at this time and cooperative trade adjustments were discussed. 27 See T h e National City Bank of New Y o r k , Monthly Bank Letter (November, 1 9 3 1 ) , p. 168.

184

DEPRESSION AND R E C O N S T R U C T I O N

flation was nowhere admitted. In any case, the strong deflationary sweep was still the more conspicuous result of shortsighted policy or lack of policy. In Europe, the dominating influences were those which grew out of the German reparation problem and its political repercussions. One farreaching result of continuous pressure for payment was the freezing of billions of dollars of credit in Central Europe. T h u s once more the important action was all in the financial field, and energetic industrial efforts here and there were not powerful enough to counter the increasing disturbance to money and credit. T h e swift sequence of dramatic events that brought about the third great collapse is sufficiently well known to obviate the necessity of detailed description here. T h e important thing to observe as the events are reviewed is that few if any observers realized the strong drift of the tide towards instability, the progressive nature of the freezing of credits which was certain to undermine an already unsound financial condition in the United States. If the general nature of the influences flowing back from Europe through the intermediaries of prices, commerce, and destructive speculation was realized, then it is clear that their force was underestimated and that the extreme vulnerability of the banking structure was not widely known. 28 T h e announcement on March 22, 1931 of the formation of the Austro-German customs union began the unfolding of a series of events which were to continue to shake the financial and political structures of the world for many years. T h e objections raised by the French, the violent reaction of Austrian opinion, and the growing discouragement in Central Europe, partly induced by threats of restrictions of credit, were followed on M a y 11 by the news regarding the freezing of assets in the Kredit Anstalt. T h e rescue measures put into effect at once by the Bank for International Settlements and the four main central banks halted the dissolution of 28 Bank f o r International Settlements, Second Annual Refort (Basle, May, 1 9 3 2 ) , pp. 1 1 - 1 4 , " T h e International Short-Term Credit Situation and Its Results".

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financial relations but did not stop it. Cooperative action in America eased the situation for a few days as the sharp decline of the Young Loan and pessimistic news from Germanyled President H o o v e r to announce his debt holiday proposal on June 2 1 . This act introduced into a critical situation one of those rare moments of opportunity, one of the turning points which determined the extent and duration of the depression. It is impossible to say what events would have followed another type of action in a complex economic situation, but it is possible to indicate three conditions which would probably have altered later events in a notable way. In the first place, if the suggestion had been made a few weeks earlier, the swift collapse of credit might have been stopped before it swept over all Europe. I n the second place, if the plan had contemplated a longer respite than one year, as some advisors urged at the time, there would have been some hope of reviving the long-term capital markets. In the third place, if France had not interfered with the quick adoption of the proposal by raising unacceptable conditions, it might have inspired confidence in a genuine cooperation for world recovery. As it was, the possibility of the "debt holiday" allowed a brief moment for conference and adjustment. Its announcement stopped the downward sweep of stock values in America and halted the rapid collapse of the German banking system for a f e w days. T h e acceptance of the tentative plan was followed by a meeting in London to adjust details and by a conference in Basle to arrange for the immobilization of private credits in Germany. Unfortunately the disease which attacked the basic sources and instruments of finance had already fastened itself on Europe by J u n e 1 9 3 1 . T h e succession of bank closings and credit difficulties grew quickly worse despite these emergency measures. England, in particular, was already weakened by more than six months of struggle to prevent the outward flow of

186

DEPRESSION AND RECONSTRUCTION

gold—a struggle which first became evident at the end of 1930. T h e financial situation became intolerable by the end of the summer. T h e adverse flow of capital had been pressing on the pound, partly because of the lack of balance between short-time debts and credits, partly because of the fear of inflation to meet the bills of unemployment relief and other causes of budget deficits. Moreover, the withdrawal of gold exchange standard balances from the London money market was fairly pronounced at this time. 29 M a n y were confused as to the true situation because the tide had been stemmed temporarily in August by loans from Paris and New York, and some considered that the drain of funds was over. T h e world was stunned, therefore, when on September 19 word came from London that the gold standard would be abandoned. It seemed as if the economic world had been shaken to its deepest foundations. Rumors of widespread moratoria were followed by a swift succession of monetary changes. T h e suspension of the gold standard in more than a dozen countries30 showed that all Europe was affected by the disaster. There was naturally a difference of opinion as to the effects of this move on economic conditions. Many in England felt a great sense of relief; 3 1 J . M . Keynes was one of those who said it constituted an important step in the direction of recovery. Others, especially those of the central banking tradition and business men interested in international trade, together with all who hoped for a liberalizing of international agreements, considered it a disaster which would hamper economic adjustments for many months. The decline in stock values, prices, production, and foreign commerce continued with unabated force. The most serious byproduct from the point of view of American conditions was " Macmillan Committee, Report, Committee on Finance and Industry, Cmd. 3897 (London, 1 9 3 1 ) , pp. 1 3 9 - 1 4 3 . ao In some cases the suspension was not admitted, but the imposition of rigorous restrictions served a similar purpose. See E . L. Dulles, The Bank for International Settlements at Work (New York, 1 9 3 2 ) , p. 4 3 2 . 31 Wallace McClure, World Prosferity (New York, 1 9 3 3 ) , p. 328.

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the subsequent effect on the American dollar accompanied by the various direct and indirect attacks on the banking situation in this country. The withdrawal of large volumes of foreign funds which had accumulated under the working of the gold exchange standard had greatly embarrassed England. The outflow of similar funds from the United States was to undermine confidence still further there. The knowledge that more liquidation must be expected in domestic and foreign values repressed any healthy tendencies to revival which might have become manifest with the gradual exhaustion of stocks of goods. Not even in the realm of interallied debts and Reparation had there been any constructive efforts. Many creditors on foreign and domestic account admitted privately, and in some cases publicly, that they could not hope to collect as much as fifty cents on the dollar. Despite the realization of their prospect of loss, they were not willing to take the logical and constructive step of relieving the debtor of legal responsibilities and burdens. While affairs were in this uncertain state, the National Credit Corporation in October 1931 gave a temporary stimulus to some undertakings. Renewed hopes for international cooperation focussed on the Hoover-Laval conversations in the same month. But these hopes were dissipated by the later statements to the effect that debt revision was not contemplated and there was no clear sign of recovery by the end of the year. T H E F I N A L P E R I O D OF INACTION,

1932

The following year, 1932, though characterized by more obvious distress and a clearer realization of the depths of the depression, was not marked by any notable step forward. The only evident policy attributable to government leadership was a vigorous attempt to allay fears of currency inflation or depreciation. Unfortunately, this was paralleled by inflationary steps of a number of kinds, and notably by

188

DEPRESSION A N D R E C O N S T R U C T I O N

the loans of the newly instituted Reconstruction Finance Corporation. 32 This organization began operations on February 3rd. It was supplied with 2,000 million dollars' worth of capital and was aimed to prevent or to mitigate further liquidation of business enterprise and to stay the exaggerated decline in values. T h e lending capacity of the Federal Land Banks was increased at about the same time. 33 Meanwhile, the anti-hoarding campaign was carried on to stimulate the more effective flow of money, 34 but this type of effort was a sign of the prevalent tendency to attack symptoms rather than causes. A s a part of the pressure to prevent the disappearance of money from circulation, the attempt to sell "baby bonds" at a low rate of interest was initiated at this time. This issue was not intended to absorb funds already in banks. T h e struggle to improve the banking situation was commanding general attention, but there was no strong administrative drive for comprehensive reforms. Most experts considered that the Glass-Steagall Act, passed on February 27th, 35 only scratched the surface of a large and unmanageable problem. Nevertheless, there was a general and probably false impression at this time that the American banking situation had improved. Despite some change of sentiment for the better, there was no significant rise in either production or employment in the early part of the year. March 1932 was disturbed by one of those dramatic and fortuitous events which often play a disproportionate part in 82 T h e authorizing bill was signed by President Hoover on January 22, 1932. 83 January 13, 1932. 81 T h e number of Federal Reserve notes in circulation between 1928 and 1933 were as follows (see Federal Reserve Bulletin) : 1928 1 , 9 1 1 million dollars cc 1929 1,989 « 1930 1 , 8 3 7 u I93I 2,661 "

244-247, 273 Democratic party, 1 9 1 Depression reserves, 35 n. Depressions (see also Business cycles, Crises, Unemployment), 36-38, 1 0 3 , 167, 1 7 9 - 1 8 3 , 3 1 4

INDEX Derived demand, 73 η. Destruction of wealth, 87 Dewhurst, J. F., 65 Dilution of purchasing power, 285 Diminishing returns, 8 Disasters, 38 Disciplinary agent, 294-296 Discount rate, 308 Discrepancies, 158 Disequilibrium, 22 Division of labor, 9 D o l l a r , 187 Dulles, E . L., 63 n., 165 n., 180 n., 181 n., 186 n. Dulles, J. F., 174 η. D u m p i n g , 15, 69, 73 Durable goods, 71, 246 Durbin, E. F. M . , 149 n., 200 Eastern markets (see China, Russia, Japan) Easy money policy, 169 Ebersole, J. F., 255 η. Economic laws, 7 - 1 1 Economic rules, 258-262 Economic system, weakness of, 33-36 Edie, Lionel D . , 124 n. Efficiency, 234 Einzig, Paul, 62 n. Elasticity, 214, 246, 276-278, 280 Electric refrigeration, 85 n. E l y , R . T . , 103 η. Emergency situation, 3-7 Emerson, Harrington, 1 1 2 η. Employee stock ownership, 170 Encyclopaedia of the Social Sciences, χ ι n. Ends, economic, 12 n. England, 86, 97, 160, 185, 187 Entrepreneur, 1 1 9 Episodes, 53 Equalization of income, 26 Equilibrium theories, 21 Errors, 7, 49, 53, 160-164 Errors in policy, 76-79 Excess, financial, 1 6 9 - 1 7 4 Expansion of production, 88 Explanations of causes, 1 1 , 17-23, 29-33 Exports (see Commerce) F a r m Board, 180, 190 F a r m debts, 123

335

Federal Land Banks, 188 Federal Reserve Board, 172 n., 175 n., 188 n. Federal Reserve notes, 188 n. Federal Reserve System, 4, 68, 120, 160, 164, 172, 175, 261, 276, 281 Fels, Samuel, 115 n. Filene, Ε. Α., 115 η. Financial attack on instability, 252281 Financial causes, 33 Financial excess, 169-174 Fisher, Boyd, 1 1 4 n. Fisher, Irving, 52 n., 54, 56, 166 n., 177, 295 n. Flexibility, 227, 266, 280 Flinn, Richard Α., 126 η. Florence, P. Sargent, 1 1 4 n. Florida land boom, 151 n. F l o w of credit, 289-292 Fluctuations (see Business cycles, Prices, Production, T r e n d s ) , 31, 304 Ford, Henry, 127 Forecasting, 31, 34, n o , 1 1 5 - 1 2 0 Foreign loans, 62 Foreign policy, 58 Foreign trade (see also Commerce), 15 Foster, W . T . , 54 η., 127 Four types of causes, 49-53 France, 86, 97 Freedom (see also Control, Laissez iaire, Planning), 90, 206-213 Freezing of credit (see also Credit), 183-187 French franc, 151 Frictions, 147 Future consumption (see Demand, Weakness of the system), 19 Gantt, Henry L., 1 1 2 n. Gay, Edwin F., 60 η., 63 η. General level of prices, 214 Genoa Conference, 261 Geographic specialization, 275 Germany, 58, 86, 97, 160, 162, 184, 274, 289 n. Gilbreth, F. B., 1 1 2 n. Glass, Carter, 195, 310 η. Glass-Steagel Act, 188 Gold, 258, 272

336

INDEX

Gold bullion standard, 271 Gold clause, 194 Gold Delegation of the Financial Committee, 59 n. Gold exchange standard, 59, 6 1 , 62, 153, 186 Gold reserves, 59, 88, 172 Gold settlement fund, 120 Gold standard, 1 5 1 , 186, 194, 271 Gold standard act, 261 Gold sterilization, 61 Goldenweiser, Ε . Α . , 104 η. Gompertz curve, 238 Government control, 211 Gray, Robert, 20 n. Great Britain, 86, 97, 160, 185, 187 Gregory, Τ . E., 54 η. Gresham's L a w , 269 Haberler, Gottfried, 49, 54 n., 200 Hand-to-mouth buying, 34, 146, 302 Hansen, A . H., 11 n., 30 n., 54, 56 Hardy, C. O., 62 n., 124, 164 n., 175 n., 196 n. Harris Foundation Lectures, 1 9 3 1 , 83 n. Harris, Seymour, 61 n., 104 n., 161 n., 175 n. Harvard Economic Service, 1 1 6 , 167 n. Hatry failure, 50, 176 Hawtrey, R. G., 54 n., 124 n., 175 n., 261 n. Hayek, F. Α . , j 4 n., 127 n., 149, 200 H e a v y industries (see also Durable g o o d s ) , 56, 71, 98, 100 Heller Committee, 133 n. High w a g e theory, 125-129 History, as a clue to depression, n , 23> 47 Hitler, A d o l f , 36 n., 191 Hoarding, 269 Hobson, J. Α . , 127 Hoover, Herbert, 179, 185, 188 n. Hotels, 74 n. Hours of labor, 26, 317 Hours, machine, 2 1 9 Houses, 74 n. Hussey, M i r i a m , 20 n. Ideas, 1 0 3 - 1 1 0 Immigration, 4., 1 1 2 Impatience, 286

Inaction, 187-191 Income (see also Purchasing p o w e r ) , 6 Income distribution, 26 n. Inconsistencies, economic, 39-41, 230 Incubation period, 49 India, 93 Indices (see also Prices, Production, Research), 156 Industrial balance, 198-226 Industrial planning (see P l a n n i n g ) Industrial research (see Production, Research) Industrial welfare, 5 Infant industries, 26 n., 204 Inflation, 21, 82, 143, 168, 192, 260, 305 Inflationary tendency, 122 Instability, 32, 53 Instalment selling, 126, 168 Institutions, economic, 29 Instruments of production research, 249-251 Insull, Samuel, 189 Insurance companies, 70 Insurance, social (see R e l i e f ) Interallied debts, 57-64, 1 5 1 , 1 7 7 , 186, 194 Interest rate, 8 Intermediate credit, 291 n. International relations, 56, 57-64 Interpretation, 7, 230-233 Inventories, 147 Investment, 2, 56 n., 282-312 Investment control, 3 0 7 - 3 1 1 , 319 Investment process, 83 Investment trusts, 50 Isolation, 323 Italy, 289 n. Japan, 93 Japanese earthquake, 97 Joint stock company, 285 Keynes, J. M . , 124 n., 170, Kredit Anstalt, Krueger, Ivar, Kuznets, S. S.,

54 n., 83 n., 121 n., 186, 200, 298 184 189 54 n., 148 n., 154

Labor copartnership, 1 1 4 Labor costs, 109, 125, 152

INDEX Labor supply, 238 Labor turnover, 1 1 2 Lags, 7, 14.5 Laissez faire, 5, 38, 89, 9 1 , 1 9 1 , 205, 2 2 1 , 225 Land boom, 1 5 1 n. Land values, 69 Lausanne agreement, 194. Laval, Pierre, 187 Laws, economic, 7 - 1 1 , 39, 258-262 Layton, Sir Walter T . , 62 η. League of Nations, 1 7 8 , 1 8 1 Lederer, Emil, 92 n. Legal tender, 269 Length of life of equipment (see also Durable goods), 72 Leontief, Wassily, 69 n. Lessons learned, 3 1 3 - 3 3 1 Leverhulme, Lord, 1 1 4 n. Liberty bonds, 1 7 1 n. Link, Henry C., 1 1 4 n. Liquidation, 84, 187 Liquidity, 294 London Agreement, 62 Loss of man-power, 87 Loveday, Alfred, 54 Macmillan Committee, 186 n. Managed currency, 259, 260 Margins, 240 Markets, 4, 42, 58, 68, 103 Marshall, Alfred, 73 n., 75 n., 241 Martin, P. W., 1 2 7 n. Marxian doctrine, 104 Maryland banks, 1 9 1 Massachusetts Utilities Commission decision, 50 Maturity, 4 McClure, Wallace, 186 n. Mechanization, 4, 2 1 , 88 Mellon, Andrew, 1 7 5 Metcalf, H. C., 1 1 4 n. Michigan, 189, 1 9 1 Mill, J . S., 108 Mills, F . C., 54, 71 n., 74, 89 n., !33> 1 34> 143) *44 η·> i54> 239 n., 300 n. Minimum wage, 35 n. Mistakes in policy, 160 Mitchell, Charles E., 1 7 5 Mitchell, W. C., l i n., 30 n., 54 n., 235 n. Mobility, 5

337

Monetary uses of credit, 265-268 Money (see also Credit, Federal Reserve System, G o l d ) , 252-254 Money panics, 1 2 4 Money problem, 252-281 Moratoria (see Banking crisis) Mortgages, 70 Motives, 46 Motor vehicles (see Automobiles) National banking system, 256 National City Bank Letter, 164 n., 183 n., 284 n. National Credit Corporation, 187, 190 National Economic Council, 104 n. National income (see also Income), 6 n., 89 National Industrial Conference Board, 1 1 3 ) 1 5 2 η·> !95 n· National Recovery Administration (see N R A ) National Socialist Party, 1 8 2 n. Nationalism, 93 Nazis, 182 Necessities, 202 Necessity of research, 227-230 New aims, 87 n. New Deal, 72 " N e w era," 56, 67, 1 0 3 - 1 3 4 New industries (see Infant industries) New stage of development, 4 New York Public Library, 1 1 n. Normal, 23-29, 35, 1 3 7 , 1 4 1 , 262 Normal rates of change, 1 3 6 - 1 3 9 Norms, 76, 1 5 7 - 1 5 9 N R A , 192, 2 1 9 Obsolescence, 22, 1 3 7 , 301 Occupations, 241 Ohlin, Bertil, 54 Oil, 61 "Old era," 1 2 9 - 1 3 2 Open market operations, 276, 308 Opportunity cost, 8 Opportunity, time of, 1 5 0 - 1 5 4 Optimism, 68, 105 Oscillations, 34 "Other people's money," 287 "Outside" events, 37 "Outside" influences, 44, 49

33»

INDEX

Overhead costs (see also Capitalization, 73, 75 n., 304. n. Overproduction, 20 Palgrave's Dictionary of Political Economy, 276 n. Panic (see also Crises, Deflation), 174-179 Paper money, 269 Paris Peace Conference, 94. Paris Ultimatum, 62 Pasvolsky, Leo, 62 n., 196 n. Patterson, E. M., 60 n. Peak (see also Prosperity), 49 Pegging·, 164, 230, 272 Penumbra, 40 Periodic swings, 31, 324 Permanent weakness of the system, 33-36 Person, H. S., 112 n. Personnel movement, 110, 112-115 Persons, W. M., 11 n., 54 n. Physical income, 134 Physical production (see Production) Physiocrats, 114. Pigou, A. C., 24 n., 27 n. Planning, 2, 221, 225, 260, 283 Policy, 6, 53-55 Policy causes, 33, 39-41, 45, 49"53> 67-69, 76-79 Political choice, 12 Political problems, 46 Population, 4, 87 η. Pound sterling, 182, 186, 267, 309 Poverty, 26, 105 Practical man, 11-16, 39 Precipitating causes, 33, 36-38, 50, 160 Presidential campaign, 189, 190 Price control, 120-125 Price fixing, 89, 214 Price fluctuations (see also Crises, Deflation, Fluctuations), 20 Price index, 271 n. Price level, 24 Price stability, 147, 169 Price stabilization, 104 Prices, 86, 95, 101, 200, 244-247 Prices as guides, 213-217, 292-294 Pricing system, 319 "Primary depressions," 84 Problem of defining causes, 17-48

Problem of formulating economic laws, 7-11 Procrastination, 323 Producers' goods, 71 n., 218 Production, 26, 106, 140-142, 203206, 235, 300 Production, adjustment to, 203-206 Production indices, 232 Production regulation (see also Control, Laissez faire, Planning) , 2 1 7 221 Production research, 227-251 Production trend, 138 Productivity theory of wages, 234 Profits, 8, 274 Programs, 23 Progress, 36, 132-134, 205, 228 Prosperity, 23, 28, 104 Psychological changes, 43 Psychological study, 113 Public finance (see Budget) Public utilities, 224 Public works, 74 n. Public Works Administration (see PWA) Purchasing power, 104, 125, 127, 256, 275, 293 Purchasing Power Doctrine (see Purchasing power, Inflation) Purpose of the study, 1-3 PWA, 196 Pyramiding credit, 299 Quantitative standards, 157-159 Quantity theory, 266, 279 Quasi-rents (see Marshall) Questions, formulation of, 9, 239-244. Radios, 85 n., 126 Railroads, 70, 89, 90 Random causes, 33, 36 Rate of expansion, 235 Rates of change, 26, 136-139, 144 Rates of growth, 108 n., 239 Ratio between necessities and luxuries, 100 Raw materials, 238 Readjustment, 87-91 Real estate overexpansion, h i Real estate speculation, 126 Real wealth, 6 Reconstruction, 17, 80, 85-87, 96, 198, 320

INDEX Reconstruction Finance Corporation, 188, 190 Recovery, 42, +3, 3 1 3 , 3 1 5 Rediscounting, 276 Rediscount rate, 50, 164 Redistribution of wealth, 2 1 9 Reed, H. L., 1 2 4 n. Reform, 1 1 , 46 Regimentation (see also Control, Planning), 206, 2 1 3 Regulation (see Control, Planning) Relief, 287 n., 325-327 Relief needs, 183 n. Rent, 8 Rent differentials, 241 Reparation, 62, 94, 1 5 3 , 1 6 2 , 187 Research, 2, 1 1 8 , 2 2 7 - 2 5 1 , 3 1 9 Resources, 7 Restrictions, 91 Resumption of specie payments, 261 Revolution, 1 3 , 37 Rhythmic forces, 282 Ricardo, 1 2 Riefler, W. W., 1 2 4 n. Rigidity, 1 7 n., 89, 90 n. Rist, Charles, 54 n. Robbins, Lionel, 1 2 n., 54 n. Robertson, D. H., 54 n., 1 2 7 n. Roosevelt, Franklin D., 72 Rules of finance, 253 Russia, 93, 96, 1 7 3 , 224, 289 n., 305 n. Salesmanship, 41 Salter, Sir Arthur, 54, 62 n., 88 n. Savings, 2 i , 222, 2 5 3 , 284, 286-289 Schneider, Franz, 1 7 5 n. Schneider, Margaret G., 66 n. Schumpeter, Joseph, 31 n., 54 Scientific management, 1 1 0 Scott, W. D., 1 1 4 n. "Secondary depressions," 84 Security, 4, 222 Security markets, 56 Security panic, 1 7 4 - 1 7 9 Semi-durable luxury goods, 74 Shirley, William W., 1 1 n. Short-term credit, 184 n. Six-hour day, 1 1 4 Smoot-Hawley tariff, 5 1 , 63, 1 8 1 Snyder, Carl, 54 n. Socialism (see also Control, Laissez faire, Planning), 287 Social theories, 1 2

339

Sources, 1 1 - 1 6 South America, 93 Special Advisory Committee, 62 n. Specialization, 34 Specific causes, 49-79 Speculation, 19, 64-67, 77, 1 5 3 , 168 Spending, 286-289 Stability, 4, 1 7 , 77, 278-279 Stabilization Committee, 1 2 1 n. Stabilization of price, 25, 278 Stabilizing influence, 279-281 Stabilizing production (see Control, Planning), 254-258 Stabilizing value, 281 Stage of development, 238 Standard of comfort, 4 Standard of living, 96, 1 0 5 , 126, 1 4 5 , 167 Statistical Abstracts, 1 5 1 n., 1 7 2 n., 182 n. Statistical measurement, n o Steps forward, 3 1 9 - 3 2 2 Sterilization of gold, 1 2 1 n. Stewart, Walter, 1 2 1 Stock market, 1 6 1 Stock market boom, 85 n. Strain (see Stress) Strategic factors, 19 Stress, 49, 55-57 Strikes, 96 Strong, Benjamin, 1 2 1 Surplus, 89, 1 9 1 n. Survival of the fittest, 234 Swope, Gerard, 1 1 5 n. T a r i f f , 58, 77, 1 7 3 Task ahead, 1 - 1 6 Taussig, F . W., 40, 63 n., 3 3 1 n. Taxation, 35 n., 41 T a y l o r , F. W., 1 1 2 η . Tead, Ordway, 1 1 2 n., 1 1 4 n. Technique, 7 Technocracy, 1 3 , 128 Technological unemployment, 19 Technology, 92 n. Theory of cause, 19 Theory of depression, 1 1 , 23 Thompson, J . Walter, 126 n. Thornthwaite, C. W., 1 3 3 n., 147 n. Three depressions, 3 T h r i f t , 129 Time series, 148 n. Timing of depression, 36-38

340

INDEX

Trade associations, 207 Trend, 2, 1 3 , 102, 1 3 8 , 156, 1 7 2 , 3 1 8 , 320 T r i a l and error, 2 Trough (see also Depressions), 49 Tucker, R . S., 290 n. Turning point, 1 3 5 - 1 5 9 Twentieth Century Fund Report, 66 n., 255 n. Uncertainty, 44 Uncontrollable forces, 1 7 Unemployment, 1 3 , 23, 27 United States Steel Corporation, 5 1 , 181 Unit of account, 2, 253, 3 1 2 Unmanageable conditions, 299-301 Utilities, construction, 74 n. Utopias, 22, 108 Value control, 2 Value of money, 272 VanZeeland, Paul, 54 n., 58 n., 62 n. Variable proportions, 8 Vested interests, 9 Volume of output, 2 Wage agreements, 41 Wage earners' incomes, 100

Wage policy, 128 Wage rates (see also High wage theo r y ) , 2 1 , 68, 78, 104, 1 2 5 - 1 2 9 , 152 Wages, 92, 95, 287 Wages fund doctrine, 126 Wall Street, 1 7 0 Wallace, Henry Α., 2o8 n. War, 19, 36, 37, 50 War changes, 4 War finance, 80-85 W a r heritage, 80-102 W a r loans (see Interallied debts), 59 War losses, 87 Warburg, P. M., 1 2 4 n. Waste, 1 1 2 Watson, Thomas, 1 1 5 η . Weakness of the economic system, 3336 Wealth (see also Income), 83, 92 Welfare, 1 1 4 Wheat, 6 1 , 1 7 1 Winslow, Emma Α., 1 2 6 η. Young, Α. Α., 6ο η., 329 η · Young Loan, 62, 180 η., ι 8 ι , Ι85

Young Plan, 177

182,