One of the most striking phenomena of modern industry is the frequent and violent convulsions of business known as crises. They are characteristic of all commercially advanced countries and are generally most marked in those countries which are most advanced. They are a product of modern methods of capitalistic production and are essentially a phenomenon of the nineteenth century. A crisis in its last analysis is the result of a lack of adjustment between production and consumption, due primarily to mistakes in production. It is significant that crises usually occur in periods of business prosperity when credit
is easy, prices high, and employment general. Such a period of business prosperity and rising credit may have been begun by a series of good harvests. The demand for manufactured commodities increases, prices rise, manufacturers enlarge their factories or engage in new enterprises, wages and profits go up. Many speculators, seeing the rise, and thinking it will continue, borrow money to buy goods with the expectation of selling again at a profit. Credit operations are expanded to a dangerous extent, and when at last a shock to confidence occurs the house of cards collapses and a painful liquidation and readjustment of industry ensues. The state of trade, in the words of Lord Overstone, “revolves apparently in an established cycle. First we find it in a state of quiescence—next improvement, growing confidence, prosperity, excitement, over-trading, convulsion, pressure, stagnation, distress, ending again in quiescence.”
The immediate occasion of a crisis is always a shock to credit or confidence. Such a shock, begun perhaps by the failure of a bank or merchant, creates a demand for ready money. No one is sure that his neighbor will remain solvent. Everyone accordingly tries to secure himself against loss by enlarging his cash reserve and thus lessens the supply for others. Now modern industry is carried on by means of credit. There is at no one time enough money in the country to meet all obligations expressed in terms of money. Considerably over three-fourths of the larger commercial transactions in the United States are carried on by means of credit. If everyone tries at the same time to get actual cash, there is simply not enough money in the country to go around. This increase of demand and diminution in the supply of money forces up the interest rate on short-time loans. Money—actual cash—is needed by many people to meet immediate engagements and they are willing to pay almost any price for it. In the last panic the rates for call money went up to over
100 per cent and in many cities in the United States clearing-house certificates and other substitutes for money were issued for use in ordinary retail trade. But even at high rates money can often not be borrowed. Many merchants and manufacturers are compelled to sell their goods at a sacrifice in order to obtain it. Vast quantities of goods and securities are thrown on the market just when investors and consumers feel least able to purchase. The result is a fall in prices. Such a fall in prices lowers profits. Enterprises have been started and engagements made on the supposition that prices would continue at the old high level. When they fall it is impossible to pay interest out of current earnings. Foreclosures and readjustments take place. There is a general liquidation and reorganization of industry. When interest contracts have been adjusted, then the effect on wages begins to be felt. As long as a manufacturer is struggling to maintain his credit he will keep his factory going, but when he has failed and perhaps been foreclosed, then the factory stops. Men are thrown out of work, and wages—the price of labor—fall. Labor troubles usually mark the end of such a period of readjustment.
This stage marks the end of the crisis and the beginning of a period of depression or “hard times,” which continues for a longer or shorter period. The panic of 1893 was followed by a long-continued depression which lasted until 1897, a period which was marked by low prices and slack work. In 1898 began a revival of business and an era of marked prosperity set in which continued for almost ten years, interrupted only slightly by a “Wall Street panic” in 1903. In October, 1907, a severe crisis occurred, recovery from which, however, has been remarkably rapid. The periodicity which has attended crises in the past is so marked—occurring as they have at intervals of about ten years—that many writers consider them inevitable. As the easiest way to answer this question we
may take up three main theories as to the causes of crises.
A much quoted, but now generally discredited, theory is that of W. S. Jevons, a noted English economist, who ascribed crises to sun-spots. Every ten years and a fraction there occur outbursts of electrical and heat energy on the sun, which we call sun-spots. These result in increased heat waves, which affect the crops on the earth, causing enlarged harvests in Europe and the United States and drought and famine in India and the tropics. The large harvests and good prices start a wave of prosperity and speculation, which culminates inevitably in a panic and depression, until a recurrence of the heat phenomenon starts the cycle again. The theory states some undoubted facts, but no causal connection between sun-spots and crises can be traced, as the latter are too irregular and the two do not always coincide. Were this theory true crises would be beyond human control.
A second theory, or group of theories, are those which attribute crises to over-production. Under modern conditions of industry a small group of men direct industry and determine what shall be produced. They try to estimate future demand and to adjust production to consumption, but they often make mistakes. They divert capital into unproductive industries, they produce the wrong things and create a comparative glut in certain lines, and when they cannot sell their goods at a profitable price they fail and precipitate a crisis. Industry must then be reorganized and frequently control be put in the hands of other men. A variation has been given this theory by the socialists, under the leadership of Rodbertus, who insist that the reason that there is over-production is because of the institution of private property. Since the capitalists own all the tools of production they pay the laborers only starvation wages. The latter cannot possibly buy all that is produced and commodities consequently heap up in the warehouses until they are thrown upon the market to be sold
at any price. Then a panic occurs and a readjustment of production.
The last of these theories regards a crisis as essentially due to a failure of credit. It is seen that a large part of modern industry is carried on by borrowed capital, by roundabout processes and for a distant market and not upon order. That is, the success of a business depends upon its ability to sell its goods when produced. Now the aggregate volume of transactions that can be carried on in a year, so runs the theory, depends upon the efficiency of the credit system; that is, in general, upon the freedom with which banks are willing to loan money to people who engage to repay it in the future out of their ventures. If for any reason the banks reduce this accommodation the amount of business that can be transacted upon borrowed capital is lessened. Either some transactions must stop or prices must fall. Either of these events causes commercial disaster. The contraction of credit makes it impossible to get the goods into the right hands, and so we have the phenomena of over-production in a great many lines. As exchange and transportation have developed and markets widened, crises have become more universal. According to this theory, they are inseparably connected with the use of credit and can be controlled only by a more careful granting of credit by the banks to industrial managers. Another phase of the credit theory is presented by those who insist that the cause of crises is the rhythmic overestimation of the profits to be secured out of certain lines of production, or their over-capitalization. The new enterprises are financed by the banks on the basis of this mistaken over-capitalization, their organizers engage to pay rates of interest which they cannot earn, and the crash inevitably follows. This is often called the over-capitalization theory, and is essentially psychological in its character.