Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

The socialists, again, seek to explain crises by the existence of private property in the means of production, and contend that if we were to cease the exploitation of the laborer by the modern capitalistic method, crises would disappear. While, however, agreeing in this general conclusion, they differ in their detailed analyses. Thus Rodbertus maintains that the secret of crises is to be found in the fact that the progress of industry causes a continually greater output of product, while the exclusion of the laboring classes from any participation in this increased productivity involves a relative diminution in demand, and thus ultimately a fall in price, culminating in a crisis. Marx, on the other hand, puts the emphasis on the fact that the necessary fall in the rate of profits (which, according to him, is a result of the surplus value, or exploitation theory) is incompatible with the greatly increased productivity of fixed capital inherent in the present system, and that the clashing of these two incongruous tendencies of modern industrial life brings about a relative overproduction of capital, and gives rise to periodical explosions. This view, finally, is sharply criticised by the latest and ablest of the socialist theorists, Tugan-Baranowsky, who in turn maintains that crises are due primarily to the fact that under the modern system it is impossible to invest the fresh accumulations of capital proportionally in all branches of industry, and that it is this relative disproportion of accumulated capital to the particular demand that causes the anarchy of the market and the recurrent convulsions of industry.

While the socialist scholars have undoubtedly made valuable contributions to the discussion of the problem, they, like the earlier economists, have erred in laying stress on the question of technical production rather than, as is done by the more recent economic thinkers, on that of business enterprise and capitalization. This is manifestly not the place to elaborate a general theory of crises. If we attempt, however, to give the bare outline of the modern explanation. It would be approximately as follows:

The problem of crises or industrial depressions is one of relative capitalization. Under the present system of enterprise, production is carried on in mass for a prospective market, rather than as formerly in small quantities to fill a definite order. Even if it be contended that certain factories nowadays are busy with producing to order, it is none the less true that numerous plants are continually being erected in the expectation that orders will be received in the future. The good times, or periods of rising prices, may be due to many causes—either in general to an augmented gold output, or in particular to the increase in the demand for some special product, whether in the iron industry through a new navy program, or in the clothing industry through the outbreak of a war, or in any other industry through a change of fashion or what not. Prices first rise in the particular enterprise, production augments, the movement spreads to other lines of business, and the new enterprises are financed by loans from the banks or trust companies, or by the sale of securities on a capitalization proportionate to the anticipated earnings. In times of buoyancy we are continually capitalizing anticipated earnings and future hopes, and we do this through the utilization of credit on a large scale. We build railways, put millions into steel plants, "boom" land sites, and form combinations of all kinds, employing the credit facilities granted by the banks, or throwing the securities on the stock market. We "water" the stock or, if that be forbidden by law, we drive the market quotations to a high point, because we think that this is warranted by prospective earnings. Sometimes we say that we capitalize the good will or, in the case of quasi-public enterprises, the franchise; but in all cases we capitalize the future because we believe that we shall earn an income which will justify this capitalization.

The peculiarity, however, of an up-grade movement which rests on modern credit facilities is that we wear magnifying glasses or look at the future in too roseate a light. It is a natural tendency of human nature to capitalize one's hopes and expectations too liberally. If this is done on a continually larger scale, the capitalization becomes so great that actual earnings do not come up to our anticipations or the fear of a discrepancy between actual and estimated earnings begins to obsess us. It becomes necessary to reduce the capitalization to its true dimensions, i. e., to a sum proportioned to actual earnings. This process of readjustment of overcapitalized values obviously involves loss; but readjustment there must be. If the realization of its necessity is sudden, we have a crisis or panic.

In the height of the period of exaltation or prosperity, something happens to disturb confidence. A chance occurrence, a mere rumor, may suffice. Some bank considers its credit too heavily engaged, or suspects the adequacy of the collateral. Just at the flood of the tide, when new demands are constantly being made, it finds itself unable or unwilling to respond. Its refusal starts or intensifies the feeling of insecurity, and with the inability of some important concern to meet its obligations, a failure occurs and the crisis is precipitated. If, on the other hand, the situation is well handled, and if the readjustment of the overcapitalized values to actual earning capacity can be brought about more gradually, we have, in lieu of a crisis, a liquidation and a period of depression which lasts until the up-grade movement again sets in.

Crises, therefore, are not necessarily the result of increased technical production. The important point is not production, but capitalization. There may be overcapitalization, without overproduction. Overproduction of particular things may indeed accompany overcapitalization, but the stress must be laid, not on the relation between production and consumption, as the old writers assumed, but on the discrepancy between the investment and its returns.

While the general features of a crisis are thus everywhere the same, the details differ in each case. Sometimes it is the banks that fail first, sometimes the general business enterprises. Sometimes it is the railway securities that first feel the strain, at other times "the industrials," and at still other times the raw materials. Sometimes the bolt comes out of the clear sky with prices at a maximum, sometimes it is only the last stage of a period of liquidation with progressively lower prices. But however unpredictable and seemingly inscrutable the actual course of events, the fundamental explanation is always the necessary readjustment of capitalization to actual earning capacity.

That this is true of all our crises can be seen from a hasty review. The crisis of 1817 was the result of the first utilization of modern capitalist methods in America. The period of the War of 1812 was marked by three facts: first, the industrial revolution in New England and the introduction of the factory system in the textile industry; second, the great development of internal improvements through canal and turnpike companies; third, the sudden multiplication of banks to finance the new enterprises. The consequence was the so-called "Golden Age," which lasted for several years, until checked by the immense imports from England after the war, and destroyed by the collapse of the overcapitalized undertakings. It was well into the twenties before the country recovered from the industrial depression, and then came the second up-grade movement, which culminated in 1837. This was primarily a land and transportation, rather than a purely industrial, phenomenon. The canals and turnpikes in the East were now being replaced by railways, and the spread of slavery caused a rush of cotton planters, not only to the black belt, but to the pine barrens and hill country of the South. It was primarily land values that were being overcapitalized, and the process went on to such an extent that the annual land revenues of the Government now exceeded the total governmental receipts from all sources of a few years before. Finally, to finance this land movement there were called into being hundreds of the "coon-box" banks, that found a champion in President Jackson in his war against the Bank of the United States. As the period of exaltation had been unexampled, so the collapse was proportionally great. The crisis of 1837, followed as it was by those of 1839 and 1841, was still more serious than that of 1817.

It was again well-nigh a decade before the readjustment of values had been completed. The following decade was in turn marked by five striking facts: first, the gold discoveries of California and Australia, which soon initiated a general rise of prices; second, the consummation of the revolution in the media of transportation by land and water, and the settlement of the entire Mississippi Valley, the most fertile portion of the continent; third, the abolition of the corn laws in England and the opening up of a market for our incipient surplus of wheat; fourth, the era of industrial invention which resulted in the application of capitalistic methods to new classes of enterprise besides the old textile industries; and fifth, the development of free banking with the "wild-cat" institutions to provide the credit facilities for this prodigious overcapitalization. The crisis of 1857, which was the inevitable result, was perhaps still more acute than its predecessors. The continuance of its depressing influence on industry, however, was checked by the economic effects of the Civil War, which gave an artificial stimulus to many forms of enterprise.

In the period immediately succeeding the war, great changes again occurred. The transcontinental roads were completed and the Eastern trunk lines consolidated; the great wheat fields of the country were opened up under the new homestead laws, and the period of large exports began; the Bessemer process revolutionized the iron industry, and the factory system was now applied to boots, sewing-machines, and agricultural implements; the great copper and silver deposits were developed, and the petroleum output grew apace; while the greenbacks and the greenback movement fomented the process of inflation. The discrepancy between the capitalization and the actual earning capacity of the country's business enterprises again became so overwhelming that the necessary readjustment took the form of the convulsion of 1873—a convulsion the depressing effects of which were felt with almost increasing severity for six years.