Booms and Depressions

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BOOMS AND DEPRESSIONS


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Booms and DepressionsSome First Principles

ByIRVING FISHER, LL.D.Professoro fE c o n o m i c s, Yale University

NEW YORK *ADELPHI COM PANY PUBLISHERS


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COPYRIGHT, 1 9 3 2 BY ADELP HI COMPANY

P R I N T E D I N T H E U N I T E D S T A T E S O F A M E R I C AB Y T H E V A I L - B A L L O U P R E S S , I N C . , B I N G-H A l l T O N , N . Y .


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T oW E S L E Y C LA IR M I T C H E L L

T H E W O R L D 'S A C K N O W L E D G E D L E A D E RI N T H E S T U D Y O F T H E S U B J E C T O F T H I S B OO K


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"Money, as a physical medium of exchange, made adiversified civilization possible, . . . And yet it is money,in its mechanical more than in its spiritual effects, whichmay well, having brought us to the present level, actuallydestroy society."SIR J O SIA H STA MP

(From Foreword to the English edition of The MoneyIllusionby Irving Fisher)


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P R E F A C EThis book grew out of an invitation to speak on the Depression of 1929-32 before the American Association for

the Advancement of Science and is an elaboration of myaddress at the meeting of the Association, held at NewOrleans, Jan. 1, 1932.The vast field of "business cycles" is one on which Ihad scarcely ever entered before, and I had never attempted to analyze it as a whole.The scope of the present work is restricted, for the mostpart, to the role of nine main factors, not because theycover the whole subject, but because they include whatseem to me to be the outstanding influences in the present,as well as in most, if not all, other major depressions.By this restriction it has been possible to make the bookmuch shorter and, I hope, much more intelligible to thelay reader than if it set out to be an exhaustive treatise onan inexhaustible subject.At any rate, the nine factors are so inherently and obviously related to each other that we are not compelled toresort entirely to empirical correlation. Empirical studiesare im portant and essential in this field5 but, by excludingthose which appa rently have no rational basis, it is possibleto mark out a clear cut set of "first principles*"The results of the analysis here presented seem largelynew. But, being so unfamiliar with the immense literature,

I decided to submit the first draft of this book in mimeographed form to a number of authorities, several of whomvii


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viii PREFACEhad given much of their lives to the study of the so-calledbusiness cycle. With few exceptions these have found inthe theory much that they regard as both new and true.Yet, as I could not, without years of searching, be surehow far any or all of what to m e seems new m ay have beenanticipated by previous writers, I leave to others to determine how far this book is the original contribution whichit is intended to be.As will be seen, the main conclusion of this book is thatdepressions are, for the most part, preventable and thattheir prevention requires a definite policy in which theFederal Reserve System must play an important role. Thisproblem is of even greater importance than the problems ofour old national banking system which led, after twogenerations of delay, first to the Aldrich Report and thento the establishment of the Federal Reserve System.In my opinion, no time should, in this case, be lost ingrappling with the practical measures necessary, includinginternational cooperation, to free the world from suchneedless suffering as it has endured since 1929.If this very practical task is not soon undertaken inearnest, nor brought to a successful conclusion before another such disaster overwhelmes the world, we may expectthat a great body of informed public opinion will then holdspecific individuals responsible. In short, ignorance cannotmuch longer serve as an excuse for neglecting this greatestof all practical economic problems.But, having myself only recently acquired such knowledge as I possess on the subject, I have felt constrained, inthis book, studiously to avoid casting blame on those who,here and abroad, might, had they done the right things,have prevented the depression.I am indebted to several of my own students for helpful criticisms, LesterV.Chandler, J. E dw ard E ly, Florence


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PREFACE IXHelm, Harold D. Koontz, J. N. Lindenberg, Taulman A.Miller, Jr., and Hildreth Winton.I also wish to thank the many economists and others whohave kindly read and commented, in a general way, onthe first draft, including, James W. Angell, Leonard P.Ayres, J. M. Clark, Victor S. Clark, John R. Commons,John H . Cover, Alfred Cowles, I I I , W . L. Crum, H . C.Cutting, Davis R. Dewey, Charles E. Duryea, Lionel D.Edie, Henry W. Farnam, Warren F. Hickernell, JacobH . H olla nd er, W . I . King, R. R. Kuczynski, W illiam C.Lee, Edmund E. Lincoln, H. L. McCracken, Ernest M.Patterson, Nicholas Raffalovich, Malcolm C. Rorty,E. R. A. Seligman, Carl Snyder, G. F. Warren, FrederickV. Waugh, E. B. Wilson, Ivan Wright, Quincy Wright,and Edg ar H . Yolland.I wish especially to thank the following who, evidentlyat personal sacrifice, gave considerable time and thought tostudying, in a detailed and intensive way, part or all of themanuscript,Harry G. Brown, J. D. Canning, C O.Hardy, Harold L. Reed, N. J. Silberling, and CharlesTippetts.Finally, I wish to thank my associate, Royal Meeker,who has assembled most of the factual material as well asscrutinized the entire manuscript and helped in rewritingit, and m y brother, H erbert W . Fisher, who at every stagehas helped in the exposition, from a layman's point ofview, in the endeavor to make an obscure subject clear.With his help I have tried to write the book in such language that "he who runs may read."

IRVING FISHERNew Haven, Conn.July, 1932


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C O N T E N T SP A R T I T H E O R E T I C A L

C H A P T E R * A G 2I IN T R O D U C T IO N 3

W h at is a Depression? 3T h e Recent Picture 3T h e M ystery of a Depression 5I I F IR ST T H R E E O F N I N E M A IN FACTORS . . . 8

Over-Indebtedness 8(The First Main Factor)Criteria of Over-Indebtedness 10T h e Deb t Cycle 11Nine M ain Factors 12Distress Selling 13Volume of Currency 14(The Second Main Factor)T h e Price Level 17(The Third Main Factor)"R ea l" Debts 17T h e M oney Illusion 18Gold and Credit 21T he Index Number 22T h e Vicious Spiral Downw ard . . . . 25T w o Paradoxes 25T h e M ain Secret 26Summary 26T h e D ollar Disease is Needless . . . . 27

III R E M A I N I N G S IX M A I N F AC TO R S 2 9Net W orth 29(The Fourth Main Factor)xi


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xii C O N T E N T SC HA P T E R * A G EProfi ts 29( T h e F i f t h M a i n F a c t o r )

P ro d u c t io n , T r a d e , E m p lo y m e n t . . . . 3 0( T h e S i x t h M a i n F a c t o r )Op t imism and Pessimism 3 2( T h e S e v e n t h M a i n F a c t o r )T h e Velocity of Circula t ion 3 4( T h e E i g h t h M a i n F a c t o r )H oa rd in g, a Slo w ing of Velocity . . . . 3 5T h e T w o P a r a d ox e s A g a i n A p p l i e d t oHo ard in g 3 6Poss ib le Consequences of Contract ion andHo ard in g 3 7R ate of In te re s t 38( T h e N i n t h M a i n F a c t o r )" R e a l " R a tes vs. M on e y R a te s . . . . 3 8Defla t ion , the R oot of A lm ost A l l the Ev i ls . 3 9Ch ron olog y of the N ine Fa cto rs . . . 3 9T h e T r o u g h of D e pre ssio n . . . . . 4 1T h e B o o m Ph ase Ag a in 4 2A Vicious Spira l U p w a rd 4 3

I V S T A R T E R S 4 4Un p ro d u c t i v e Deb t s 4 4Produc t ive De b ts 45Some His tor ical I l lus t ra t ions 4 6T h e Shady Side 47M on eta ry In fla tion Alo ne 4 8C o m b in ed S ta r te rs . . . . . . . 4 9V " T H E " B U S IN E S S C Y C L E ? 5 1

T h e D e v e lo p m e n t of t h e C y cle I d e a . . . 5 1" F o r ce d " C y c le s 5 2" F r e e " C ycles . . . . . . . . . 5 3A ny Un balan ce ma y cause Cyc l ica l Te nd enc ies 5 4B u t T h e s e t en d t o die D o w n 5 5" T h e " Business C yc le a M y th ? . . . . 5 5Cycles as Fac t s o r Te nd enc ies 58


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C O N T E N T S xiiiC HA P T E R P A GE

V I O T H E R T H E O R I E S 6 0M a n y T he or ie s M u tu al ly C onsisten t . . . 6 0Pr ice-Dis loca t ion T he or y 61Ineq ua li ty -o f-F ores igh t T h e o ry . . . . 6 2C h an g es - i n - In co m e Th eo ry 6 2F lu c tu a ti on s- in -D i sc o un t T h e o r y . . . 6 2V aria tions-o f-C ash-B alance T h e o r y . . . 6 3Ov er -C o n f id en ce Th eo r y 6 3O v e r - I n v e s t m e n t T h e o r y 6 3O v e r - S a v i n g T h e o r y 6 4O v e r - S p e n d i n g T h e o r y 6 4Dis crep anc y- between - Savings - and - I nv es t m en tT h e o r y 6 4Ov e r -C ap ac i t y T h e o ry 6 5U n d e r - C o n s u m p t i o n T h e o r y 6 5O v e r - P r o d u c t i o n T h e o r y 6 5Conclusion 66

P A R T I I F A C T U A LV I I T H E O V E R - I N D E B T E D N E S S T H A T L E D T O T H E

W O R L D D E P R E S S I O N 7 1T h e W a r a n d t he N e w E r a 7 1Inv es t in g in Equi t ies on Bo rrow ed M on ey . 72M iscellaneous Influences 73T h e S te ad y C o m m o d it y P r ic e L e v e l . . - 7 4Inve s t ing Ab road 75Misce llaneous Bo rrow ing M ove m ents . . 77Repara t ions 77In t e r -G o v e rn m en ta l Deb t s Pay ab le t o Am er ica 7 8In te rn a t iona l Pr iva te Deb ts 79Pub l ic Deb ts in the U n i te d S ta tes . . . . 7 9Pr iva te De b ts in Am er ica 80Bro kers ' Lo ans 81T ot a l s in 192 9 81G old and the De b ts 82


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xiv C O N T E N T SC H A P T E R * A G EV I I I T H E W O R L D D E PR ES SIO N O F 192 9-32 . 85

In General 85T h e Am erican Stock M arke t 86T h e Panic 9 Preliminaries in the Com modity M ark et . 91T h e Commodity M arket 92T h e Currency 96T ra d e and Profits 97Upturns 98International Accelerators of the Vicious Spi

ra l1931 100Balancing the Bud get 104Summary as to the Nine M ain Factors . . 1 0 6T h e Real D ollar , . . 1 0 7

P A R T I I I R E M E D I A LIX PALLIAT IVES VS. RE M ED IES 113

W h en Form is Substance 11 3First Aid 114Reducing Cost . r 116Retarding the Debt Disease . . . . . 1 1 6Replacing Inflexible Bonds 117O th er Measures of Debt Flexibility . . 1 1 8D eb t Scaling 118T h e International Debts in 1932 . . . . 1 1 9X R EM ED I ES 1 21

Cred it Con trol 121T h e M andate to T re a t the Do llar Disease . 121T h e Equation of Exchan ge 122T h e Quanti ty Th eory 123Adjusting Credit to Business 12 4Reflating and Stabilizing the Price Level . . 1 2 5Regulation Th roug h the Rediscount Rate . . 1 2 6T h e Federal Reserve System 127


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C O N T E N T S xvPAGERegulation Through "Open Market Operations" 128

W ha t is T rad ed in Open Ma rket Operations . 129Autom atic Regulation of Reserves . . . 131Adjustments to Facilitate Open Market Operations 131Conflicts of Function 133A Unified Banking System 133Stabilization Properly a Governm ent Function 134A Bond Secured Deposit Currency . . . 135Gold Control 136T h e Surplus Reservoir Plan 137T h e Lehfeldt Plan 138T h e "Compensated Do llar" Plan . . . . 1 3 8Velocity Contro l 140Confidence in Banks 141Stimulating Borrowers and Buyers . . . 1 4 2T H E W O R L D M O V E M E N T F OR S TA BL E M O N E Y 143

No t Altogether New 143T h e Present W orld M ovement . . . . 145T h e Am erican Legislative M ovem ent . . . 147T h e Federal Reserve Efforts 148T h e Goldsborough Bill of 1932 . . . . 1 4 9Opposition to the Goldsborough Bill . . . 1 5 0"W hat 's in a N am e? " 151O u r Do llar's Bad Record 152W a r , a De-stabilizer 155Can W e Keep Capitalism? 156


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A P P E N D I C E STo Part I {Theore t ical)

Append ix IAp pr ox ima te Chr on olog y o f the Nin e Fac tor s . . 16 1Ap p en d ix I ISor t s o f Data Av ai lab le on the Nin e Fac tor s . 1 6 4

To P art I I {Factual)A p p e n d i x I I I

Stat is t ics of Debts leading to Degress ion of 192932 168In te rna t io na l Pr iva te Deb ts 168Publ ic D ebts 168A m e r i c a n F a r m M o r t g a g e s 1 7 1M o r tg a g es O th e r t h an Fa rm M o r tg ag es . . 1 7 3Co rpo rate L o n g an d Short De bts . . . . 174Ba nk Lo ans and Discoun ts 176Bro kers ' Lo ans 181T o t a l De b t s 1 8 3

Ap p en d ix IVGold Bas e {an d Gold Shor tag e ) 186Append ix VDegress ion of 192932 189

Sta ti st ics of Cu rren cy Volume and Veloc ity . 1 8 9(F ac to r s 2 and 8 )

Statistics of Pric e L eve ls 19 0( F a c t o r 3 )Stat is tics of N e t W o rt h s and Fai lures . . 19 3( F a c t o r 4 ) xvii


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xvi i i APPENDICESStatistics of Profits and Incomes 198(Factor 5)Statistics of Production, T ra d e and Em ploym ent . 205

(Factor 6)Statistics of Inte rest Ra tes 211(Factor 9)

To Pa r t I I I (Remedial)Appendix VIOutline of a Complete StabiVvzationProgram . . 2 1 2

Commission on Stabilization 21 2Cooperation of Federal Reserve System . . . 2 1 3Comments 216Some Technical Details 22 1Comments 222Fed eral Reserve 222

Appendix VIIOther Plans for Reflation and Stabilization . . , 2 2 5M aking General Use of Acceptances . . . 2 2 5

Subsidies to Producers 22 5Subsidies to Retailers 225Loans to Retailers ' Customers . . . . 2 2 6T h e Stamped M oney Plan 226T he Gold Tru ce Plan 230Miscellaneous 232O n Silver and Gold 23 3Shall W e keep the Gold Standard? . . . . 2 3 5Summary 240M r. Hoover's Relief Prog ram 241

Appendix VIIISelected Bibliography 244Index 253


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LIST OF TABLES1 Corporation N et Profits of 50 0 Corporations . . 972 Estimated To tal Debts in the United States . 1 0 93 Private Am erican Lo ng T e rm Investments Abroad 1684 Combined Federal State and Local Debts . . . 1 7 05 Public Debts of Britain 1716 Farm Mortgages . . 1 7 27 Corporate Domestic Security Issues, 19 19 -3 1 * - 1 7 58 Corporate Domestic Security Issues, Ja n . and Feb .193132 1769 Loans, Investments and T ot al Deposits, A ll Banks in

the U . S 17910 Loans and Deposits of All M ember Banks . . . 1 8 011 T ota l Reported Security Loans . . . . . . 1 8 312 Gold Holdings of Ce ntral Banks and Governm ents 18813 Indexes of Velocity of Bank Deposits . . * . 1 9 214 Percentages of Com mercial Failures to the T o ta l

Num ber of Business Concerns in the U . S. . . 19615 Bank Suspensions Number of Banks . . . . 1 9 616 Bank SuspensionsDeposits 19717 Estimated Realized Income and Purchasing Pow erin 19 13 Dollars of the People of Continental U . S. 20018 Ind ex Num bers of Farm Prices Received by Com modities, and Retail Prices Paid by Fa rm ers . . 20 319 Farm er s' Gross Incom es, Expenditures, and Balance

Available for Capital, Labor and M anagem ent . 20 420 Indexes of Production, Em ploymen t and Payroll . 21 0xix


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LIST OF CHARTS1 Com parison of Commodity and Stock Price Indexes(19 13 -F eb . 1932) 882 Ind ex of Industrial Comm on Stock Prices ( 1 8 7 2 -Feb. 1932 ) 893 Ind ex of Velocity of Bank Deposits (1 9 1 9 -F eb .

*932) 944 Loans and Deposits of All M ember Banks ( 1 9 1 5 -J 930 955 Some Business Indexes (1 9 1 9 -J a n . 193 2) 996 W holesale Commodity Price Index (1 8 6 0 -1 9 3 1 ) - *537 Dom estic Corporate Issues (1 9 1 9- Ju n e 19 31 ) . 1778 Security Loans (192 8-S ept. 1931 ) . . . . 1 8 29 To tal Money in Circulation (1 9 1 4- Ja n . 1932 ) . 191

10 Stock Price Indexes (1 9 1 3 -1 9 31 ) 19411 Comm odity Price Indexes (1 91 3- 19 31 ) - * 19512 Intere st Rates on Different Types of Loans ( 1 9 1 3 -

Feb. 1932) 20813 Bond Price Indexes (1 92 6- F eb . 193 2) . . . 20914 A "W a ra " (Stamped Money) Note . . . . 2 3 1

y i r i


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PART ONETHEORETICAL

C H A P T E RI . I N T R O D U C T I O N

I I . F I R S T T H R E E O F N I N E M A I N F AC TO RSI I I . R E M A I N I N G S I X M A I N F AC T OR SIV. STARTERSV . " T H E " B U SI NE SS C Y C L E ?

V I. O T H E R T H E O R I E S


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CHAPTER II N T R O D U C T I O N

W HA T IS A DEPRESSION?A DEPRESSION is a condition in which business becomes unprofi table. I t might well be called The Private Profi tsdisease. Its worst consequences are business failures andwide-spread unemployment. But almost no one escapes adegree of impoverishment. Some of the mightiest and bestm an age d enterprises, such as rai lroads, are .among theworst sufferers. If they do not break, it is often only because they are saved by their reserves. Many rich stockho lde rs, too, are com pelled to l ive on reserves j w hile manypersons who had l ived modestly are compelled to l ivefrom ha nd to mo uth 5 and m any w ho already l ived fromhand to mouth become jobless and live on charity, or die,or become thieves. In a word, a depression is a form ofalmost universal poverty, relat ive or absolute. And thoughthis poverty is transient for society as a whole, it is, forcountless individuals, t ragically permanent.

T H E R E C E N T P I C T U R EA great orator of New England has put i t thus:"A few months ago, the unparalleled prosperity of our coun

try was the theme of universal gratulation. Such a development of resources, so rapid an augmentation of individual andpublic wealth, so great a manifestation of the spirit of enterprise,3


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B O O M S A N D D E P R E S S I O N Sso strong and seemingly rational a confidence in the prospect ofunlimited success, were never known before. But how suddenlyhas all this prosperity been arrested T h a t confidence, which inmodern times, and especially in our own country , is the basis ofcommercial intercourse, is failing in every quarter; and all thefinancial interests of the country seem to be convulsed and disorganized. The merchant, whose business is spread out over awide extent of territory, and who, regarding all his transactionsas conducted on safe principles, feared no embarrassment, findshis paper evidences of debt, and acceptances and promises whichhe has received in exchange for his goods, losing their value;and his ability to meet his engagements is at an end . . . andloss succeeds to loss, till he shuts up his manufactory and dismisses his laborers. The speculator who dreamed himself rich,finds his fancied riches disappearing like an exhalation.

* * *"Already, in many a huge fabric that but a few days sinceresounded with the roar of enginery, all is silent as in a de

serted city. Already many a great work of public improvement,upon which multitudes were toiling to bring it to the speediestcompletion, that commerce might rush upon its iron track withwings of fire, is brokenoff, and stands unfinished, like the workof some great conqueror struck down amidst his victories. Already want, like an armed man, stands at the threshold of manya dwelling, where a few days ago, daily industry brought thesupply of daily comforts.* * *

W h a t more may be before us in the progress of G od's ju dg mentswhat tumultswhat convulsionswhat bloody revolutionswe need not now imagine. It is enough to know thatthis distress is hourly becoming wider and more intense; andthat no political or financial foresight can as yet discover theend.* * *


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I N T R O D U C T I O N 5"Amid these present calamities, and these portentous omensof the future, it is not strange that many minds are seeking, andall voices are debating, the cause and the remedy."A truer picture of 1932 could scarcely be found. Yetthis speech was delivered 95 years earlier, on the 21st ofM ay , 1837, by the Reve rend Le on ard Bacon, f rom thepulpi t of Center Church in New Haven, Connect icut

T H E M Y S T E R Y O F A D E P R E S S IO NSimilar ut terances have been made during other depressions, especially those of 1857 , 187 3, and 18 93 . A ndyet, despite all these duplications of experience and despite the enormous mass of literature on depressions whichthey have brought forth, a banker in 1931 could say:"T h is depression is beyond m e ."A depression seems, indeed, to fal l upon mankind outof a clear sky. It scorns to choose a moment when theearth is impoverished. For, in times of depression, is thesoil less fertile? Not at all. Does it lack rain? Not at all.Are the mines exhausted? No; they can perhaps pour outeven more than the old volume of ore, i f anyone will buy.Are the factories, then, lamed in some waydown atheel? No; machinery and invention may be at the verypeak. But perhaps the men have suddenly become unableor unwill ing to work. The idea is belied by the spectacleof hordes of workmen, besieging every available employment office.Perhaps, then, the world has become over-populated.Bu t how could that happ en in so shor t a t ime? W h e n thecalamity starts there seems to be (at least in America)

enough of every good thing to go around; everybody


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6 BOOMS AND DEPRESSIONSwants it, and nearly everybody wants it enough to workfor it j yet some cannot get it, and many who can ge t someof it must be content with less.There are those who ascribe this individual impoverishment to the very fact of collective wealthnot overpopulation, but "over-production"too much food and toomuch of all else.Later in these pages there will be more about this. It isenough here to note that those who, at the beginning of adepression, cry "over-production" and expect recovery assoon as over-production ceases usually become disillusionedwhen later almost universal poverty appears. If, in 1932,anyone thought there was still over-production, he shouldfollow his own argument all the way through as follows:"How do I know there is over-production of goods? Because more goods are for sale than the public will buy.And why, then, will the public not buy? Because theyhaven't the money. Why haven't they the money? Becausethey are not earning it. Why aren't they earning it? Because they are not producing: men and machines are idle "But if non-production is the trouble, why call it overproduction?Perhaps the secret, then , is to be found in the machineryof distribution. Between the producer and the consumerthere must be a chasm in need of a bridg e. But no 5 at thisvery moment, the Hudson River has a brand new bridge.There are plenty of physical bridges, and the railroadsthat cross them are in good condition. As for ships and ship-canals, they are as well equipped as ever, and as eager toserveonly the shippers are few.There is, however, another distributive mechanismwhose name is money. There is no more reason why thismoney-mechanism should be proof against getting out of


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I N T R O D U C T I O N 7order than a railroad or a ship-canal. Moreover, profitsare measured in money. If money, by any chance, shouldbecome deranged, is it not at least possible that it wouldaffect all frofits>in one wayyat one time?


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FIRST TH REE FACTORS 9much of his income it is well to apportion to clothes andhow much to food. As in other economic adjustments, so inthe adjustment of debts, the individual stops "at themargin" where, in his judgment, the desirability of afurther expansion of his debts is balanced by the undesira-bility of further sacrifices and risks. In each case, the pointof equilibrium is where opposed considerations balance.Where do they balance?Chance is inseparable from life. Every transaction is ataking of chances, and over-indebtedness is whatever degree of indebtedness multiplies unduly the chances of becoming insolvent. Everyone who is not a gambler, provides himself with a margin of safety. He puts a bufferbetween his debts and the collector. This buffer is thedifference between assets and liabilities. Corporations call it"capital and surplus." But the sufficiency of the buffer isnot solely a matter of quantity. It must be varied accordingto the quality of the assets. It must also be varied accordingto the quality of the liabilities. Slow assets and quick liabilities (such as call loans) require a larger buffer thanquick assets and slow liabilities. The quickest asset, andtherefore the safest when pressure comes, is cash. Thequickest liability, and therefore the most unsafe in timesof pressure, is the call-loan. Over-indebtedness is largely aquestion of dates of maturity. The entire set-up of assetsand liabilities, therefore, has to be considered,and notonly the ratio between the two sides of the capital account,and between current assets and current liabilities, but theratio between the two sides of the income account; theratio between the income and the assets, between the income and the debts, between the income and the balancingitem of capital and surplus. A balance sheet is the result ofanxious efforts to weigh correctly these and many other considerations.


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BOOMS AND DEPRESSIONSCRITERIA OF OVER-INDEBTEDNESS

Banks, in extending credit to different sorts of borrowers,have to consider questions of liquidity and of safe marginson collateral. Credit men, accountants, lenders on realestate, brokers, governments and legislators, all have somesort of standards of over-indebtedness. The standards aresomewhat rough. The line of balance is more or less atwilight zone; but an entire book could be written aboutthe history and the current practice of stopping the debtsat a point which is neither too rash nor too conservative.Can a more definite criterion be devised for the community than the individual? In any event, such guides willhave to be considered as the ratio between the nation'sincome and certain fixed expenses, like taxes, rent, andinterest; the ratio between th e income and th e accumulatedvolume of outstanding debts; the ratio between debts andthe gold on which the banks (in a gold standard country)base their loans. As low income endangers the debtors, lowgold endangers the creditor banks, which then begin topress the debtors. On these last two criterianationalincome and national gold reservesome interesting remarks have been made by Mr. Warren F. Hickernell.1H e concludes tha t, at a given moment, the outstandingtotal of bank loans and investments should not exceed onehalf of the country's income for one year; and that thecountry's gold should always be at least equal to 9 per centof the outstanding bank loans and investments. The overstepping of either of these limits, Mr. Hickernell regardsas jeopardizing th e solvency of an undue proportion of thecommunity.This national gold buffer is exposed to one adverse

%W hat M akes S toc k M ar ke t P r i c es ? by W arren F. H ickernell ,Harper & Bros., 1932.


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FIRST THREE FACTORSchance seldom considered by either lender or borrowerthe chance of the mal-distribution of gold internationally.Such mal-distribution may be caused by a one-sided condition of international indebtedness, both public andprivate, and by tariffs which prevent international payment in goods and compel payment in gold. If these orother causes should drain a country of too much of itsgold, the banks of that country would begin to cancelloans, including some which looked conservative enoughwhen made. Th us , what was not over-indebtedness may betransformed into over-indebtedness by depriving thecreditor banks of sufficient gold or sufficient access to it.Thus an unexpected rise in the tariff of one country, saythe United States, renders unsafe a volume of indebtedness to that country from another country, say Germany,which without that rise would be safe, simply because thecreditor has made it hard for the debtor to pay.Over-indebtedness means simply that debts are out-of-line, too big relatively to other economic factors. If thedebts are out-of-line relatively to only a few unimportantfactors, little harm may result. The great disturbancescome when the debts are decidedly out-of-line with practically everythingincluding assets, income, gold and liquidities (i. e., quickness or slowness of assets and liabilities.)

THE DEBT CYCLEWhat, now, are the consequences of a mistake of judgment on the part of debtor or creditor or both? First, consider the individual debtor. If he has not borrowed enough,he can, under normal conditions, easily correct the errorby borrowing more. But, if he has gone too far into debt,especially if he has misjudged as to maturity dates

freedom of adjustment may no longer be possible. H e may


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BOOMS AND DEPRESSIONSfind himself caught as in a trap. If he cannot pay his debtwhen it comes due, he will try to put off the evil day.Governments and corporations accomplish this by refunding their maturing and short term obligations. But this isnot always possible and if insolvency threatens the debtor,the creditor often makes matters all the harder by pressingfor payment.Ultimately, of course, the over-indebtedness, whether ofone individual or of a whole community, will be wiped out,with or without business failures. But sometimes theliquidation, or the psychology accompanying it, does morethan restore a normal debt situation. Those debtors whohave burned their fingers by over-indebtedness, and thosecreditors who have burned theirs by over-lendingespecially if the two groups comprise most of the communitybecome over-cautious, and end in an undue reaction againstborrowing. Th en the pendulum may gradua lly swing back,caution may again be thrown to the winds, and over-indebtedness again prevail. The pendulum may even swingback beyond the point of equilibrium, where people willagain go too far into debt, but presumably not so much toofar as the first time. This swinging back and forth may goon indefinitely, constituting a debt cycle j but , unless someoutside force intervenes, each successive swing of the pendulum will have less scope than the last.

NINE MAIN FACTORSThis, however, is not the whole story of the expansionand contraction of debts. If it were, no one would thinkof devoting a whole book to it. But it happens that thecycle tendency of debts is the initiating one of at least ninemain cycle tendencies which carry in their vitals much of

the tragedy of economic life. The nine are listed here, and


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F I R S T T H R E E F A C T O R S 13each will be discussed on its downswing to Depression,before th e upsw ing of any of th em is considered 5 for thefirst task is to see how the debt-structure, once erected, maytopple into the trough of depression and take us with it .Following are the nine oscillating factors to which reference has just been made:

1. The Debt Factor2. The Currency-Volume Factor3 . The Pr ice-Level Factor4 . The Ne t -Wor th Fac to r5. The Profi t Factor6. The Product ion Factor7. The Psychological Factor8. The Currency-Turnover Factor9. Rates of Interest

The depression tendencies of the first three of thesefactors (Debts, Currency, and Price-Level) are closelylocked together, and the key that locks them is distress-sell ing.

DISTRESS SELLINGWhen over-indebtedness, whether by sheer bulk or byrashness as to maturity dates, is discovered and attemptsare made to correct it, distress selling is likely to arise.That is, in order to protect the creditors, some of the possessions of the debtor may have to be soldhis stocks, hisbonds, his farmlands, or whatever his available assets maybe. The debtor may choose, on his own responsibility, tofacilitate liquidation by selling some of his property, eventhough he never pledged any of i t for the debt} or hisbank or his broker may cash in on the debtor 's collateral ;

or the mortgagee may foreclose the mortgage; or the


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14 BOOM S AND DEPRESSIONSdebtor may go into bankruptcy, and the trustee in bankruptcy may then auction off his assets. In short, the debtorbecomes the victim of distress selling either on his owninitiative or on the initiative of his creditors.Distress selling perverts the operation of the law ofsupply and demand. Normally, sales are made becausesupply-and-demand has worked out a price attractive to theseller j but w hen the seller is in distress, the sale is madefor precisely the opposite reason 5 not the attraction ofa high price, but the compulsion of a low price, whichthreatens his solvency. The danger or the fact of insolvency is the all-important consideration in distress selling.W hen a whole community is involved in distress selling,the effect is to lower the general price level.

VOLU ME OF CURRENCY(The Second Main Factor)This excessive eagerness on the selling side of a marketmay seem enough to explain how distress selling tends tolower the price level j but it is not the fundamental influence. In fact, the buyer largely gains the spending powerwhich the seller loses, and spending power is what sustainsprices. But the stampede liquidation involved in distress

selling has a radical effect on the price level, by actuallyshrinking the volume of the currencythat is, of "depositcurrency."Deposits are the balances on the stubs of check booksthe "money" which people have in banks and which theytransfer by check, A typical depositor deposits neither goldnor silver nor any other money but merely his promissorynote.What he thus accomplishes is to trade his debt to thebank for a debt from the bank to himself3 the object being


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FIRST THREE FACTORSthat he may get something which will circulate. His ownnote will not circulate, but the bank's deposit-liability tohim will. Against this, he can draw checks which, in hisown business circle, will be accepted almost as freely aslegal-tender money. In short, he converts his own non-circulating credit into the bank's circulating credit. New"m oney" is thereby created, not by the mint nor the Bureauof E ngraving , but merely by the pen and ink of th e bankerand his customer. But when the customer fays his note, heundoes the whole transaction j that is, he wipes out anequal amount of circulating credit. In this respect, the payment of a business debt owing to a commercial bank involves consequences different from those involved in thepayment of a debt owing from one individual to another.A man-to-man debt may be paid without affecting thevolum e of outstanding currency j for whatever currency ispaid by one, whether it be legal tender or deposit currencytransferred by check, is received by the other, and is stilloutstanding. But when a debt to a commercial bank is paidby check out of a defosit balancey that amount of depositcurrency simply disappears.Thus to pay a debt at the bank tends to contract thecirculating medium. But this tendency is, in normal times,neutralized by a counter-tendency. For generally, as fast assome bank debtors pay off their debts, the extinguishedcurrency is replaced by new depositors who obtain newcredits. When, however, by reason of a general state ofowr-indebtedness, there is a stampede of liquidation, thenthe new borrowings will by no means suffice to restore thebalance, and there must follow a net shrinkage of deposits,or "credit currency."In this process of contracting credit currency, commercialbank debts are the only kind of debts directly involved.Yet other debts may aggravate the process of contraction.


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16 BOOM S AND DEPRESSIONSA man may owe very little to his bank, and yet owe somuch in other directions that, in order to reduce the total,he will choose to pay off his bank debt* Or a debtor, without any bank debt at all but owing money abroad, mayhave a deposit in a banksay, a thousand dollarsandwithdraw it in gold to pay some of his foreign debts. W henhe does this, he deprives the bank of the lawful right toissue credit currency to an amount far in excess of thethousand dollars thus withdrawn.This sort of contraction by means of cash drawn frombanks may be on a large scale, especially if the debtor isa bank or a savings bank, which, in order to replenish itsown cashgold, silver, or paperso as to meet a run by itsdepositors, may draw on other banks. Even public debtsdebts of city, state or nationmay have a contractingeffect on deposit currency, through the pressure of taxesupon citizens already in debt. This pressure, to be sure,is spread over so many people that its effect is light inproportion to the huge size of the public debts, but thepressure is always there, and often reveals itself, not onlyin the ways mentioned but in tax-sales with all the usualeffects of distress selling.Credit currency is recorded in the statistics of the Comptroller's Office, under the heading, "Individual depositssubject to check without notice." Its shrinkage is of vastimportance j for, in the U nited States at least, credit currency is the most important kind of Twentieth Centurycurrency. It transacts nine-tenths of the country's business,and, when it is deflated, the general price level tends tofall, because, with less funds less buying can be accomplished.2

2 T hi s is in accordance w ith w ell kn ow n prin ciple s. See, for instance,The Purchasing Power of Money> by I rv ing F i she r (Macmi l lan , NewYork , 1931) .


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FIRST THREE FACTORSTHE PRICE LEVEL

(The Third Main Factor)Thus, the volume of the most important circulatingmedium is tied to the volume of debts, especially debts atthe banks, one of the most im portant kinds 3 so that asudden disturbance of this debt-volume is passed on to thecurrency-volume and consequently passed on to the generalprice level 5 for, as all authorities agree, an increase in thevolume of currency tends, in some degree at least, to raisethe price level and a decrease, to lower it. What we nowhave to consider is the way in which a changed price levelchanges the burdensomeness of all outstanding debtsina word, changes real debts, as distinguished from nominalor money debts.

REAL DEBTSThere are few people today who do not grasp thedifference between nominal or money wages, on the onehand, and "real" wages, on the other. Let money wagesremain unchanged, and we all acknowledge tha t, if the costof living rises, real wages fall5or, if the cost of living falls,real wages rise. We know that money wages may rise andyet real wages fall, as in the case of Germany's post-warinflation. For real wages are the budget of goodsthecomposite of commoditiesthe "living"which the moneywages will buy. Only by translating money wages intoreal wages can we express the true economic state of thenation.This same principle applies to debts. Though a debt bepaid with the same number of money dollars, yet thesedollars, when prices are falling, will cost the debtor more

goods. To earn them, he must sell more goods. In other


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18 BOOM S AN D DEPRESSIONSwords, when the price level falls, each dollar, to all intentsand purposes, is a bigger dollar.For instance, suppose a farmer contracts a debt whenwheat is $1.00 a bushel, and pays it when wheat is 50 centsa bushel. Obviously, to him the dollar has doubled interms of w heat 3 he must use twice as much wheat to payeach dollar of his debt. That is, when the price of wheatis halved, the farmer's real debt is doubled. Likewise, ifthe general price level is halved, the real debt of theaverage man is doubled.

And this is but half of the deb tor's predicament 5 forfirst, he gets fewer of these bigger dollars for his goods(while owing the same number of them on his debts)5 andsecond, his security is worth fewer of these bigger dollarsin the market, and therefore worth less in the eyes of hiscreditor. Th e creditor is unaware of receiving more than heis properly entitled to, and the debtor is unaware of paying more than he properly owes. One gains and the othersuffersbut both suffer from what is about to be discussedas the Money Illusion.THE MONEY ILLUSION

Few people look at money for their explanations, becausemost people simply lookthrough money, think in terms ofmoney, take money for granted, assume that a dollar isalways a dollar. Since we measure everything else in dollars, it does not readily occur to us to measure the dollaritself.Few people realize, for instance, that the depressiondollar of 1932, as compared with the pre-depression dollarof 1929, became really a dollar and two thirds; and stillfewer realize the tremendous significance of this fact. Yetits significance is all the greater just because it is notclearly realized.


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F I R S T T H R E E F A C T O R SThe real meaning of a unit of money is the goods whichthat unit wil l buy. Instead of measuring goods by dollars,the economist is accustomed to measure dollars by goodsnot by any one article of goods such as bread, but by thegeneral budget of goods such as food-stuffs, clothing andcloth, furniture and houses, building materials , services,amusements and so on. When the price of bread alonechanges, this is presumably due to some change in thequantity or quality of wheat, and not to any change in thedollar . But when a thousand other prices change at the

same t ime, and al l change in the same direction, or al lchange on the average in the same direction, we are, ingeneral, justified in saying that the dollar has changed inth e offosite direction.Never theless , the Money I l lus ion 3 goes on tel l ing usthat the dollar stands st i l l while other things move. ThisMoney Illusion is analogous to the illusion of a passengeron a train who seems to see the landscape rushing past him.It is analogous to the illusion of sun-rise and sun-set, whichmakes the earth appear f ixed with the sun swinging 'roundit once a day. So when prices change, we forget the moneyon which we ride and ascribe the change to something outsidethe goods, the merchant, the consumer, the producer,the fert i l i ty of the earthanything at al l except the moneyin terms of which we think.German money, af ter the World War, furnished a goodexam ple . W e in Am erica , measur ing everything in dol lars ,said the mark had fal len. But Germans, measuring everything in marks, said the dollar had risen. In 1922,1 visi tedGermany and took part icular pains to learn from manyrepresentative citizens how they accounted for the skyrocketing of German prices. Practically all ascribed it to

3 See The Money Illusion by Irving Fisher. (The Adelphi Company,New York, 1928.)


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BOOMS AND DEPRESSIONSsome misbehavior on the part of commodities, or to theafter-effects of the w ar, or to th e Allied blockade, or to thewastefulness of the new German government, or to almostany cause but the important one; which was, of course,that the German government was paying its debts andother expenses with new paper money manufactured forthe purpose.Yet Germans are no more prone to the money illusionthan others. Over a generation ago, when England wason the gold standard and India on the silver standard,General Keating, in conversation with an Indian merchant,mentioned the then recent fall in the value of the silverrupee. The Indian merchant was non-plused. He said thathe had never heard of any fall of the rupee, although hehad agents all over India. After a pause, he added, "Butmy agents have mentioned the rise of the pound sterling.Perhaps that is what you are thinking of."Sometimes both observers (even if one be an American)are equally deluded. Before the World War, an Americanwoman owed money on a mortgage in Germany. After thewar, she went to the German bank and offered the amountwhich she conceived to be due$7,000. "But," said thebanker, "The debt is in marks, not dollarsit is 28,000marks; and today that comes to about $250.""Oh " she said, "I am not going to take advantage ofthe fall of the mark. I will pay the full $7,000." Thebanker, thinking in terms of marks, could not see the point.Indeed, the fair-minded American lady only half saw it,and "cheated" her creditor after all; for even Americanmoney was worth less than when the debt had been contracted. To pay the full amount in terms not of marks, ordolla rs, but in terms of the purchasing power which she hadborrowed, the lady should have paid not $7,000 but$12,000. Yet, had the German banker known this and sug-


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F I R S T T H R E E F A C T O R Sgested i t , the lady's indignation at such an "unfair" suggestion would doubtless have exceeded the banker's astonishment at receiving 28 t imes as much as he thought wasdue .

G O L D A N D C R E D I TWhen i t comes to gold money, we are even more apt tobe deceived. The reverence for gold, as if i t were something ultimately stable, is a form of ancestor worship.M on ey was inven ted by primitive m an, unconsciously j and

modern man has taken it for granted ever since. A certainamount of evolution has been at work upon money, butvery little conscious invention. The first great step in itsevolution was the unconscious trying-out of one substanceafter anotheroxen, wampum, si lver, gold. Gold f inallyprevailed, not for any stability of purchasing power, butfor sheer physical convenience. Stability was scarcelyth o ug ht of, un til something* else came on th e scene toafford a means of comparison. That something was paperm on ey . G old is not so easily inflated as pa pe r j bu t go ldis by no means stable. It comes out of mines, subject toth e w ill of m ine-ow ners an d to th e accident of discov ery jand if a dozen new gold mines should open at one stroke,the influx of gold would tend to depreciate the purchasing power of each individual gold dollar and of everypaper dollar redeemable in gold. And this very thing hassom etimes h app ened w ith serious effects on the price lev el.

Moreover, and conversely, gold has now become depend ent on paper money and checks. W h e n m ode rn maninvented the check system, he did not dream that depositssubject to check would come to be regarded as money. Butto al l intents and purposes they are money, and theylargely determine the purchasing power of gold. A golddollar and a dollar-check and a paper dollar , so long as


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BOOMS AND DEPRESSIONSpost-war inflation. A so-called "multiplicator" was suppliedby the hotelj and, by means of it , each guest could translate 5 th e prin ted prices on his bill of fare. H e foun d th eprice of his dinner l isted as, say, "6 marks," and the priceof his room as "9 marks"; but , before he paid his bi l l ,these f igures had to be mult ipl ied by the "multipl icator."This was a factor, or index, representing the price level ,or scale of prices, and varied from day to day, going up asthe mark went down. I t had nothing to do with the realprice of the dinner, ei ther in terms of labor, or relat ivelyto the pr ice of the room. Whether the mul t ipl icator was100,000 or 1,000,000 made no difference to these relat ions, but only changed the dinn er and roo m from 600 ,000and 900,000 to 6,000,000 and 9,000,000. The mult ipl icator, or index, saved the trouble of too frequently reprinting the price l ists when the price level was changing sofast.The almost universal fai lure to dist inguish between aprice and a price level, or scale of prices, is responsible foruntold confusion of mind on the subject of this book. Thisconfusion is characteristic of most speeches and writingson economics, including the pronouncements of editors,officials, business men, and bankers, and even of some whobear the title of economists but who have not, for somereason, separated supply and demand on the one handfrom the "equation of exchange" on the other. 6 The concept of a price level , i ts measurement by an index number, and i ts reciprocal , the purchasing power of the dollar ,are pre-requis i tes for unders tanding what happened in1932.

BSee The Money I l lus ton) by Irving Fisher (The Adelphi Co. , 1928),pp. 4 8 - 9 .6 See T he P ur c / tas i ng P ow er o f M oney, by Irving Fisher, (Macmillan,1 9 3 1 ) .


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F I R S T T H R E E F A C T O R STHE VICIOUS SPIRAL DOWNWARD

W e a re no w in a posit ion to explain the statem ent tha ta disturbance of the price levelor (as we may now express it) the alteration of "the real dollar" reacts on thede bt situation which first caused th e alteration . W h e n awhole community is in a state of over-indebtedness, thedollar reacts in such a way that the very act of liquidat ion may sometimes enlarge the real debts instead of reducing them Nominally, of course, any l iquidation mustreduce debts, but really (by swell ing the worth of everydollar in the country) i t may swell the unpaid balance ofevery debt in the country, because the dollar which hasto be paid may increase in size faster than the number ofdollars in the debt decreases. And when this process starts,it may go on and on, much after the fashion of a viciouscircle. First , mass payment by the weaker debtors swellsthe w ho le com m unity 's d ollar , and so weakens the f inancialposit ion of stronger debtorsj whereupon, many of theserush to l iquidate too, thus further swell ing the dollar ,till i t weakens the position of still stronger debtors; whereupon many of these in turn rush to l iquidate, thus furtherswell ing the dollar and weakening st i l l other debtorsandso on in a vicious circlej or, rather, in a vicious spiraldownward a tail spininto th e trou gh of depression,

TW O PARADOXESAfter the weak, or rash, or improvident debtors (ortheir creditors) have started the vicious spiral, we canscarcely blame the others individually for going on withit , through further l iquidations, even though every l iquidat ion makes bad matters worseaccelerat ing the tai l spin.

For, granting that mass l iquidation has once started, each


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26 BOOM S AND DEPRESSIONSindividual who does not join in will come off still worse.For, even if he stays out, his ten thousand neighbors willliquidate just the same, and thereby swell his dollarand thereby swell hiswhole debt instead of fart of it.The same principles apply to creditor banks. When abank calls a loan, it helps deflate th e credit currency j butother banks, equally scared, would deflate it anyhow; andif one bank stayed out, its debtors would go insolvent before they could be dunned. In a word, the banks, too, areforced into cut-throat competition for cash or "liquidity."

THE MAIN SECRETWhen over-indebtedness thus goes so far that the resulting mass liquidation defeats itself, we have the paradox which, as I think, explains the so-called mystery ofdepressionsat least of many depressions. It is more thanthe fact that the dollar, when thus expanded, adds to the

burden of every debtor. I t is rather that this expanding dollar may (and sometimes does) not only grow, but growfaster than the reduction of the num ber of do llars of debt.When this happens, liquidation doesn't really liquidate,so that the depression goes right onuntil there aresufficient bankruptcies to wipe out the activating causethe debts.SUMMARY

We have now mentioned, on their depression side, thecycle-tendencies of three of our eight economic factors,i. Debts (their liquidation)2. Volume of Currency (its contraction)3. T he Do llar (its swelling usually considered in term sof a shrinking scale of prices).Of these three depression tendencies, the second (cur-


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FIRST TH RE E FACTO RS 27rency contraction) is important only as a connective process between the other twowhich two should be calledThe DebtDisease (too much debt)The DollarDisease (a swelling dollar)That the dollar diseasefalling pricesis the mainsecret of great depressions is confirmed by the observationsof Professor Wesley Clair Mitchell and Dr. Thorp to theeffect that depressions last three or four times as longwhen prices are falling and are very short when, by somegood fortune, an up-tide of prices intervenes.

THE DOLLAR DISEASE IS NEEDLESSBut the mere fact that the debt disease may lead to thedollar disease does not prove that it must do so. The dollar disease will be unavoidable only "if other things remain equal." Should other elements in the body of thecurrency not remain equalshould gold coin, for instance,

become copious in the nick of timethis gold inflationmight counteract the credit ^flation. Prices might even goup instead of downj that is, the dollar might dwindleinstead of swell. And the same result might come frompaper inflationfor instance, by way of financing a war.And it should be equally clear that deflation, or dollarbulging, is not an "Act of God" with a special mandate tobaffle the human race. We need not wait for a happy accident to neutralize deflation. We ourselves may frustrateit by design. Man has, or should have, control of his owncurrency.Such a control, so exercised as to neutralize the influences which tend to swell the dollar, would, of course,not avert from any rash initial debtor the measured consequences of his own rashness j but his punishment wouldbe due to the nature of his separate debt and would, there-


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28 BOOMS AND DEPRESSIONSfore, be chiefly confined to himself and perhaps a smallcircle of associates. The rest of the community would notsuffer from any vagaries of the universal dollar. And eventhe rash debtor has a right to pay his debt in the samedollar in which he contracted it. It is manifestly unfair torequire even a rash debtor to pay $1.50 or $2.00 forevery dollar he really owes. The principle of simplejustice implied in the term "real wages" is no more applicable to wage earners than it is to debtors .In a word, if wemust suffer from the debt disease, whyalso catch the dollar disease? If we catch cold, why let itlead to pneumonia?


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CHAPTER IIIREMAINING SIX MAIN FACTORS

NET WORTH(The Fourth Main Factor)

BUT, assuming for the present, that neither accident norhuman currency-control has forestalled the Dollar Disease,let us trace its further consequences through the series ofeconomic factors, of which we have thus far discussed butthree:i. Debtstheir liquidation2. Currencyits contraction3. T he D ollarits swelling (usually considered interms of a falling price level).The fourth factor is Net Worth.The fall of prices reduces the money value of a business man's assets (except cash and debts due from others),while his liabilities, being debts, remain "fixed." Therefore his net worth, which is the excess of assets overliabilities, must shrink. Indeed, it will shrink faster thanthe assets do, because net worth is smaller than the assets,and yet takes the entire loss. Net worth is squeezed between the upper and the nether m illstone j and often itpasses below the zero mark, pushing the owner into business failure.

PROFITS(The Fifth Main Factor)

Profits are, in the same way, squeezed between an upperand a nether millstone. Profits are the spread between the29


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BOOMS AND DEPRESSIONSreceipts which fall when prices fall and the expenses whichare, if not quite fixed, at any rate less responsive to theassault of deflation than prices are. These relatively unyielding expenses in the profit account include interest,taxes, rent, salaries, and to a less extent wages. The moreunyielding the expenses the worse they pinch.1In this way,profits are reduced,2 and often turned into lossesjustas net worth is reduced and sometimes turned into failureand bankruptcy.A depression might be defined as the contraction of networths and profits.So our list lengthens to:1. Debt Liquidation2. Currency Contraction3. Dollar Swelling4. Net Worth Reduction (turned sometimes to failure)5. Profit Reduction (turned sometimes to losses)But, once more, it should be noted that the drop, bothin net worths and in profits, will be largely forestalled ifthe drop in the price level is forestalled.

PRODUCTION, TRADE, EMPLOYMENT(The Sixth Main Factor)

In a capitalistic, or private profit, system, it is the profittaker who usually makes the decision as to the rate atwhich his enterprise is to be run. Therefore, variations in1 It follows that the pinch is especially felt by modern business because of its greater proportion of overhead and fixed expenses. If, asseems likely, business organization continues its tendency toward morefixed charges and less running expenses, its profits will be more andmore sensitive to changes in the price level.2 Th is effect m ay be mitigated or escaped when through invention s,technological improvements and improved scientific management, ex

penses are greatly reduced.


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REMAINING SIX MAIN FACTORSprofits, or in the expectation of profits, lead the businessman to vary correspondingly the general policy of hisenterprise.When his profits are squeezed too thin for comfort,naturally he will cut his production and release some ofhis employees, so that the community's general out-put,trade and employment, will take a slump.That is, current out-put varies with current profits.Thus, currency contraction reduces out-put by reducingprices and so reducing profits.

There is a special category of production, namely constructionor the production of new equipment, such asbuildings and machinery, intended to increase the capacityfor current out-put. Construction is much more sensitiveto changes in profits than is ordinary production or currentout-put. Construction increases fastest with the approach ofa peak load, or a strain upon existing equipment. And itis not much more sudden in starting than it is in stopping.Right amid the new-equipment fever, at almost the firstsign or forecast of impending trouble, new construction mayabruptly fall. It falls earlier and faster than current output; and it produces a greater reaction in employment. Infact, construction affects the slump in profits, employmentand so on, like an amplifier.The derangement of this group of factors (production,trade, and employment) covers the most obvious and commonly recognized symptoms of a business depression. Infact, it is often called a depression of trade.Again our list grows:i. Liquidation2. Currency Contraction3. Dollar Growth4. Net Worth Reduction

5. Profit Reduction


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BOOMS AND DEPRESSIONS6. Reduced Production (especially o equipment) alongwith reduced Trade, and reduced Employment.But once more be it noted: if something will only forestall the price deflation (the Dollar Disease), thus largelyforestalling the reduction of Net-worths and of Profits,then the slump in Production, T rad e and Em ploym ent willalso, to a large extent, be forestalled.In passing it may be noted that currency contractionalso reduces the demand for goods by reducing purchasing power-y hus demand and supply shrink together. That

is, currency-contraction not only acts indirectly on production and trade through the above series of six steps butalso acts directly by reducing the wherewithal for buyinggoods. This effect (of Factor 2 on Factor 6) would be felteven if there were no fall of prices; in fact, it would begreater. Also unemployment means reduced purchasingpower.OPTIMISM AND PESSIMISM

(The Seventh Main Factor)All of the down movements thus far mentionedespecially the down movements of Net-worth, Profits, andEmploymenthave psychological effects. Already we haveseen that shrinking net-worth leads to distress selling. But

distress selling implies distress. A conscientious businessman, caught too deeply in debt and forced into bankruptcy, may become despondent, even to the point ofsuicide. Distress also occurs when profits merely decline,though there may still be hope for a better future.Yet those who reckon their net-worths and their profitsare a very small class compared with those whose employment is affected by a depression; and to be employed orunemployed is, to the employee class, a question almost


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REMAINING SIX MAIN FACTORSof life or death. Therefore, a depression affects the moodsof that class with especial force.There are, of course, some persons whose incomes runopposite to the general trend. That is, certain bondholdersand salaried folk have fixed and safe money incomes j andwhenever prices fall, these incomes will buy more. Interms of real income, their fortunes have actually improved. But even most of these people share the generalfears. In fact, they are the very type most accustomed toplay safe and are, therefore, the most easily alarmed bygeneral conditions. They begin to wonder if their incomesare safe after all. Indeed, they see some of their own classeither out of employment or ruined by the ruin of theenterprises on which they had depended for their supposedly safe incomes. In a word, pessimism, in a depression, becomes practically universal.Nor is this psychological movement only emotional.Partly it is intellectual as wellj for it involves illusion andmis judgm ent. During depressions, the sober judgment ofmany people gives way to over-estimates of the degreeand permanence of "hard times." And, as our estimatesare largely guessesguesses as to what other people willdo or think, and as to what and how much they will buyor sellthere enters the element of mass psychology.Everybody's opinion is largely guided by the opinion ofeverybody elsej even the people with the coolest headswill at least "fear the fears of other men" and contributeto the panic of which such fears are a part.Our list now is:1. Liquidation2. Currency-Contraction3. Dollar Growth4. Reduced Net-Worth

5. Reduced Profits


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BOOMS AND DEPRESSIONS6. Reduced Production7. Increased Pessimism and loss of confidence.But here again, if (by the checkmating of deflation)the failures and the unemployment be forestalled, pessimism and loss of confidence will also be forestalled.

THE VELOCITY OF CIRCULATION(The Eighth Main Factor)

Hitherto, under the head of deflation, we have considered only thecontraction of currency (meaning depositcurrency). But now we come to the slowing of currencythrough pessimism. For, while distress liquidation is contracting deposit currency, the loss of confidence that accompanies the distress slows down all currency, bankdeposits included j for scared people hold on to their money(of all kinds) a little longerthey spend it a little moreslowly.And here again, all kinds of debts (including publicdebts through the pressure of taxes) have their effect inslowing the turnover of currency, because all kinds ofdebtors (including taxpayers) are especially subject tocaution and fear. Even buyers at distress-sales, who gainthe buying power that the sellers lose, will be cautious andpostpone their buying and hold on to their money a littlelonger.It takes contraction and slow turnover together to makeup the full dose of deflation. Suppose, for instance, thatthe currency, besides being contracted 50 per cent is slowedanother 50. This means that there is only half the currency moving half as fast. Therefore, the currency as awhole will do only a quarter of its former work. EitherPrices must drop three-quarters, or Trade must contractthree-quarters, or else both Trade and Prices must drop in


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REMAINING SIX MAIN FACTORSsome degree.And this combination effect is what usuallyhappens.N o one incident unites both contraction and slowingsoeffectively as a stock market crash.A stock market crashwipes out great masses of credit currency with unusualsuddenness jand, at thesame time,it sostirsthe cautioussideof human nature thatmenhangon harder than everto their available moneyof every remaining sort. In combination, these two sequels of a stock market crash (contraction and slowing of currency) constitute a dose ofdeflation almostasgood (or as bad) as abonfireof a largepart of the nation's cash. A stock market crash is evilenoughin itself; but it is notconfinedto itself.Throughitsdouble effect on the currency in which commodity pricesare registered, it sets commodity prices sinking in sympathy with the stock pricesmore slowly but also moreinjuriously to the foundations of the economic structure.And at last, something likea panic develops in the commodity market.

HOARDING, A SLOW ING OF VELOCITYHoarding is a slowingof currency turnover of the ex-tremest kind. It is the supreme manifestation of popularmoods in a depression. Housewives and their breadwinners then become distrustful of everything exceptmoney. Bills and coinsare confided to stockings or mattresses, or are put underground, or (in a larger way)stored in safety deposit vaults. Credit deposits may behoarded too. In such banksas are considered safe, largecredit deposits will be kept, but kept idle. Checkingaccounts, based on cash deposits, will often be changed intotime deposits, bearing more interest than checking ac

counts. Finally, if there be any reason to fear for the


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36 BOOMS AND DEPRESSIONSsolvency of a bank, it will be subjected to a "run"; andthe money, after it is withdrawn, will be hoarded at home.It should be clear that hoarding, once introduced, becomes a tremendous factor in the vicious spiral, and cancontinue it with or without over-indebtedness. Hoardinglowers the price level. The lowered price level hurts business (debts or no debts) ; hurt business increases fear, andthe fear increases the hoarding.

THE TWO PARADOXES AGAINAPPLIED TO HOARDINGWe have seen, with respect to the contraction of thecurrency by mass liquidation, how debtors and theircreditor-banks, by making, or trying to make, things betterfor themselves individually, make things worse for themselves collectively. The same applies to the slowing ofthe currency by hoarding. Every man who hoards doesit for his own protection; yet, by hoarding, he aggravates

the very condition that started his fear. This is especiallytrue when his panic puts panic into the banks. They sometimes make runs, so to speak, on their customers beforethe customers can make runs on them .In fact, banks find themselves engaged in a race for"liquidity." They begin to call their loans; but by callingloans, they help further to extinguish deposit currency.Moreover, the cash which each bank collects comes largelyout of other banks; and these, in turn, have to replenishtheir cash, which they can do only by, in turn, callingloans, thus further extinguishing currency. This hoardingof money by banks has a magnified effect on deposit currency; for every dollar of reserve in a bank may support,say, ten dollars of loans. When, therefore, one bank forcesanother bank to surrender one of its physical reserve dollars, it forces a potential reduction of ten dollars of deposit


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REMAINING SIX MAIN FACTORScurrency. Even the bankers often fail to appreciate thisten-fold effect, because the initial effect of a physical dollarwithdrawn is only one dollar of deposits withdrawn.3

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

If all deposits were thus extinguished, as is not impossible theoretically, then the only circulating medium remaining would be physical, hand-to-hand, or pocket,money. There would then be a 90 per cent shrinkage inthe circulating medium, and a slowing down of such currency as remained. The price level might readily sink toless than one-tenth of what it had been, despite a reduction in the volume of trade. Then almost all business menin debt, including farmers, would be completely ruined.We thus again add to our list:1. Liquidation2. Contraction3. Dollar Growth4. Reduced Net-Worth5. Reduced Profits6. Reduced Production7. Pessimism8. Hoarding and a general slackening in the velocity ofcirculation, both of deposits and of physical money.

But here again, if deflationor the swelling of thedollar (due to both the contraction and the retardation ofthe currency) be checkmated, the slowing of velocity andhoarding will be checkmated too. For instance, an increasein volume, if sufficient, may conquer a decrease in Velocity.3 The details of the magnifying process have been set forth by DeanChester Phillips of Iowa University in his Bank Credi t (Macrnillan,19 20 ) and have recently been further worked out ma thematically by

Professor James Harvey Rogers of Yale University.


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38 BOOMS AND DEPRESSIONSRATE OF INTEREST

(The Ninth Main Factor)Debts bear interest. Consequently, a cyclical tendency indebts will involve a cyclical tendency in interest rates. In aword, as borrowers grow discouraged and therefore scarce,interest (in the large centers at least) tends to go down.Nor can we say of this disturbance of interest rates, as wehave said of other cycle-tendencies, that if the deflationwere annulled, the disturbance of the interest would be

entirely forestalled. For the cycle-tendency of debts carrieswith itdirectly andnecessarily a corresponding tendency ininterest rates. This, however, is relatively harmless."R EA L" R A TES VS . MO N EY R A TES

But here enters another paradox: the inconsistency between this nominal or money interest and real interest. If,last year, I borrowed ioo dollars and am to pay 105 thisyear, my nominal or money rate of interest is 5 per cent.But if, meanwhile, the dollar has swollen so that, whenthe due date arrives, 105 dollars have become worth 106of last year's dollars, my real interest is not five per centbut six per cent.4 In a depression, therefore, when interestismeantto be low, the real interest am ounts, sometimes, toover 50 per cent per annum 5 The really important dis-4 T h e distinction between the mon ey rate of interest and the real r ateof interest is like the distinction between money wages and real wages,and between money debts and real debts. But it is more complicated, andso more often overlooked. We translate money wages into real wagesor money debts into real debts at one 'point of time. But to translatemoney interest into real interest we must take account of at least twopoints of time, namely the time when the debt is contracted and the time(or t imes) when i t is repaid. For further analysis , see Chapter XIX ofThe Theory of Interest by I rv ing F i she r (Mac mi l lan , 1 93 0) .

c But the various nominal rates themselves move unequally. The pes-


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BOOMS AND DEPRESSIONSBut, while the order of the nine major events as aboveset forth is a good pedagogical order, it is not a strictlychronological order. Its principal departures from chronology lie in the items of interest and pessimism, both ofwhich, if treated chronologically, should come earlier.Pessimism was purposely delayed in the exposition untilall the chief reasons for it had been catalogued. It wasthen inserted once for all. Perhaps, more than any of theother factors, it really comes in progressively all along theline. The first touch of liquidation has a depressing effect

on moods j and this first approach of the pessimistic moodretards circulation.Even the very start of the liquidation may be the psychological discouragementeither of the debtor or thecreditorfrom a realization that the debts they owe, or thedebts owing to them, are too high and should be reduced.This realization may be borne home by many causes j butthe chief cause may well be that earnings, current or expected, have begun to disappoint the excessive expectationswhich originally led to the debts. It is often said that the"turn of the cycle" may be due to a very trivial precipitating cause. Anything which causes a slight revulsion ofmood may be the last straw. Then, with liquidation anddistress selling, the depression spiral begins its tail spin.Sothe slowing of circulation m ay show itself statistically inadvance of th e credit contraction, though the contraction waslisted first for convenience of exposition and the retardation of velocity was not mentioned until the full reasonsfor it had come into view.Not only may the retardation of currency begin beforeits contraction, but there may be at first an actual expansion of currency, if enough cautious people set about accumulating cash studiously.

Nor are these the only chronological complications. Our


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REMAINING SIX MAIN FACTORSdespite their accumulating numbers. Thereafter, buyingand borrowing become still more aggressive. The buyersrush still faster, so that their purpose may be accomplishedwhile the buying is good. At the same time, the reflation,by raising prices, raises net worth, thus dispelling fear ofbusiness failure. Profits, too, are raised, thus encouragingthe profit-takers to increase their out-put, their construction, and their pay-roll. T rad e grows.

A Vl'CIOUS SPIRAL UPW ARDIf only the movement would stop at equilibrium Butour narrative in the last paragraph already implies avicious spiral upward, the counterpart of the vicious spiraldownward. It involves, like the downward spiral, three ofthe nine oscillatory factors, namely, Debts, Circulation,and Real Dollars. As reflation lightens the real burden ofthe debts, the debtors, including new and weaker borrowers,

are lured into further extending their enterprises, and, fortha t purpose, into incurring m ore debts, which furtherdilute the real dollar and so further lighten the real debt-burden, and so still further tempt the business world (including new and still weaker borrowers) to incur stillmore debts, and so on and onuntil again, after the number of dollars of debt grows faster than each dollar growssmaller, there comes an awakening to the fact that thereis an over-indebtedness which must be corrected. Thenborrowing diminishes, liquidation sets in; and once morewe are headed for depression.


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CHAPTER IVS T A R T E R S

UNPRODUCTIVE DEBTSW E began the discussion at the crest of the wave, with astate of over-indebtedness presupposed. But what startedthe debts?First, as an approach to the problem of the origin ofover-indebtedness, let us classify our debts.Chiefly, there are two general classes of debts: productive and unproductive.1An unproductive debt is incurred after some misfortunehas cut a hole in the borrower's income-stream 5 and theloan partially fills up the hole, while the borrower awaitsbetter times. Thus, if a workman falls ill and cannot, fora w hile, earn w ages, he gets a loan to tide him over 5 andwith its proceeds he ekes out the straitened family income,repaying the debt later when that income is increased bythe resumption of wages. Occasionally, of course, suchmischances may affect great numbers of people at onetime, and so result in general over-indebtedness. A greatearthquake, conflagration, flood, drought, pestilence, orwar may result in unproductive debts on a large scale.Farm depression is often aggravated, if not caused, bydrought, and crop failures. A war will create huge debtswhich are not only unproductive but devoted to destructivepurposes.

1 For fuller discussion, see T he T heor y o f I n ter es t by Irving Fisher(Macmi l lan , 1930) .44


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STARTERS 45Unproductive debts, however (except in w ar) , are likelyto be sporadic j and, since the borrowing in each case isreluctant and often cautious, it is likely to be limited bythe available security. On the whole, therefore (exceptin war), this kind of indebtedness is not apt to be greatlyoverdone.

PRODUCTIVE DEBTSAs an explanation of economic crises, or of most economic crises, productive debts are far more important than

the unproductiveexcept war debts. In the case of productive borrowing, as in unproductive, there has been ahole cut in the income, but this hole is no accident. It hasbeen deliberately cut by the borrower. A man who seesan opportunity to invest at a tremendous profit would bequite willing, if he could not get a loan, to sacrifice the enjoyment of a large part of his present income, in order toinvest in the supposed bonanza, even if, for a while, hemust live on bread and cheese. That is, he saves instead ofspends. But if he canget a loan, he may fill up the holewhich he cut in his enjoyable income. That is, he willsacrifice little if at all on his current spending. And if hefinds that he can borrow very freely, he may be temptedto go still further into debt, and spend even more thanbefore the loan, relying on the expected returns from hisinvestment to repay both his investment and his extravagance. His psychology is not that of the unfortunate. Hismood is not fear, gloom or caution. It is enthusiasm andhope.Often, if not usually, the opportunity to invest is theresult of new inventions, new discoveries, or new businessmethods. When inventors, or their backers or exploiters,think they can, by borrowing at (say) 6 per cent, makeprofits of ioo per cent, why should they hesitate to bor-


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46 BOOMS AND DEPRESSIONSrow, and keep on borrowing? Examples of such lures arethe opening of the Erie Canal, the building of new railways, the exploitation of the Bessemer steel process, newuses of electricity, and new industries, such as automobile,airplane and radio.

SOME HISTORICAL ILLUSTRATIONSIn 1792-93, in England, the lures were canals, realestate and machinery. In 1814-16, when Napoleon's inter

ference with international trade had been broken, the lure,in England, was the prospect of renewed trade with theContinent. English speculation in exportable commoditiesbecame a stampede. In 1825, in the same country, therewere various lures: mines and other commercial enterprisesin Mexico, South America, and other foreign partswhatG. H . Pow ell calls "exaggerated views of coming prosperity," through the profits to be had by investing. SaysTooke:"This possibility of enormous profit by risking a small sumwas a bait too tempting to be resisted; all the gambling propensities of human nature were constantly solicited into action;and crowds of individuals of every descriptionthe credulousand the ignorant, princes, nobles, politicians, patriots, lawyers,physicians, divines, philosophers, poets, intermingled withwomen of all ranks and degrees (spinsters, wives, and widows)hastened to venture some portion of their property in schemesof which scarcely anything was known except the names."

In America, the chief depressions were 1819, 1837,1857, 1873, and 1893. In most of these there was inflationbeforehand and then deflation through contraction of thecurrency and bank credits. In 1819 and 1837 there hadbeen wildcat banking causing inflation. In all cases there


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STARTERS 47was speculation in real estate j for, as Victor C lark pointsout, a new country like America offers its opportunitiesfor big profits largely in connection with the exploitationof new areas of land. In 1819 the land boom and collapsewas in the east. In 1837 it was in the west and southwest.Whenever and wherever new lands were opened therewas land speculation, the latest case being the Flo rida landboom of 1926. The crisis of 1837 followed land and cotton lures, and the lure of canal building, steamboats andturnpikes. The speculation was led by Biddle, the greatPhiladelphia banker of that day. The result was to openup each side of the Appalachians to the other. The opening of the Erie Canal had profound economic effects.The investments in these internal improvements weremade possible by large loans from Europe.The crisis of 1857 followed the exploitation of the California gold discoveries and the beginnings of railways, theextension of internal improvements, and the opening ofthe Northwest.The panic of 1873 followed the exploitation of transcontinental railways, and western farms through theHomestead Act. These new farms were mortgaged toEastern lenders.Preceding the panic of 1893, in America there was anover-exploitation of farm implements resulting in overproduction of, farm products, pointed out by ProfessorBogart. But the main cause appears to have been distrustof the monetary situation due to the injection of too muchsilver into our currency. The gold base was too small.

THE SHADY SIDEA genuine opening of new opportunities for profitable

investment is only the first step. At first, it is the legitimate


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So BOOM S AND DEPRESSIONSAnd, finally, war stimulates other starters, such as invention.Sometimes, by coincidence we get all conceivable sortsof starters working in the same directionsuch as war, golddiscoveries and new processes, new banking systems, withcapacity for great credit expansion, great inventions andthe rebound from a recent depression. Many of these coincided in the United States in the period 1913-19 andmany also in 1926-9.


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BOOMS AND DEPRESSIONS" T h e first gr ea t achiev em ent of the scientific s tudy of crisesand depressions was the discovery that business mo ves in cycles.T h e first cycle to be discovered wa s the m ajo r cycle, which

runs i ts course usually in from seven to eleven years. This cyclewas f i rmly es tabl ished by the great work of Clement Juglar inhis Des crises cornm erdalesy first published in i 8 6 0 . On ly i n t h elas t two decades was i t es tabl ished (notably through the workof W a r r e n M . Pe r s o n s an d W es l ey C . M i t ch e l l ) t h a t th e re is ,at least for the United States, a much shorter minor cycle ofabout for ty m on th s ' du rat io n . T h a t i t should be especia llypro m ine nt in the U ni te d S ta tes is perhaps due to the fact thathe r domestic ma rk et is so vast th at inte rna l min or fluctuationscan develop here that are not reflected in the outside world.Historical ly, in the United States every second or third minordepression develops into a major depression. Finally, i t rem ained for Professor N . D . Ko ndrat ieff of M osc ow , Russ ia , topoint out the existence of ' long waves, 5 each extending over aperiod of from forty-five to sixty years."

" F O R C E D " C Y C L E SCertainly there are in economic affairs cyclical tendencies; and these are of two sorts: those imposed upon theeconomic organism from the outside, or what may becalled "forced" cyclical tendencies, and those inherentin it.Th ose imposed from the outside are large ly of astronomical origin. It is not impossible that among these there maybe economic rhy thm s longer than a year. W . StanleyJevons thought he detected a ten year economic rhythmproduced by sun spots. H . S. Jevons seemed to uncover athree and a half year economic rhythm which he supposedto be the effect of solar radiation.Prof. H. L. Moore imputed an eight year economic rhythm to the conjunctions of

Venus. More recently, Dr. Abbott of the Smithsonian In-


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T H E " BUSINESS CYCLE? 53stitution has been studying what appear to be long timecycles in solar radiation. It is, of course, quite possible thatthese cycles may have some obscure effect on the economicaffairs of earth. All these tendencies may possibly existandexist consistently with one another, and with many morealthough they seem as yet to lack sufficient proof.There are, however, shorter rhythms in human affairs,indubitably caused by astronomical forces. These rhythmsare yearly and daily. The swing of the earth around thesun causes variations of light, heat, and moisture, and thesedetermine the seasons, thereby causing rhythmic tendenciesin planting and reaping, and in certain resulting phases ofcommerce and of banking. These yearly rhythms havecome to be called, not too happily, "seasonal variations";they might rather have been named seasonal cycles orcyclical tendencies. So, also, the turnings of the eartharound its own axis cause the alternation of light and darkness, thus producing, in all human activity (business included), rhythmic tendencies every twenty-four hours.There are other cyclical tendencies imposed from outside the economic mechanism. These are customary or institutional rhythms. For instance, the religious and traditional observance of Sunday sets the weekly rhythm ofpayrolls; and the still more arbitrary month sets therhythm of salary checks and billings.All these "forced" rhythms, that is rhythms imposedupon the economic mechanism from the outside, are permanent, or at any rate as long-lived as the customs or astronomical or other outside influences which impose them.

"FREE" CYCLESNo one denies the existence of these "forced" rhythms;but none of them seems clearly to coincide with booms and

depressions. To find the causes of booms and depressions,


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BOOMS AND DEPRESSIONSwe must step inside the economic mechanism and considerrhythms relatively "free" of outside control.Bu t when we have done th at, we find that clearness endsand debate begins. We find fairly clear "trends" or progressive changes, but these are not rhythms. And we findmuch evidence of rhythmic tendencies, but these are notclearj and their name is legion. This book has dealt withonly one group of nine cyclical tendencies closely interrelated, and even their inter-relations are not simple, butform a tangled network of permutations and combinations.All their possible interactions by pairs would come toover 360,000 and this number could be multiplied indefinitely by sub-classifying our nine factors and addingothers.

ANY UNBALANCE MAY CAUSE CYCLICAL TENDENCIESThe dis-equilibrium of any factor, theoretically at least,may start up oscillations in many or all of the others.The starting point may be not the two we have discus

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Booms and Depressions