Crises & Cycles

CHAPTER IV. THE CAUSES OF CRISES AND CYCLES.

§ 9. INTRODUCTORY.

In the preceding chapters an attempt has been made to acquaint the reader with the general phenomenon of crises and cycles, both from a morphological and from an historical approach. Our next and infinitely more difficult task must be to find out the cause or—what even prima facie seems more probable—the causes, of the said phenomenon. This is not only in order that we may satisfy our scientific curiosity, but also that we may discover, through an understanding of the causation, what policy should be followed in order to control and moderate the driving forces behind economic fluctuations and disturbances.

The history of doctrines which have attempted to clear up the mystery of recurrent disturbances of economic equilibrium is now more than one century old, Jean Baptiste Say and David Ricardo being perhaps the first to grasp the real problems involved. But though present-day economic science may be said to have made great advances towards a better and deeper understanding of the intricate questions to which the study of economic disequilibrium gives rise, and of the working of the mechanism of our economic system under the influence of disturbing factors, it would be unduly optimistic to assume that there has been found a solution of the problem of the causation of crises and cycles which leaves nothing to explore or which is satisfactory from all points of view. As in every other branch of economic science, a communis opinio doctorum on the origin of crises and cycles cannot be expected, and even on some of the most important points serious divergences of opinion still exist, though with a fair chance of being diminished as time goes on.

On the other hand, however, the theory of crises and cycles has that also in common with economic theory in general that the extent of actual agreement is much greater than is generally supposed by those who are not thoroughly acquainted with the subject, and who often betray their very ignorance by censuring economic science for hopeless divergences of opinion. It would be easy to show that the science of medicine gives the appearance of a still wider disagreement on very important questions of pathology and therapeutics, but every medical man will tell us that the bitter warfare in his science is being conducted on a rather broad groundwork of universally accepted principles. More often than not, it is not the principles in medicine as in economics that are at stake but the conclusions to be drawn from them, their arrangement and combination, the emphasis to be placed on the different factors, the interpretation of new experiences, and the expediency of practical measures—though, in fairness to the outside observer, it has to be conceded that the embittered spirit in scientific warfare must sometimes give the impression that there are unbridgeable abysses hopelessly separating the opponents. Finally, there is the human element which accounts for the fact that the real differences of opinion are often much exaggerated, common vanity and pugnacity playing a prominent part. It is all too common that an economist—and the writers outside of academic circles are sometimes even worse—wants to make himself immortal by presenting a brand-new theory of cycles and making room for it by abusing all the others and emphasizing the differences rather than the similarities. In direct contrast to these tendencies, it is the special aim of the present author to keep watch for every possible reconciliation and to endeavour to combine elements from different and even opposed schools of thought. This is not to be done in a spirit of a kind of scientific pacifist who shuts his eyes to secret armaments, nor is the author unaware of the danger of easy compromises. What he is striving after is a synthetic attitude rather than an eclectic one. This is, he believes, an urgent necessity in present circumstances.

It would at first seem to be an attractive idea to start the analysis by giving a synoptic account of the doctrinal history of the theory of crises and cycles. On second thoughts, however, this idea loses much of its attractiveness. In order to be of any value, such a synopsis must be more extensive than is compatible with the scope of this book.1 But even if this difficulty were overcome there would still arise the more serious difficulty of how to arrange the different theories in accordance with their most significant characteristics, which is essential if the synopsis is not to be merely a pointless chronology. A systematic classification of the theories of crises and cycles is difficult to attain because almost every theory so far developed, save the most eccentric ones, contains some elements belonging to another type of explanation so that an attempt at systematic classification inevitably leads to numerous overlappings and cannot do justice to the theories in question. To quote only one instance, it is almost impossible to draw a clear dividing line between the under-consumption theories and the over-capitalization theories, there being a large margin of overlapping, and even the division between monetary and non-monetary theories, though indubitably a very important one, has many loopholes. This accounts also for the fact that none of the several attempts which have been made at systematic classification of the theories of crises and cycles seems really satisfactory.

This is true even of the most successful attempts at classification among which those made by Wesley Mitchell and Alvin H. Hansen are especially noteworthy. Mitchell2 divided the different theories into three large groups: firstly, theories which trace crises and cycles to physical processes (cycles of crop yields, &c.), secondly, theories which relate crises and cycles to emotional processes (especially with mass alternations of optimism and pessimism), and, thirdly, theories which connect crises and cycles with institutional processes, i.e., with factors arising out of the structure and the institutions of our present economic system. The large third group is then subdivided into a great number of subordinate groups with different points of view. Hansen,3 while clearly demonstrating the difficulties and shortcomings of any classification, distinguishes (1) the Capitalistic Economy schools, which stress either the capitalistic process of distribution or the capitalistic process of production; (2) the Exchange Economy school, which considers crises and cycles to be a function of the competitive exchange economy and points particularly to recurrent errors of judgment (the psychological school in Mitchell’s classification), and (3) the Money Economy school which believes that the root of crises and cycles lies in the monetary and financial mechanism of our economic system, a school which is, broadly speaking, equivalent to what is more generally known as the monetary theory of crises and cycles.

In view of these difficulties, the present writer has preferred to forego a classified presentation of theories and theorists, and to adopt a different approach. The programme of this chapter is to examine all the elements and circumstances which offer any chance of explaining the origin of crises and cycles and to set aside for a final analysis those elements which, in the process of sifting, prove useful in this respect. In the last two paragraphs, special attention will be given to the problem of the origin and course of the present crisis. Following this programme, it is to be hoped that the analysis may seem less scholastic than is all too often the rule in these matters and may seem more realistic without losing its rigidly scientific character.

There remains the cumbersome but indispensable task of dealing with certain methodological questions which the problem involves. Among these the most important and also the most controversial question is to ascertain whether the method of deductive analysis or that of empirical description offers the better chances of bringing us nearer to a solution of the problem.

While the older literature on crises and cycles was principally based on deductive reasoning, though of necessity starting from the facts presented by the actual history of economic fluctuations, there has sprung up, in the last decades, a new school which claims, emphatically and with ill-concealed scorn for “theoretical” analysis, that the collection of statistical data, their intelligent arrangement, and their mathematical analysis constitute the only method appropriate to the problem. This method is sometimes spoken of as “quantitative analysis” (in contrast to the “qualitative” analysis of the deductive school), as “descriptive analysis” (Mitchell) or in the German literature, as “Konjunkturforschung” pure and simple (in contrast to the “Konjunkturtheorie” of the deductive school). Its general background is always the curious but ineradicable misconception of scientific methodology which was the characteristic of the late Historical school and which has been evolved further in its modern reincarnations, especially by the Institutionalist school in the United States.4 The recrudescence of the fundamental error inherent in this whole methodological trend is closely connected with the activities of the numerous research institutes which have been founded in the last decade in the United States and also in many other countries, with a view to obtaining a better diagnosis of economic conditions and their fluctuations and also, in the eyes of the more optimistic workers in this field, a prognosis of changes in economic conditions. These institutes—among which the Harvard Committee of Economic Research, the National Bureau of Economic Research in New York (with Wesley C. Mitchell as one of the directors), and the Institut für Konjunktur forschung in Berlin (with E. Wagemann as president) are the most noteworthy5—have been developed into large economic laboratories where, with a most refined apparatus of mathematical distillation, the raw material of statistical facts is worked up until we get the finished products in the form of all kinds of “cycles,” of “coefficients of correlation,” of “trends,” of “moving averages,” of logarithmic scales, of business “indices” and “barometers,” of “isolated time series” and what not. It is easy to understand that, in this atmosphere of institutionalized science with its air of exactness and progressive technique, not many escape the temptation to look down upon old-fashioned “theory,” with its small business unit of the private study, as something hopelessly behind the times and to claim for their descriptive and statistical method a wider field of application than is compatible with the logic of scientific methodology. Instead of confining themselves to the more modest but very meritorious task of collecting, arranging, and interpreting all the available facts and statistical data and of verifying the results of deductive reasoning, these men thought it possible to replace deductive reasoning entirely by their empirical and statistical method. Deductive theory, essentially centring around the static conditions of economic equilibrium, was declared to be totally unsuited to explain the disturbances of this equilibrium; the new “Quantitative Economics” was claimed on many sides, as the only suitable method for complying with the desideratum of Dynamic Economics. Other writers of this same school—for instance, Wagemann and to some extent also Mitchell—go so far as to deny that the search for causal relations in crises and cycles is a legitimate object of economic science.

Now, there cannot be the slightest doubt that the development of statistical research work, with its refined methods of observation and interpretation of the facts of cycles and crises (“Konjunkturforschung”), has been, in its proper field, a great advance, and there is nobody who does not appreciate very highly the work done by the several research institutes. The picture of the phenomenon of crises and cycles given in the second and third chapters of this book has been largely based on this work. The empirical basis on which the theoretical analysis of crises and cycles must necessarily be constructed has been broadened by it in a manner which leaves less room for mere guesswork and vague hypotheses, and also there is no disputing the educative influence emanating from the work of the empiricists on the mental sobriety of the theorists. On the other hand, however, it is equally indubitable that the scope of the work that can be usefully done on these lines is rather more limited than was believed in the early enthusiasm of the ’twenties. The present crisis, which has reduced so many extravagant expectations to more reasonable proportions, has also exploded the more far-reaching hopes of the cycle statisticians. The attempts at prognostication especially have lamentably failed as was most conspicuously demonstrated by the breakdown of the “Harvard Barometer.” Since this is a striking example of the inherent defects of this kind of work, it may be useful to explain that the diagnosis and prognosis given by the Harvard Committee was based on the combination of three time-series the temporal order of which was supposed to follow a regular course so that, at a given moment, the point in the business cycle corresponding to the constellation of the curves at that moment could be determined.

It was indeed an ingenious idea to apply the principle of nautical astronomy to economic forecasting, but there was one fatal flaw. For as long as we have not made a thorough investigation into the causal relationships between the time-series, the mere temporal sequence does not tell us any more than that something has happened in the past which might not happen in the future if some variables in the causal mechanism should change. But in investigating the causal relationships we are thrown back from statistical empiricism to “theory” in the deductive and analytical sense. Hence this whole procedure of the empiricists falls little short of the reasoning of the legendary army doctor who, being informed that a foot-soldier sick with typhoid fever had quickly recovered after having eaten by mistake a liberal portion of sauerkraut, decided that sauerkraut is a cure for typhoid fever. And many hasty attempts at introducing some sort of theory, after the flaw in the empirical procedure has been detected, come quite near to the reasoning of the same army doctor who, after having applied his recipe on an unfortunate lancer with fatal effect, corrected his first deduction by saying that everything depends on the kind of arms. A great deal more could be said on this subject to show that the whole idea of forecasting, whatever its methods, is based on a number of misconceptions which go far to rule it out as a useful undertaking.6 Even the accomplishment of the more modest task of economic diagnosis encounters great difficulties. The errors in diagnosis and prognosis made by the Cycle Institutes in the last five years have, indeed, been so many that it is really to be wondered whether the world would not have been better off without these more ambitious activities, considering the harm done in economic policy by misleading diagnosis and forecasting. These experiences are closely connected with methodological misconceptions about the merits of statistical empiricism and the demerits of analytical theory. It can be safely assumed that, to-day, there is perhaps a better understanding everywhere of the fact that no intricate statistical research work, no calculations of “coefficients of correlation,” “trends,” and “moving averages” can bring us a single inch nearer to the solution of the problem of the causation and of the mechanism of crises and cycles. By the statistical method, we ascertain facts, but we cannot explain them, i.e., bring them into logical order so that we “understand” them. Only analytical theory can do that, and if there has been, in recent years, any furthering of our insight into the mechanism of crises and cycles, this has been the work of the theorists and not of the empiricists.

While it can be safely assumed to-day that the legitimacy of the method of analytical theory is hardly contested any longer (with the possible exception of very hard-boiled Institutionalists in the United States), there still continues a lively discussion about the real nature of the problem involved in the phenomenon of crises and cycles and about the type of theory appropriate to it.7 For all our aversion from every kind of “prolegomenism” and from philosophizing endlessly about tools without really getting to work, it is well to be clear on two points : first, that the phenomenon of general economic disequilibrium as revealed by crises and cycles constitutes a problem unexplained by general economic theory which is essentially a theory of economic equilibrium and of the forces working interdependently for its continuous restoration, and, second, that, in spite of this, there cannot be any doubt that the problem constituted by the recurrent disruption of the economic equilibrium must be tackled by the same type of analysis as that applied to the problems of economic equilibrium. To decry this type of economic analysis as “Static Theory,” and to clamour for a “Dynamic Theory” instead, is to confuse a question of method with a question of subject and to misconceive the real nature of analytical economic theory which must of necessity be the same whether applied to questions of Statics or to those of Dynamics. The real task and purpose of the theory of cycles and crises, therefore, is to modify and enlarge the scope of general economic theory so as to include the explanation of the recurrent disruptions of economic equilibrium. Since practical economic life has been up till now continuously caught in the ups and downs of disrupted equilibrium, the theory of crises and cycles is of special importance in making the whole body of economic theory more realistic. Such a theory, it must be repeated, is not a new and independent kind of theory with methods of its own, but a part of the general body of economic theory, based, as a kind of superstructure, on the theory of economic equilibrium and modifying or enlarging its general propositions. It must be, in the celebrated words of Böhm-Bawerk, “the last, or the last but one, chapter of a written or unwritten system of Social Economics and the ripe fruit of the knowledge of all economic processes and their functional connections.” It must be noted, however, that in order to harmonize with the general body of economic theory, the theory of crises and cycles must be able to explain in a really convincing manner why the very strong forces always working for equilibrium are recurrently counteracted so that the whole system of balancing factors breaks up. Not all theories so far advanced have proved able to do this, for they point to disturbing factors which, in the light of general economic theory should be easily digestible by the economic system. It is well to remember this point in the subsequent sections.

Something more must be said in order to describe more exactly the real nature of the theory of crises and cycles. Mention has already been made in § 4 of the fact that the scientific analysis of economic fluctuations began with the phenomenon of crises and only at a comparatively late date was it realized that the theory of crises must be incorporated into the more general theory of cycles, Juglar being the outstanding pioneer in spreading this new conception. It must not be thought, of course, that the earlier writers up to the last quarter of the nineteenth century were ignorant of the phenomenon of cyclical fluctuations; it was only that their scientific curiosity was predominantly directed towards the more dramatic phases of the crisis and the depression. The obvious reason for this narrowness of viewpoint lies in the fact that the boom phase of the cycle, characterized as it is by full employment of the factors of production and by an altogether healthy aspect of economic life, gives the outward appearance of perfect economic equilibrium—except for the last stage of hectic speculation which aroused enough suspicion even among the earlier writers. Hence it was generally thought that this phase was just that phase which corresponds to Equilibrium Economics, without there being anything peculiar about it demanding a special explanation, and again from a practical point of view there seemed nothing pathological about the boom phase to give rise to concern and uneasiness. The only trouble was that it did not last; it did not only just come to an end but was usually followed by the worst kind of economic disequilibrium. This had to be explained, but it was only by a slow process that the origins of the crisis and of the depression were traced to the preceding boom and thus the real pathological character of the latter discovered. In all this, the attitude of the earlier writers corresponds closely to the attitude of the general public in these matters : the boom is generally taken as something normal and enjoyable with nothing the matter with it, and when the crisis breaks out the causes are sought in all directions save for the one direction in which they should be sought, i.e., in the unhealthy and abnormal conditions created by the boom. The regular temporal sequence of boom and crisis (or depression) experienced during one century of capitalistic development has, of course, done much to shake this attitude and to suggest that the temporal sequence implies a causal one.

There remains one final question. Is it really true that the phenomenon of crises and cycles is a general one like the phenomenon of price or interest, or is every crisis and every cycle just an “historical” event more or less unique in its kind, with a kaleidoscopic change of constellations? If the latter should be the case, then a special theory of crises and cycles has evidently no real raison d’être since nothing useful could be said on crises and cycles in general; every crisis and every other phase of the cycle would create a new concrete situation which would have to be analysed with the tools of general economic theory. This is, in fact, a view held by several writers.8 The present writer, however, is not prepared to accept it. Though he would concede that many cycle theories have the defect of making too sweeping generalizations, it seems that the radical view referred to overlooks the fact that all crises and cycles of our economic system can, if their ever-changing accessory traits are eliminated, be reduced to a uniform pattern of typical constellations of data. The common denominator of all crises and cycles is to be found in the typical reaction of the mechanism of our economic system to certain disturbing factors by which the economic equilibrium is totally upset. This typical reaction is such a regular occurrence that it calls for a special explanation, which it is the task of the theory of crises and cycles to give. We may conclude, then, that this last and perhaps most serious attack on the legitimacy and necessity of the theory of crises and cycles can also not be said to have been really successful.

§ 10. THE GENERAL SOURCES OF DISTURBANCE.

The real nature of our present economic order is characterized on the one hand by an extremely great differentiation of the productive processes (the division of labour), and on the other by the lack of any central, conscious planning authority to guide this vast complicated machinery. It is a blend of the finest differentiation and almost complete anarchy, and is based upon a boundless wealth of voluntary decisions, and upon freedom in production and consumption and in the lending and borrowing of credit. Economic theory shows by what inherent laws these millions and billions of individual decisions and economic acts are so welded together that this anarchist type of economy, which is capitalism, does not lead to a state of chaos, but actually makes capitalism capable of very high achievements, causing the achievements of the economic systems of the past to seem insignificant, and also assuring to the economic system of our day a position superior to that of any collective system of the future. That a social system of such extreme differentiation and complexity is likely to possess a very unstable equilibrium and to be subject to manifold disturbances is at once obvious. The miracle is not that it functions amid continuous disturbances and oscillations, but that it functions at all, and with such comparatively good results. That is the great miracle which has again and again fired the curiosity of men in modern times and has given rise to the science of economics.

The only way to understand the phenomena of economic fluctuations and disturbances, crises and unemployment, is to realize at the very outset that our present social order is an economic system based upon division of labour carried to its extreme limits. In any study of crises and cycles, it must be realized from the first that in such a vastly complicated, knife-edged economic organization as that of to-day held together by the bond of voluntary decisions, frictionless co-operation cannot be expected. It is inevitable that the individual parts of the process will fit in with each other sometimes better and sometimes worse, and it is at least conceivable that the disturbances and frictions may become so great that the whole machinery will at times come to a complete standstill—with the paradoxical effect that millions of people who are able and willing to work must sit with idle hands, because they can find no work, although the distress of the masses during this very period of crisis cries out for an increase in production. If things are going badly in a country of self-supporting peasants like China, for instance, because over-population leaves too little land for each individual, the obvious thing is for the peasant to work more. He would not understand the phenomenon of unemployment and would think it a good joke if he were told that there are countries where work has become a boon for which men beg as for bread, and that those who do extra work in their spare time are hated by their fellows as “double wage-earners.” He would consider this a grotesque state of affairs, and we should be obliged to agree with him. But we should have to reply that the periodic recurrence of this grotesque state of affairs is the price which we must pay for the enormously higher productivity of an economic system based on the logical carrying out of the principle of the division of labour. The susceptibility of the economic process to disturbances of equilibrium grows with the degree of the division of labour, but so does the productivity of the economic system as a whole. If we wish to avoid all disturbances of equilibrium, we must return to Robinson and his miserable standard of living; and if we do not wish to do that, we must be prepared to accept the greater instability of the economic system. That is the dilemma in which we find ourselves.

But the choice is no longer ours, since the increase in productivity due to the increasing division of labour, and the production technique made possible thereby, have led to a tremendous growth of population throughout the world, so that we cannot diminish the present degree of the division of labour without endangering the existence of countless millions of people and with it the existence of our social order—a very hard and sober fact which puts an end to all the dreams of economic romanticists and autarkists, but should also put a necessary damper on the usual optimistic appraisal of the growth of population and the equally common pessimistic view of the present decline in that growth.9 In other words, the pronounced instability, combined with the top-heaviness and complexity, of our economic system, based as it is upon a high degree of division of labour, are the high price which we must pay for an increased productivity, which has resulted partly in greater prosperity and partly in a tremendous increase in population; and as far as this latter result is concerned, we are no longer masters of our decisions but prisoners of our fate. This must be kept in mind in passing judgment on the growth of population in the past, as well as the decline of population in the present and the future. If the present world economic crisis is perhaps already a sign that the more and more stilted industrialism based on the division of labour has reached its limit, the falling tendency of the birth-rate of the present day and of the future certainly deserves special consideration in this connexion. If the growth of population in the past was a factor making for expansion and instability, the decline of population in the future will be a factor making for stability.10

The instability of our present economic system, due to the division of labour, is now being rendered still greater by the fact that with the increasing division of labour the technique of production has changed in such a way that the production of consumption goods is becoming more and more indirect, and follows the roundabout way of the previous production of producers’ goods (machines and the products necessary for the construction of these machines, transport, building, &c.). The modern process of production is therefore not only based on the division of labour, but is an indirect process following circuitous and therefore time-absorbing routes. If the division of labour as such demands that the producers should estimate each other’s demand for goods correctly, in order to avoid disturbances of equilibrium, the special production technique connected with this system of division of labour leads to the further necessity of correctly estimating also the demand for intermediate products, and the volume of the intermediate products must be kept in the proper ratio to that of the final products, and this despite the difficulties involved in the time-absorbing character of our production process. It is easy to see that we have here a storm centre of the first rank. That it is indeed the principal disturbing factor, round which every adequate theory of crises and cycles must be built, will be shown later.

In so far as a socialist state maintains the present-day scale of the division of labour and the production technique described—and it will have no other choice, unless it immediately exterminates a considerable part of the population—it, too, must inevitably fall a victim to the disturbances which arise from the complexity of the economic system. It is therefore quite wrong to assume that a socialist regime would be able to bring about a state of affairs from which crises and disturbances were absent. Moreover, there is reason enough to assume that the bureaucratic, centralized organization of the socialist state, with its inevitable abolition of the pricing mechanism of the free market, would lose the indispensable measuring-rod of direction and economic calculation, and would finally provoke such violent disturbances that the further continuance of this system would prove altogether impossible. The reader should therefore be warned against drawing conclusions from a comparison of the present state of the Russian economy, which has only had a few years in which to test its staying power, with the present state of the capitalistic world, which has shown, over a period of more than a hundred years, not only that it is capable of continued existence, but that it is able to create prosperity, in spite of all its crises That a socialist system may succeed in building electricity works and things of like nature in gigantic style causes us as little astonishment as the successful building of the Cheops pyramid. In both cases the only astonishing thing is the tremendous social pressure and the great capacity for restricting consumption, which make such investments possible, and the politico-social system which withstands such pressure.

Russia is to-day experiencing a boom which, like the boom in a capitalist country, is characterized by the forcing upwards of investment activity, and the prudent observer will wait and see what the final end of the Russian investment orgy will be. Russia cannot avoid the necessity of finding a new equilibrium of the national economy at the end of the investment period (which can be lengthened until the unhappy population are in a state of complete misery); and exactly as in the case of a capitalistic boom, this new equilibrium is all the harder to find, the steeper has been the rise of the investment curve. It will soon dawn upon us that the verdict of many people on the present Russian “prosperity” is as short-sighted and lacking in historical perspective as their verdict on the American “prosperity” of a few-years ago, and that they fail to foresee the possible end, although the lack of foresight and perspective in this case is still more inexcusable, (1) because the American lesson lies behind us, (2) because the weak places in the Russian investment boom are still more obvious, and (3) because its violence can be plainly read in the simultaneous impoverishment of the Russian people while a capitalist boom usually leads to a rise of consumption. It does not show any very deep understanding of economics to assume that something is to be gained by replacing the ensemble of individual decisions, guided by self-interest, which is characteristic of capitalism, by the control of government authority. The contrary is true.

It is a striking fact that, in contrast to this view, popular opinion in many countries to-day takes it for granted that a Socialist Economy (which is, technically speaking, equivalent to a totally Planned Economy) has, whatever its other shortcomings may be, at least the advantage of being a cycle-proof economy. It seems that this opinion rests mainly on a kind of short circuit of reasoning. There is, of course, no denying the fact that, theoretically, an economic system is conceivable in which the typical disturbing factors of our present economic system are eliminated by a suitable management of the whole economic process in its every detail. To admit this is one thing, but it is quite another thing to jump to the conclusion that the magic word “Planning” suffices to open the door to this—in many respects rather dubious—paradise, promising to make the world safe for stability. It is not sufficiently recognized that “Planning” is only just a word vaguely indicating the general principle of Socialist Economy, and it is a safe bet that the overwhelming majority of our planners have probably no inkling of the gigantic problems which lie behind this word. In fact, Collectivist Economic Planning presents so many and such crushing difficulties that there is very little prospect of its coming anywhere near the productivity of our present economic system (even in its present deplorable state) and of its guaranteeing an harmonious balance of the economic body.11 The socialist economic system will in all probability lead both to diminished productivity and to a greater lack of economic balance, and these two effects are closely interrelated.

As it is, the economic disharmony which promises to become a chronic ailment of the Socialist Economy will show this marked difference from the temporary disharmony of the Capitalistic Economy, that it will not become manifest at the place of its origin but will be shifted from the economic apparatus on to the shoulders of the consumers. In other words, the original tumour will breed, as it were, metastases in the more distant parts of the economic body. There will be no more bankrupt firms, and, given a certain inventive faculty for disposing somehow of embarrassing masses of human beings, there will not even be unemployed as we know them to-day. But that, of course, does not mean that we have got rid of the innate economic disharmonies. What it means is rather that we shall have destroyed both the machinery registering the place of their origin and those forces which, under our present economic system, work automatically to do away with them. The economic machinery continues to “function” in a way, but the population, besides being deprived of elementary personal liberties, will have to bear the consequences of the economic disharmonies by being worse off than before. “Crises” in the Socialist State of perfect Planning will be characterized, then, by the fact that people will suffer by them as consumers rather than as producers while the economic apparatus will show, at best, the outward appearance of being in some sort of order. But the latter, as already indicated above, is not an advantage but a great disadvantage as compared with capitalism. Hence the result we are most likely to get will be as follows: The socialist system of Total Planning will probably succeed, in a very short time, in turning the present paradoxical “poverty amidst plenty” into the more respectable “poverty amidst shortage”; but as the innate economic disharmonies will be a lasting feature of this system, the poverty is bound to become just as chronic as the corresponding disharmonies. What we get in exchange, then, for capitalism with all its shortcomings is poverty and disharmony being greater than ever before and becoming chronic into the bargain—and this without the economic, political, and personal liberties for which even the poorest unemployed in the capitalistic countries will regretfully yearn when it is too late. It is perhaps pertinent to add that the colour of the political flag under which the system of Total Planning is launched makes, of course, absolutely no difference.12

It is hardly possible to over-emphasize the fact that every economic system, no matter how organized, which is based on a very high degree of division of labour and on a technique of production as complicated as the present one, is bound to be exposed to all sorts of dynamic disturbances. On the other hand, however, it would not be defensible to deny that the regulating principle of the capitalistic economy—the fundamental freedom of individual decisions and economic acts, which is bound up with the private ownership of the means of production and with competition—leads on its side to specific disturbances, which could perhaps be avoided by a modification of this regulating principle. It is indisputable that competition can lead producers astray into economic conduct which is guided more by the behaviour of the competitors than by considerations of the general economic interest. In this way the boom, like the depression, can easily assume an exaggerated form, and so to-day a considerable weakness of our individualistic competitive system is observable in the fact that no single entrepreneur believes that he dare take on new investments (a fact which explains the duration and acuteness of the present depression) as long as investments do not show a general tendency to rise.

In addition to the division of labour, the pronounced and growing importance of the production of producers’ goods, and the special regulating principle of our economic system, there is the fact that our economy rests upon the use of money and credit, a further very serious source of trouble. Although it is an indispensable simplifying method to represent the complicated economic process of to-day as a procedure in which money is only an auxiliary and ultimately goods are exchanged for goods, it would be false to ascribe a merely passive rôle to money in economic life. On the contrary, changes in the volume of money (or of credit) and in the velocity of circulation of money can call forth changes and disturbances in the economic process, which are so important that one group of economic theorists (the adherents of the so-called monetary theory of the cycle) see the ultimate cause of economic fluctuations in happenings within the money and credit sphere.

Furthermore, it is important to note that freedom in the application of money income is indissolubly bound up with the regulating principle of our economic order. This freedom means, on the one hand, freedom of the individual to determine how much of his income he shall spend and how much he shall save, and in what way he shall save, and, on the other hand, it means his freedom to choose the goods on which he shall spend his money. As the economic equilibrium can only be maintained if the component parts of production correspond to the application of the individual incomes (while this application can be more quickly changed than the corresponding components of production), it is obvious that this freedom to consume and to save is a further source of disturbance of the first order.

Finally, our economic system is, like every other, exposed to the disturbances which force their way into the economic process from without, either through nature or through politics. Particularly important in this connexion are the fluctuations of harvests, by reference to which attempts have been made to explain crises and cyclical fluctuations. But none of the representatives of this climatological theory of the cycle has succeeded in fully proving his contention.13 The same is true of population changes, which doubtless represent a dynamic factor of great importance, but are not sufficient to explain crises and cycles.14

§ 11. OVER-PRODUCTION.

The paradoxical nature of the crisis is characterized by the fact that production is curtailed in every direction, and there is no work anywhere, while so far as the economic position of millions of people is concerned, we could really be doing nothing better than getting every ounce of product out of men and machinery. Curtailment of production follows curtailment, dismissals of workers follow dismissals; machines and rationalization have made production easier all along the line during the previous boom, and have rendered human labour superfluous. In vain do we look round for new and profitable possibilities of production, which might reabsorb the unemployed. What is easier, then, than to assume that the cause of the crisis is general over-production, developed in the preceding boom—in other words, that the total production has outstripped the total consumption, and that the crisis must therefore be overcome by a reduction of production (curtailment of work, suppression of rationalization, and restriction of output). As a matter of fact, this is the most popular crisis theory at all times of crisis, and to it there corresponds the contraction of production which the producers, in the difficult position in which the crisis places them, undertake, or are forced by the government to undertake, all along the line. At such times men’s thoughts and actions are dominated by a “fear to produce.”

It is an indisputable fact that a general slump, which does not permit of the scale of production reached in the boom being maintained, sets in during the crisis, and it is equally indisputable that this general slump is the result of the total demand suddenly falling behind the total supply. But let us make sure what this means and what it does not mean.15 Under no circumstances can it mean that the cause of the general slump is to be sought in the fact that production has outstripped consumption and that too many of all goods at once are being produced. Closer consideration shows that there is no logic in such a view, for in relation to what can too many goods be said to be produced? Surely not in relation to wants, i.e., to the willingness-to-consume, for that would completely upset the idea of all economy as an activity concerned with the overcoming of the eternal scarcity of goods, and cannot be seriously considered. The standard of living among the masses, measured by what is considered as necessary to-day among the upper strata of society, is still at such a miserably low level that a hundred times the production hitherto attained would scarcely suffice to bring the well-being of the masses up to the level of the upper classes. Until that is done there is not the slightest sense in disputing that all productive forces at our disposal must be employed in the fight against the scarcity of goods. We are not really at a loss to know what to do with our productive forces as long as we do not live in Lubber-land.

Taking all in all, therefore, we cannot have too many workers, but only too few; we cannot have too many machines or too much rationalization, but only too little. But are the millions of unemployed not a shattering proof of the fact that we have too many workers? The best answer to this question is not long theoretical arguments but the following simile. The struggle against the scarcity of goods which we are condemned to wage for all time, and always with inadequate forces, can be compared to the struggle of the German army against the superior numbers of their opponents during the World War. Every soldier was used in that struggle, and the Germans would have been glad if they had had at their disposal more millions of men, or of tanks to replace soldiers, such as their enemies had. Nevertheless it happened, owing to difficulties of organization which could scarcely be avoided in such a huge and complicated structure as the German army, that from time to time isolated troops were kept out of action, while at other places on the front they were sorely needed. Thus a scarcity of soldiers in general was here accompanied by a superfluity of soldiers at certain isolated places. No one in possession of his senses would have concluded from this that these soldiers who were temporarily kept out of action should have been sent home as superfluous or that the “work” of the army could have been “spread” by lengthening the men’s leave or replacing guns by halberds and pikes. The juxtaposition of too little in general and too much in particular was in this case so obvious that it could not escape even the densest observer. And yet most people find it extraordinarily difficult to believe that in the economic system it is fundamentally the same. This is because money and the division of labour, which characterize the particular method used by our economic system in its fight against the scarcity of goods, have drawn a thick veil over the connexion between the two, the piercing of which requires a special mental effort and, above all, the courage to reduce things to their simplest terms.

An economic crisis (that of to-day like those of the past) can therefore not be interpreted as a general over-production of all goods at once, a surpassing of the possibilities of consumption by the possibilities of production, but only as a lack of proportion between the different lines of production, in short, as a functional disturbance within the highly complicated modern exchange economy. The disparity between the goods at our disposal and our unsatisfied wants is more obvious than ever, but the wheels of the machine which delivers the goods do not fit together properly at times of crisis.

According to the logic of the over-production myth, the total volume of production in question is a more or less fixed quantity, to be shared by the people, with the result that each watches jealously to see that the others do not receive too large portions. A further result is that in international exchange the individual States strive by tariffs or other hindrances to imports, to preserve as large a portion as possible of the limited volume of production for their own national economy. But how is this production quantum to be determined? Apparently by the fact that there is a fixed limit to the purchasing power needed to buy the products. But the incomes with which the goods produced are bought come ultimately from the production itself, and the total sum of the incomes is also determined by the total sum of the production. If we follow out these relationships to their logical conclusion, we find that production is not determined by consumption, but consumption by production. That is to say, there is no limit to profitable production as a whole (i.e., apart from the question of the correct composition of the total production), since the saturation point of human wants is immeasurably far off, but there is, unfortunately, a limit to consumption, which is determined by the utmost we can produce with our limited forces and means. Anything else is absurd: the fear of production is absurd, as is the view that we must constantly be prepared to “spread” the volume of production; and equally absurd is the campaign against all efforts to increase productivity.

The over-production myth often takes the form also of connecting up the level of unemployment with the excess of the number of workers over the total amount of profitable production, and thus of interpreting unemployment as a symptom of over-population. But this idea that the number of unemployed expresses the degree of over-population of a country is equivalent to the erroneous conception that the total sum of the production to be undertaken is a given fixed quantity, which, beyond a definite number of the population, is not sufficient to occupy everyone. This conception is contradicted not only by all the theoretical arguments which have already been levelled against it, but also by the fact that the world crisis of to-day is afflicting rich and poor, thickly populated and thinly populated countries, with equal force. Unemployment in France—which, in the first phase of the world crisis, many believed to be safe from the scourge of unemployment as a country not suffering from over-population—also later reached considerable proportions corresponding to the degree to which France was affected by the world crisis. Finally, if we were to decrease the population of Germany by deporting twenty million people, taking care to leave unchanged the relative numbers of workers in the various branches of economic activity, we should not be one step nearer solving the problem of German unemployment, but we should find new confirmation of our thesis that it is a question of the qualitative factor, of the functioning of the apparatus, and not of the quantitative factor or the size of the economic apparatus.

That all these considerations are old-established propositions of political economy is shown by the following passage from Ricardo’s Principles of Political Economy and Taxation (Chapter XXI)—

Productions are always bought by productions, or by services; money is only the medium by which the exchange is effected. Too much of a particular commodity may be produced, of which there may be such a glut in the market as not to repay the capital expended; but this cannot be the case with respect to all commodities; the demand for corn is limited by the mouths which are to eat it, for shoes and coats by the persons who are to wear them; but though a community or a part of a community may have as much corn, and as many hats and shoes as it is able, or may wish to consume, the same cannot be said of every commodity produced by nature or by art. Some would consume more wine if they had the ability to procure it. Others, having enough of wine, would wish to increase the quantity or to improve the quality of their furniture. Others might wish to ornament the grounds or to enlarge their houses. The wish to do all or some of these is implanted in every man’s breast; nothing is required but the means, and nothing can afford the means but an increase of production. If I had goods and necessaries at my disposal, I should not be long in want of workmen who would put me in possession of some of the objects most useful or most desirable to me.

An indirect disproof of the over-production myth may be given as follows. If it were correct and not merely a myth, we should have to conclude that, during the depression production all along the line must be pushed back to the level of consumption, that is to say, to the market opportunities. And it is just this conclusion that is drawn by every single entrepreneur faced by a glutted market when, in the case that a fall in costs does not take place to the necessary extent, he tries to reach a new equilibrium at a lower level by diminishing his production or by suspending his business altogether. Nobody can reproach him for this since he is compelled to do it by the circumstances. But if everybody acts similarly and has to do so out of individual economic necessity, does this remedy the malady as a whole? Undoubtedly not, so long as the diminution of production in one place does not make room for an extension of production in another. The “fear to produce” may be well founded in the individual case, but, in so far as everybody gives way to it, the effect is senseless because it runs directly counter to the purpose. What in fact happens is that the curtailment of production leads to the further destruction of purchasing power simply by virtue of the interdependence of production and the creation of purchasing power, an interdependence which we must continually stress. So long as no new production starts up, the economic system is caught, via the universal practice of curtailing production, in a cumulative decline in which the original disequilibrium between supply and demand is progressively enhanced on an ever lower level. Consequently general over-production cannot be the cause of the depression since a diminution of production does not only not overcome it but even makes it worse.

It should be beyond all doubt that a general over-production relative to the desire and the capacity to consume is inconceivable. When we consider that purchasing power is created afresh with production, it follows furthermore that it is equally impossible to produce too many of all kinds of goods at once in relation to purchasing power. It is inconceivable that all producers can have produced an excess and that they cannot mutually exchange the surpluses provided that they have adjusted their production correctly to the corresponding demand. Let us assume an isolated economy consisting of two producers, of whom one (A) produces only bread and the other (B) only shoes. The equilibrium of the system depends on whether A and B estimate correctly each other’s demand for bread and shoes respectively. If A, for example, miscalculates in this connexion, then a part of the bread he produces will be unmarketable. The total supply in this miniature economic system exceeds by so much the total demand. Over-production is undoubtedly present, but not in the sense that too much of all imaginable goods has been produced—B in our example would gladly have accepted a roast chicken—but because not the right kind of goods has been produced. But if this is the case, the equilibrium of the economic system can be seriously disturbed and a general glutting of the market occur. The essence of all these considerations is this: A depression is a time of a general glutting of the market, which can be described as the exceeding of total demand by total supply and expresses itself in a general price fall. But this glutting of the market is caused not by a general overproduction (of all conceivable goods) but by a disproportionality disruptive of the equilibrium of the economic system in the composition of total production, in other words a partial over-production, which by reason of the mutual interdependence of all producers finally leads to a glutting of markets, that is, to a lagging of total demand behind total supply extending to all branches of the economy.

This elementary consideration must form the starting point for any adequate theory of cycles and crises. It is the task of this theory to show how a disproportionality destructive of equilibrium comes about. The rejection of the over-production theory does in no way imply that the crisis is unobjectionable. It simply dismisses an impossible explanation. To those who are hit by the depression it may be quite indifferent whether we call it “general over-production” or “general glutting of the market”; it loses none of its gravity thereby. Neither should it be imagined that the partial over-production (disproportionality), which leads eventually to the general glutting of the market, still manifests itself in the crisis in such a way that those who produce too much find their counterpart in those who produce too little. The disproportionality develops in the upward swing of the cycle, but in the depression it is in vain to look round for branches of production where too little is being produced. The foregoing analysis will have made it clear why this is so: the disruption of the equilibrium in the economic system has disturbed the process of exchange all along the line, a disturbance in which the whole of production is involved. The requisite additional production has become a mere latent possibility which only comes to light with the restoration of equilibrium.

All these conclusions are of the utmost practical importance because without them we are absolutely unable to find our way through a mass of complexities. To the alarming question as to what shall ever become of the millions of unemployed and of the unused plant of rationalized producing units when all markets are glutted and every occupation and branch of production is overcrowded, the answer can only be: The market for the products of these at present unused reserves of productive resources will present itself when those who are at present pushed out of the productive process have, by their reabsorption, again become buyers, and that will be the case when the equilibrium of the system has been restored. The unused reserves of productive resources correspond in the same measure to unused reserves of purchasing power—this is the lesson that we have learned from the refutation of the over-production theory.

The restoration of equilibrium creates purchasing power. No discerning person will surely believe that the level of production at which we are now working constitutes the magnitude to which we are condemned in the long run, that the paradox of the parallel existence of highly productive but idle plant and millions of unemployed men willing to work and at the same time hungry for goods will remain permanent, and that the millions which we have spent on the modernization and rationalization of our productive equipment were wasted. In every depression the typical popular feeling is that the depressed state of the economic system has come to stay for all time, just as in the boom it is typical of popular feeling to forget that on the fat years lean ones follow.

But calm consideration should convince even the most resigned pessimists that our permanent economic fate should not be confounded with the passing poverty in which the crisis, to the extent of the decline of production, has plunged us, and that once the “fear to produce” has been overcome by the reattainment of equilibrium it will turn out that we are much richer than we believe to-day when we are deprived of the production of the unemployed and of the idle equipment.

Furthermore, the recognition of the untenability of the overproduction theory does us the inestimable service of guarding us, in times of crisis, against measures which are next to useless even in the most favourable case, and which usually only protract and aggravate the malady, since they hinder the reattainment of equilibrium. All those measures, much discussed in all countries, such as spreading the work, labour service, relief work, the campaign against “double earnings,” and the raising of the school leaving age, must be judged from this angle. All these measures are of a purely symptomatic nature, which may make the effects of the crisis more bearable but may harbour the danger of delaying the recovery from the depression. Their true nature can be realized if we return to the military analogy developed above and recall that it may seem absolutely necessary to “occupy” the soldiers who are temporarily out of action by pots-and-pans inspections and other means specially devised for this purpose, so as to protect them from demoralization. But it has also to be remembered that nobody in the war was struck by the idea that because we were somewhat at a loss to know what to do with a section of our men we should make this “occupation” an end in itself and a permanent institution. On the contrary, everything was done to avoid disturbances in the military organization and to get the troops that were held up back into the fighting lines. Here, just as in the economic sphere, the counsel of reason is the restoration of equilibrium.

We have by now already acquired the first essentials for a critical examination of rationalization, the aversion to which to-day overshoots the mark just as much as did its uncritical exaltation a few years ago. It is easily forgotten that even if the word is new the thing itself is not. It is as old as the history of mankind. Men have always striven to raise the productivity of their labour by means of tools, machinery, and the most efficient organization, because they have never been satisfied with the extent to which they have been supplied with goods. It was in this sense that we declared above that we cannot have too much but always only too little rationalization. This proposition does, however, not exclude, of course, the possibility that the direction, extent, and tempo of rationalization may have been wrongly chosen so as to lead to a disruption of the proportionality in the structure of production. The effect of this in its social application is that the labour displaced in the first instance by the rationalization remains unemployed for a long time. Undoubtedly effects ensue from the rationalization which lead eventually to a reabsorption into the productive process of those rendered unemployed (increased employment in the machine-making industries, cheapening of the products resulting in an increased demand either for these or for other products to which the purchasing power set free by the price reduction, or under a monopolistic price policy the increased purchasing power of the entrepreneur, is applied). But this process of compensation requires time and this all the more the more inelastic the economic system has become through wage rigidities or through the inelasticity of the credit system.16

So it is that the present ossification of our economic system by all kinds of rigidities has rendered the process of absorbing displaced workers much more difficult. But this ossification is just that development with which most critics of the powers of adaptation of capitalism are heartily in agreement.

§ 12. UNDER-CONSUMPTION.

The discussion of the possibility of a general over-production brought us to the conclusion that we must substitute for the untenable proposition of a general over-production the concept of disproportionality, a concept to which we shall often have to revert. The further question now arises whether the crisis can perhaps be explained by the fact that in the course of the upward swing of the cycle a deficiency of consumers’ purchasing power is somehow introduced, rendering one part of the production unsaleable at prices covering costs. This question has repeatedly been given an affirmative answer especially by the socialists who contend that the unequal distribution of income to the disadvantage of the masses—an, as they believe, inherent failing characteristic of capitalism—is responsible for the deficiency of purchasing power which brings in its train over and over again a breakdown of production (as, for example, Rodbertus, and in a certain sense also Marx and his disciples). While the socialistic type of Under-consumption Theory can be traced back to writers of the first half of the nineteenth century, there has sprung up during the last decades another variety based on alleged defects of the monetary mechanism of our economic system. Though both types have much in common, it seems preferable to keep them separate, and we shall call the first type the Distributional Under-consumption Theory and the second the Monetary Under-consumption Theory The latter will be discussed separately at the end of this section.

So far as under-consumption theories assume the possibility of a general over-production, they do not merit any further discussion here. Moreover, their popular form, which starts from the assumption that the entrepreneur pays the labourers too low wages and brings about thereby a deficiency in the total demand, needs no lengthy disproof. For it is obviously forgotten that to the minus in the purchasing power on the side of the worker there corresponds a plus in the purchasing power on the side of the entrepreneur so that nothing is changed in the total amount of purchasing power. On the same reasoning, a drastic raising of wages in the upward swing of the cycle without an increase of the quantity of money and credit, would likewise only take place at the expense of the non-wage incomes and could therefore not prevent the breakdown. It is another question whether it hastens or retards it.

This same argument proves also the falsity of the widespread purchasing-power theory of wages and national welfare. This theory demands that the purchasing power of the masses should be raised in order to ensure sufficient buying power on the market for the continuous increase in national output made possible by mass-production and machinery and, conversely, that increased purchasing power should provide beforehand the prerequisite for the increase of production, so that the concentration and increase of general demand may increase the general welfare. If we pump purchasing power into the hands of the masses without treading the path to inflation, there must occur a diminution in the incomes of entrepreneurs, so it is only the composition of demand and not its total amount that is changed. As in the over-production case, the question arises here also whether the composition of demand as determined by the distribution of income and its changes, is not an important factor for the explanation of disturbances of economic equilibrium. This is indeed a question worthy of discussion and is the one point which gives scientific rank to the modern varieties of the under-consumption theory.17 That the socialists particularly should have seized on it in order to demonstrate the inherent defectiveness of the capitalist economy is all the more understandable inasmuch as here was presented the unique possibility of combining the criticism of the capitalistic organization of production with a still more vehement criticism of the capitalistic organization of distribution. The under-consumption theory is equally fitted to lend support both to a pessimistic prediction of the power of duration of capitalism (as with both Marx and Rosa Luxemburg) and to the recommendation of a change in the distribution of income in favour of the working classes. It is for this reason popular and ineradicable. So much the more seriously should its justification be tested.

Something must be said in passing about the development of the Marxian under-consumption theory by the Neo-Marxists (Rosa Luxemburg, F. Sternberg, &c.). Karl Marx had assumed that, owing to the inherent disharmonies of capitalism (progressive concentration and accumulation of capital by the capitalists and progressive destitution of the proletarian masses), economic crises would become more and more severe in character, leading in the end to the final collapse of capitalism. To the great discomfort of the Marxian theorists, however, the development actually taking place up to the Great War went absolutely contrary to this prophecy, crises and depressions not growing but markedly declining in severity. In order to save the central point of Marxism, i.e., the idea of the self-destruction of capitalism, in the face of this altogether distressing development, Marxists had to discover circumstances to account for the postponement of the day of reckoning. For this purpose, the phenomenon of modern imperialism came in very handy. All one had to do was to assert that the life of moribund capitalism had been prolonged by imperialism easing the pressure of over-accumulation by opening up new markets in the non-capitalistic countries overseas. But this could not go on for ever. The supply of those countries would soon become exhausted, and with decreasing opportunities for expansion, the scramble for colonies, protectorates, and “zones of influence” would involve the capitalistic countries in political conflicts until the capitalistic world would blow up in the smoke of a world war. In this way quite a number of birds were killed with one stone : the philosophy of the doom of capitalism was resurrected, modern imperialism was stigmatized as the inevitable result of capitalism, and, as a final by-product, an explanation for alternating booms and depression was found in the ebb and flow of imperialistic expansion. This whole argument may sound rather captivating, but when we look at it more closely it reveals itself as a rather vulgar kind of faulty reasoning; for, supposing that a problem of capitalistic accumulation really exists, it is not conceivable that imperialistic expansion into the undeveloped regions of the globe can ease the pressure of over-accumulation. To realize this, one has only to examine how the capitalistic countries dispose of their “surplus production” by exporting to undeveloped countries. We have then to contemplate the following possibilities:

1. The additional export may be paid for immediately in cash so that the exporting country comes into possession of more gold or foreign exchange. These may be used : (a) For augmenting the volume of currency, i.e., other things being equal, for inflation. Besides the fact that this—via the production and exportation of goods and the fight for foreign markets—is a rather cumbersome and roundabout way to start inflation, it is difficult to see how the problem of over-accumulation can be solved in this way. On the contrary, inflation is, as we shall see later, sure to lead to a real and not merely imaginary over-accumulation, so that imperialism would be apt to intensify over-accumulation rather than to ease it. (b) To pay for additional imports, with the sole result that home goods are now replaced by foreign goods, without the problem of surplus production being brought any nearer to solution.

2. The additional export may be made on credit. So long as nothing is paid for interest or amortization, the exporting country has, indeed, got rid of the surplus production, but in no other sense than as if it had given it away or destroyed it. If this is the end of the matter, it becomes again legitimate to ask whether such a dangerous and round-about way, with its political entanglements, is necessary in order to get rid of embarrassing goods without anything to show for it. But as soon as payments are being made for interest and amortization, this case differs in no way from the first case where the additional exports were paid for immediately. It has to be remarked, moreover, that if additional exports on credit (foreign investments) really offer a way out of the plight of over-accumulation, there is no reason why the same should not be done, and with less trouble, inside the country.18

We may conclude then, that imperialism offers no solution of the problem of over-accumulation, whatever this may mean. If we should accept for the moment the crude view that increasing productivity leads capitalism into serious trouble, we should expect that imperialism would be apt to accentuate the problem of glutted markets rather than to alleviate it since the intensification of world economy consequent on imperialistic expansion works clearly in the direction of enhancing general economic activity. This conclusion, incidentally, throws some sidelight on the question as to whether the problem of over-accumulation is a real one. For it is a strong presumption against the existence of this problem that up to the Great War capitalism developed on a gigantic scale and without any dramatic disturbances, while the parallel imperialistic policy of the Great Powers was no real remedy for the disease of over-accumulation. So long as no other factors can be pointed out in explanation of the healthy aspect of capitalism before the war, it must be assumed that the disease of over-accumulation—at least as a chronic disease of capitalism—is imaginary rather than real.

Let us take as the central idea of that form of the distributional form of the under-consumption theory which is capable of scientific discussion, the idea that the share of the workers’ income in the total national income is too small and the share of the entrepreneur’s income too large to secure equilibrium in the economic system. Then the objection immediately presents itself that the crisis is preceded not by a slack time but by a boom in which the income of the worker rises along with the total income. In the same vein it must be objected that, contrary to what the under-consumption theory would lead us to expect, it is the consumers’ goods industries which are usually the least and the last affected by the depression, as has been witnessed also during the present depression. This is really fatal to the idea that it is the appearance of a deficiency of consumers’ purchasing power which is the factor bringing the boom to an end.

The under-consumption theory could only satisfy these objections if it were able to show that a dislocation of the income stream causes the upward swing of the cycle as well as bringing about its break-up. Only then would it be an acceptable theory of cycles and crises. Such a demonstration can, however, hardly be carried out on the basis of the under-consumption theory. Even if it were shown that the occurrence during the boom of a worsening of the income distribution to the disadvantage of the masses leads to a forcing upwards of capital accumulation (oversaving), supplied mainly out of the incomes of entrepreneurs, which finally disrupts the economic equilibrium, the question still remains unanswered how the boom is started. The conclusion consequently is, that the under-consumption theory neither grasps nor explains the real problem of economic fluctuations. Nevertheless, we must acknowledge that it has served to contribute to the explanation of the mechanism of the boom. For it cannot be denied that, in the course of the boom, there occurs a dislocation in the structure of prices, incomes, and costs which by reason of the lag of important cost elements behind the rise in selling prices of goods, raises the average profits of entrepreneurs, and so enhances cumulatively the original tendencies to increased activity. Chief among these cost elements, apart from interest, are wages. In so far as this over-expansion in the boom—which represents an over-expansion of real capital—contains within itself the germ of the later breakdown, the dislocation of the price and income streams occurring in the boom is an important link in the explanation of the boom and the crisis. In other words, if the ups and downs of trade cycles are to be explained by an increase of investment—that is, real capital accumulation at the expense of consumption—taking place by fits and starts and therefore associated with shocks, then we must welcome every indication of a circumstance which helps to explain this periodic concentration and acceleration of capital accumulation, and the modern underconsumption theorists supply us with such an indication. There exists in fact a close connexion between the fundamental ideas of the under-consumption theory and the over-capitalization doctrine presently to be described, even though this connexion may be found difficult to acknowledge in face of the unscientific formulation of the popular variety of the under-consumption theory.

The inertness of contractual incomes, which explains the lag during the boom, leads in the depression to the reverse, so that these incomes, and especially wages, tend to follow the fall in commodity prices only very hesitatingly resulting thus in a fall in the average level of business profits. The same factor which intensifies the boom and the crisis, intensifies the depression likewise, but as a rule no mention is made of this by the more tendentious formulations of the under-consumption theory.

It might easily be concluded from our concession to the fundamental ideas of the distributional under-consumption theory that it would be a good trade-cycle policy to push wages up as early and as vigorously as possible in the boom period as a means of avoiding an over-expansion. This conclusion is, however, unjustified since we interpret the change occurring in the distribution of income in the boom not as a cause but only as an intensifying factor accompanying the boom. A forcing up of wages can, therefore, hardly be the appropriate means of combating cyclical fluctuations. The danger is rather that in view of the extraordinary complex nature of the cycle, a forcing up of wages contains within itself a new element of tension expressing itself in an augmentation of unemployment. It is sufficient to point out that a forcing up of wages during the boom gives a dangerous incentive to the overextension of rationalization, as was undoubtedly the case in Germany in recent years. This in part explains also the extraordinary phenomenon that during the last boom in Germany, unemployment stubbornly remained at a high level. Finally, it is to be borne in mind that to a policy of wage-raising in the boom there must correspond a policy of wage-lowering in equal measure in the depression and that the lowering of wages is all the more difficult the more vigorously they have been raised previously. The essential truth in the distributional under-consumption theory does on no account give any clear-cut criterion of a trade-cycle policy for wages.

To complete this section, some special remarks seem necessary about that variety of under-consumption theories which I termed Monetary Under-consumption Theories. As this term indicates, the deficiency of consumers’ demand, which is the gist of every under-consumption theory, is here sought not primarily in the unequal distribution characteristic of capitalism but in the monetary machinery of capitalism. Both types of under-consumption theory work with the idea of a continuous deficiency of consumers’ demand brought about by a defect inherent in the capitalistic mechanism, but while the distributional school stresses the unequal distribution of incomes as the fatal defect, the monetary school emphasizes the defective flow of purchasing power. Accordingly, the remedy prescribed by the first school is a more equal distribution (if possible within the bounds of capitalism), while the remedy prescribed by the second school is—to put it bluntly—inflation. The atmosphere of the first school is provided by socialists or mildly anti-capitalistic reformers, while that of the second school is dominated by monetary schemers without any marked anti-capitalistic ardour.

As an extreme example of the monetary school, most familiar to English readers, we may cite the theories of Major C. H. Douglas—as formulated especially in his books Economic Democracy and The Monopoly of Credit. In the opinion of this author, the economic machinery as constructed to-day produces a deficiency of purchasing power arising from the fact that only a part of the cost incurred in the production of commodities goes to the consumers as income, so that current income is not able to buy current output at cost prices unless the gap is filled up by an additional issue of money. As has been shown by various writers, to which the reader may be referred,19 this view reflects a serious misconception of the economic process in general. No “deficiency” of purchasing power can occur as long as the economic system is in a state of equilibrium, but Major Douglas and the numerous other writers advancing similar views fail to show, in more than a vague manner, how equilibrium can be destroyed.

Apart from these more radical heretics, most theories of this monetary school of under-consumption amount more or less patently to the contention, already mentioned in our treatment of the distributional school, that there is a tendency inherent in our economic system towards over-saving. In contrast to the distributional school, the monetary school presents this view in terms not of maldistribution of income but of monetary maladjustment, so that the remedy offered is also a monetary one, i.e., inflation.20 It is the process of saving which puzzles these writers. They do not deny that saving is necessary for adding to the productive wealth of society, but since saving means essentially non-consumption, thus creating a deficiency of consumers’ demand it is believed that it tends to defeat its own final purpose, i.e., the better satisfaction of consumers’ wants, and thus to provoke depression—unless the monetary mechanism is so constructed as to take care of this “dilemma of thrift” by providing additional purchasing power. There are many defects in this argument, as has been abundantly shown by a number of critics.21 For instance, it is commonly overlooked that new productive investments, made possible by saving, reduce the unit cost of production so that, to this extent, the prices of consumers’ goods can fall without involving producers in serious difficulties. The gravest defect of most of these theories, however, seems to be the confusion of a static with a dynamic point of view. In other words they fail clearly to distinguish between the effects of saving per se and the effects of an increase in the rate of saving. As regards the effects of saving per se, i.e., a uniform or even gradually increasing rate of saving, it must be vigorously denied that it can disrupt economic equilibrium. In this “static” sense there certainly exists no problem of over-saving with reference to a maximum which cannot be exceeded without destroying economic equilibrium. On the other hand, it cannot be denied, however, that a sudden and marked increase of the rate of saving presents a real problem. We shall deal with this in § 14, but it must be said at once that the inflation cure, in which the reasoning of the monetary under-consumption theory invariably culminates, is bound to provoke just that sudden increase in the rate of saving which constitutes a real problem of over-saving. What is meant by this final shot at the under-consumptionists will also be made clear later on.

Summing up the contents of this section, we may conclude that there is a certain truth in the general trend of the under-consumption theory which may make some contribution to a final solution of the problem. This element of truth, however, is buried beneath a heap of very dubious arguments. How unsatisfactory the under-consumption theory is in providing a real solution of the problem might be inferred from the fact that neither of the remedies prescribed—the distributional nor the monetary remedy—promises to be efficacious, and they may be positively pernicious.

§ 13. PSYCHOLOGICAL FACTORS.

In an economic system which is based on the free decisions and economic conduct of millions of individuals the fluctuations of mind underlying these decisions must be of decisive importance for the equilibrium of the economic system, and the question arises whether the phenomena of economic oscillations do not depend in the last analysis on such fluctuations in mass feelings and opinions. An affirmative answer to this question is given by the theory of the trade cycle of the psychological school.22 There is much that this theory can count in its favour, especially the important circumstance that the upward swing of the cycle is characterized by a feeling of general optimism and the downward swing by one of general pessimism, and that the one is carried just as far in the upward direction as the other is in the downward direction. In every cycle the experience repeats itself with wearisome regularity, that in the boom people seem to trust to the eternal duration of prosperity, while in the depression they are seized with a dismal melancholy bordering almost on a feeling that the end of the world is approaching. They speak of the “end of capitalism” and forget that up till now every depression has none the less come to an end. It is a case of a mass mental epidemic which only very few are able to withstand, while the vast majority are carried away by the power of suggestion of popular feeling. This is what is in the main at the back of speculative extravagances on the stock markets in which people eventually lose touch with every real foundation of fact. In describing this frenzy, Lavington has compared people to boys who tread on a surface of ice on which there are already many people skating and are given courage by the very fact that there are already so many others on the ice, although the danger that the ice may break increases with the increasing number of the skaters. If a speculative price movement sets in on a market, it tends to be accentuated in a vicious circle and driven to excess. This is as true of the upward movement as of the downward one, so that the French saying: “La hausse amène la hausse” can be equally well applied to the “baisse.” If, for example, the public, frightened off and disheartened by security losses in the crisis, has turned away from the security market, then the desertion of the stock exchange is likely to intensify the lack of disposition towards investing savings in securities. This in turn presses on the whole economic situation and thereby strengthens the real grounds for the depressed state of security prices.

The psychological factor is particularly important in connexion with fluctuations in investment activity which in fact constitute the essence of the cyclical movement. In accordance with the very nature of transactions directed towards the uncertain future, they are dependent in special measure on subjective estimates, that is, estimates highly liable to error, and on the average level of confidence. The snowball-like growth or decline is strengthened all the more by the fact that the increase in investment by one entrepreneur induces investment by another entrepreneur not merely because he is affected by the more optimistic mood, but also because more orders now fall to his lot. For the depression the opposite is true. As a rule the force of competition leaves no choice to the entrepreneur but to swim with the stream. He dare not be the first to restrict his business undertakings in anticipation of an over-production and over-speculation: he always calculates that another will take the lead in this direction with the result that nobody does so. This is only human and it would be surprising to find it otherwise.

People take part in the ups and downs of popular feeling not only as entrepreneurs but also as savers and consumers. In the boom they confidently put their savings in the illiquid form of securities and mortgages while in the depression they hold them mistrustfully on demand deposit at the banks, or even, if the mistrust has reached its peak and spreads even to the capacity for payment of the banks themselves, withdraw them and keep them in the form of cash (possibly even in gold as has recently been the case in France). As consumers, they are prepared in the boom to convert their money rapidly into goods, while in the depression they buy only very hesitatingly in the expectation of a further fall in price. The conduct of both saver and consumer has the effect, via its influence on the liquidity of the banks and via changes in the velocity of circulation of money, of intensifying both the boom and the depression.

Lastly, it is of special significance that the bankers themselves are also subject to the psychological ebb and flow. So it is that in the boom, infected by the general ardent optimism, they loosen the reins of their credit policy, sift less strictly the demands for credit, look less fastidiously at collateral, overestimate the productivity of the credits they grant and are satisfied with less liquidity. In the depression the memory of the sins of the boom, and the “frozen credits” with which they atone for these sins, cause the banks to fix the most extreme requirements for their liquidity and to subordinate to this all other considerations.

It is true of all these psychological factors that they could not reach such large proportions if the uncertainty about economic data, the defectiveness of economic information (which is again closely bound up with competitive considerations), and the uncertainty of the future did not give wide scope for mere presumptions and vague predictions highly coloured by sentiment, and for errors of all kinds. But, even for facts that are to a certain extent definite, the saying of a Greek philosopher is true that it is not the facts that determine human action but the opinions about the facts.

Nevertheless the reference to psychological factors cannot give a satisfactory explanation of cycles and crises. A theory which imputes the change from boom to depression to mere fluctuations of feeling and to mistakes, prejudices itself by its very simplicity when we consider the complicated nature of economic fluctuations. It fails in fact to give satisfactory answers to many vital questions. How, for example, does this rhythmical oscillation from optimism to pessimism, from activeness to lethargy, come about? Is it conceivable that mere mass feelings and mass mistakes cause real changes in the spheres of goods and money such as characterize the movements of the trade cycle? Is it imaginable that these mass psychological phenomena would last so long if there did not lie at the root of them real events from which they took their origin and which are continually giving them new force? Why does the psychological rhythm not repeat itself from month to month instead of spreading over years?

A satisfactory theory of cycles and crises cannot be content with merely describing the admittedly exceedingly important psychological events which are to be observed during the movement of the cycle, any more than fluctuations in the value of money can be adequately explained by referring to the factor of confidence without showing at the same time how this factor relates to the final determinants of the value of money—the quantity of money, the velocity of circulation of money, and the volume of goods. In the same way, price theory cannot be content with the mere statement that the ultimate forces behind price formation are the feelings, calculations, moods, and decisions of human beings; its task is rather to show the basic rules according to which these forces work. It is the same with the theory of cycles and crises. It must always take into account that it is the judgments and decisions of human beings that move the economic process and it has to have regard to all anomalies, errors, and mass mental epidemics to which human beings may be subject, to describe their origin and to analyse their repercussions. But it cannot stop here. Its real task consists in showing how these psychological events connect up as a whole with the real facts of economic life, what disturbances there may arise in this manner in the structure of production, in the income structure, in the banking system, and in the structure of costs and prices. This is not to deny that psychological factors can in certain circumstances play a very active and independent role, as in overcoming the pit of the depression, or in magnifying the forces of expansion, or, lastly, in entangling the economic system in the net of a progressive depression. The last case is exemplified particularly forcefully by the present situation all over the world.

We see now more clearly than ever before that our economic system—like any other, including the Russian—rests, in the last analysis, on certain psychological reserves without which it ceases to work, in spite of its glorious technique and organization. Formerly, this requisite appeared so obvious that people did not think it necessary even to mention it, for they hardly contemplated a state of affairs in which it did not exist. It would almost seem as though the fact had been forgotten that the psychological—especially the moral—forces behind any economic system are the centre upon which everything else hinges, and that the most elaborate technical apparatus is of comparatively little significance if the electric current of these forces has been switched off. In fact, the gigantic apparatus of our economic system is absolutely dependent on an invisible network of psychological forces and relations between the individuals, between the individuals and the community, and between the individuals and their material environment. It cannot exist without confidence—in other individuals, in the State and its legal order, and in the future in general—without some possibilities of and inducements for making preparations for a more distant date than the immediate present, without a link between the present and the future, nor even without some ideology—or, indeed, a creed in the most general sense. Nor can it exist without an atmosphere of peace, liberty, and reason. Our economic system has multiplied the economic productivity of the world by mobilizing all moral and intellectual forces on an unprecedented scale and this is the real secret of its enormous success. But, on the other hand, it is also dependent on the existence of a minimum of these forces, otherwise it is bound to decay. That is the lesson which the present depression is teaching us. Hence, we cannot help feeling deep sympathy with the general trend of ideas of the psychological school.

§ 14. SAVINGS AND INVESTMENT.

As we have already had occasion to remark, people who are not well acquainted with economic theory are always easily inclined to exaggerate the dissensions between schools and theories and, amidst the conflict of opinions, to overlook established truths. In the sphere of trade-cycle theory no less than any other there appears at first sight to exist a hopeless muddle of opinions. This leads to the false conclusion that in this question, which has to-day become a question of vital economic, political, and cultural importance, science fails to give guidance or explanation. This conclusion, while it offers a convenient excuse for avoiding a serious study of difficult trade-cycle theory, is hasty and superficial. A closer examination reveals that from out of the conflict of the various theories of the trade cycle a common core of knowledge has gradually been built up in the course of the last decades. To this belongs especially the fundamental recognition that the real causes of the crisis must be sought not in the economic conditions of the moment of the crisis but in the mechanism of the preceding boom, and the further recognition that the mechanism of the boom culminates in an increase of capital investment financed by an expansion of credit which, via a chain of reciprocal reactions, eventually sets the whole economic system in motion. The study of the cycle leaves no doubt whatever that the swing from boom to depression is primarily a change in the volume of investment and of the production of capital goods while the production of consumers’ goods tends to be subject to smaller fluctuations. The rising curve of investment during the boom has its counterpart in the falling curve of the depression, and the more steeply inclined upwards is the first the more sharply does the second tend to slope downwards.

It is generally agreed that the real centre and root of the cycle is to be found in this rhythmical expansion and contraction of investment and the separate theories of the trade-cycle diverge from each other only so far as they give a different explanation of this rhythm. An increase of investment means the growth of the economic fabric, an increase and improvement in the productive equipment, and a step forward in economic development. So the swing from boom to depression reflects the fact that economic development does not proceed evenly but in rhythmical jumps whose force shakes for a time the equilibrium of the system so that contraction follows on the expansion. In other words, the cycle is to be considered as the typical form in which the growth of the capitalist economy takes place. In this light the crisis and depression appear as growing pains of the economic system from which we cannot escape so long as economic development proceeds by jumps instead of moving in a smooth even rise. The history of cycles and crises teaches us further that the jumpy increases of investment characterizing every boom are usually connected with some definite technical advance. In fact the beginnings of almost every modern technical achievement—the railway, the iron and steel industry, the electrical industry, the chemical industry, and most recently the automobile industry—can be traced back to a boom. It seems as if our economic system reacts to the stimulus of some technical advance with the prompt and complete mobilization of all its inner forces in order to carry it out everywhere in the shortest possible time. But this acceleration and concentration has evidently to be bought at the expense of a disturbance of equilibrium which is slowly overcome in the time of depression. This is a fundamental proposition which must be particularly stressed.

The origins of this proposition can be traced back to the early under-consumptionists (Lauderdale, Malthus, Sismondi and others). It was developed very much further by Marx. The same trend of thought has been followed up by the Russian Tugan-Baranowski23 who is, not quite correctly, usually regarded as the real founder of this modern over-capitalization theory. His work has been developed further with some substantial modifications by Spiethoff and from there onwards the concept has become common property through the writings of Cassel, Schumpeter, Aftalion, Bouniatian, D. H. Robertson24 and others.

Schumpeter lays special emphasis on the rôle of technical innovations and of the “active entrepreneurs” who do pioneer work in putting them into effect. He links up with the over-capitalization element both the technical and the psychological element. Liefmann and, most recently, Lederer also attribute an important rôle to technical progress.

If the essence of the cycle is that in the boom there takes place an over-extension of investment which is followed by an inevitable reaction in the depression, it only needs one further step to reach the conclusion that the formation of real capital in the economic system can apparently not be speeded up and extended beyond a certain limit without introducing a disturbance corresponding to the degree of “forcing.” In this sense, then, there undoubtedly exists an excess of capital formation. Since, however, the formation of real capital (investments) must be balanced by a restriction of consumption, however this may be brought about, the inference is: that the proportion between consumption and real-capital formation cannot be changed at will without causing disturbances. However desirable the accumulation of real capital may be, difficulties and possibly very serious shocks occur if the process of accumulation is forced. Up to this point there is unanimity of opinion among the greater part of trade-cycle theorists. Two further questions now arise in the answering of which ‘opinions differ. The first question is: from where does the money capital come which makes possible the investment activity of the boom? The second is: why does this increased investment activity lead to a more or less violent reaction?

A widespread theory, first represented by Tugan-Baranowski, seeks to answer both questions at once in the following manner. In the depression idle savings are accumulated as a result of the lack of attractive investment opportunities. These idle savings serve to feed the investment activity of the boom, but are at length exhausted, and the boom is then brought to an end for lack of capital. It is then revealed that the investments have been extended beyond the limits allowed by the supply of capital in the community, so that there has to take place a painful process of recession. According to this theory, there corresponds to the change in investment activity, and therewith from boom to depression, a change also from a superabundance to a shortage of capital.

In this theory which, under the designation of the “shortage of capital theory,” is the most popular theory among the more intelligent sections of the business world and among journalists, the one point is certainly correct: that the changing proportion between saving and investment—an excess of saving over investment in the depression and an excess of investment over saving in the boom—is a decisive factor. It is also true to a certain extent to say that a storing up of “capital” takes place in the depression corresponding to the extent to which the rate of saving surpasses the rate of investment. This has more than once been disputed and it has been quite mistakenly supposed that all that is saved in the depression is also invested. Even quite apart from the fact that in the depression people are disposed, out of mistrust, to estimate cash more highly, and apart from the rise in cash reserves (slowing up of the velocity of circulation), a storing up of money capital can take place by way of savings being accumulated as bank deposits instead of being invested in securities. This is equivalent to a sterilization of purchasing power in so far as the banks have to hold liquid reserves against the money deposited with them and are particularly anxious to keep liquid in the depression.

Investments abroad also represent some reserve of power which accumulates in the depression ready for the boom, but only with certain reservations. It has also been supposed that there were stocks of goods corresponding to the stored-up money capital and that these stocks of goods supplied the real bases of the expansion of production in the boom. In fact, however, commodity stocks tend to be particularly low at the end of the depression.

The storing up of money capital during the depression is, then, an undeniable fact which furnishes an important elucidation of the depression. But it would be totally wrong to suppose that these accumulated reserves could contribute substantially towards fostering the heavy investments of the boom years. The conclusion is that the means of financing the boom can only be derived in the main from the boom itself. Its sources are increased savings during the boom period and, above all, additional credits (credit expansion). The inference from this is a further extremely important proposition to which we shall often have occasion to revert in the next paragraphs. In any case it disproves this part of the theory of alternating superabundance and shortage of capital.

We turn now to the contention often denominated as “the ruling theory of the trade cycle” that the cause of the crisis and depression is the shortage of capital setting in at the end of the boom period. Superficially considered, this is correct, but it offers no real explanation, since the shortage of capital is not a new independent element but a result of the whole mechanism of the boom. The shortage of capital is the signal for the breakdown, but it is made inevitable by the over-expansion of investments. If the emphasis is laid on the shortage of capital it gives the impression that a further increase of the supply of capital could avert the turn. But if the increase of investments has taken on pathological dimensions a further increase of capital can only postpone the turn and this only at the expense of a later and all the more severe reaction. The shortage of capital at the end of the boom period is a sign that the credit system has put its last reserves into the firing lines in order to support the wavering front. The scale of investments at length even outgrows the framework of capital creation artificially extended by the expansion of credit. To use a simile, those who lay the main emphasis on the shortage of capital as the factor turning the boom into depression may be compared to some well-known politicians in Germany after the war, who used to say that the defeat could have been avoided if the people had shown more military strength instead of “stabbing the army in the back” by its defeatist spirit. It would have been excellent, of course, for Germany if, at the end of the war, she could still have had the armies and the spirit of 1914, but this is absolutely beside the point because it was precisely as the result of four years of war that Germany was down and out, and any effort to make possible the impossible would only have delayed the ultimate defeat at a terrible cost. It would be a grave injustice to accuse the German people of a lack of spirit of sacrifice instead of accusing the length of the war and its ever-growing dimensions. We may conclude, then, that the emphasis must be laid not on the supply of capital, but on the demand for capital. The evil is not that too little has been saved but that too much has been invested. The shortage-of-capital theory distorts, therefore, the causal sequence, limits itself to the surface and places the accent in the wrong place.

We answered the first question, as to the origin of the money capital which nourishes the boom, mainly by pointing to the rise in the supply of capital which comes about during the boom via increased savings and, above all, via additional credits. To the second question as to what causes the breakdown of the over-investment, we have yet to give a satisfactory answer. We shall try to give a summary of the most important points to be taken into consideration.

Firstly, it should be clear that the total income of a community is allocated partly to direct consumption and partly to saving, and that the total production is devoted partly to the production of consumers’ goods and partly to the production of capital goods. Now it is essential for the equilibrium of the economic system that the composition of production (out of which income is created afresh) should correspond to the manner in which the public spends its income. If the proportions between the production of capital goods and the production of consumers’ goods correspond to the proportions in which the public saves and spends its income respectively, then the economic system is in a state of equilibrium.

Now, if the savings proportion is in any way suddenly and substantially raised, the equilibrium between the composition of production and the allocation of income is disturbed. The usual way in which a sudden increase in the amount of savings of the community takes place is the following: an increase in investment is the primary factor and it is by a roundabout process of the expansion of credit that this induces an increase in the volume of savings of the community leading to complications in our formula which cannot be gone into in more detail here. The increase of investment then goes on rising by its own force, since the expansion of capital investment brings more and more new orders to the capital-goods industries. The scale of investment grows, and so long as the rate at which it grows remains constant, or even increases, the boom has the power to last. Eventually, however, the moment must come when investment is not suddenly broken off certainly, but ceases to grow at the previous rate. We cannot always be building and “rationalizing” further, always constructing new electricity works or railways and installing new machines; especially as the power of the credit system to go on continually financing this investment delirium is finally exhausted. At this point the boom must come to an end since a shrinkage of the capital-goods industries is unavoidable. Whether the breakdown takes the form of a crisis or of a gentle transition to the depression depends on the circumstances. We shall see the process more clearly if we reflect that a boom in, say, poultry or silver-fox farming is also for some time self-maintaining, that is, so long as new farms are continually setting up and exercising a demand for breeding stock. But, finally, the moment comes when the establishment demand for fowls or silver-foxes is satiated. Then it appears that the fowl or silver-fox production is greater than corresponds to the normal requirements for consumption and breeding purposes. This will become apparent immediately the number of farms ceases to grow at the former rate. It is evident that once the fowl cycle is set in motion the breakdown is unavoidable. According to the shortage-of-capital theory, it is possible to postpone it by the stimulus of continually providing capital for the setting up of poultry farms, but it is obvious that this only magnifies the avalanche. Just as we cannot continually pursue fowl production for the sake of producing more fowls, no more can we eternally produce capital goods for the purposes of producing more capital goods. Since after a certain time the latter in their turn produce more capital goods, such an insane economic system can only go on so long as the scale of the production of capital goods is continually expanded. In other words: sooner or later the end must come and it is all the worse the further the scale of investment has been pushed.

This self-inflammatory character of any rise of the rate of investment due to the mechanism of intensification described above (“principle of acceleration”) has been stressed by many trade-cycle theorists (Aftalion, Bouniatian, Bickerdike, Carver, Marco Fanno and especially by J. M. Clark25). As it is of the greatest importance for a better understanding of the whole process of the business cycle, something more must be said in order to make its meaning quite clear. From the examples given above, it will be easily grasped that any increase in general economic activity will have the tendency to produce a disproportionate expansion in the higher stages of production, the rate of expansion being the greater the higher is the stage of production, i.e., the further it is removed from the sphere of consumption. The opposite is true for any decrease of general economic activity.

The reasons for this intensified impact on the higher stages of production are twofold : (1) In the absence of excess capacity any increase of the productive equipment of the country necessitates a further increase of the productive equipment in order to produce the initial increase (as in the example of the poultry and silver-fox farms). In order to produce more machinery the machine industry itself has to produce more machines for producing more machines; an enlargement of the cement factories calls forth not only an increased demand for building the additional cement plants, but also an increased demand for enlarging other factories delivering the equipment of the additional cement plants and so forth. (2) Assuming that in all stages of production and distribution a certain fixed percentage of sales is held as stocks, any increase of general economic activity (as measured by the volume of sales or goods produced) will bring forth an increase of orders greater than the initial increase of sales. If the demand for shoes increases, dealers will place orders equivalent to the aggregate of additional sales and additional stocks, and the same thing will be repeated in the higher stages on a progressively rising scale. But this whole machinery of increasing intensification will stop the moment the increase comes to an end. In substance, this process of intensification by the enlargement of stocks of working capital amounts to the same thing as the process of intensification by the enlargement of the productive equipment (fixed capital). In both cases the increased volume of production in the upper stages can be maintained only if the increase of demand in the lower stages goes on at the same rate. It is, therefore, not sufficient that the demand does not decrease absolutely, nor even that it continues to increase if only at a lower rate; for the maintenance of the top-heavy superstructure of production, it is necessary that the ultimate demand should rise at the same rate or, in other words, in geometrical progression.

This proposition is, however, subject to a number of qualifications: (1) If capital equipment is being continuously increased, a secondary demand is thereby created which is not dependent on a continuous and progressive increase of ultimate demand but only on its steady level. This secondary demand is the demand for the replacement of durable means of production which is bound to develop as time goes on and so partly to take care of the problem of how the top-heavy superstructure can be permanently maintained. It is conceivable that, under certain circumstances, this factor may serve as a parachute for the blown-up structure of production, the decrease in new construction being compensated to a considerable extent by the increase in replacement demand. But the peculiarities of the business cycle do not make it very likely that this will happen. Apart from the fact that the top-heaviness of the structure of production is usually much too great at the end of the boom to be relieved in this manner, the replacement demand is itself highly elastic and subject to the mass psychology of the different phases of the cycle. As it is, this factor is apt to work in a direction inverse to what is desirable for the purpose of compensation. For it is precisely during the boom period that replacements are speeded up, and it is precisely during the depression that replacements are postponed as long as possible. In both cases, this factor acts to intensify rather than to attenuate the violence of the movements. It is a well-known fact that the intensity of the present depression owes much to the circumstance that the replacement demand has been reduced to the utmost minimum. (2) Account has to be taken of the possibility that, on the average, stocks may not rise in proportion to the growing volume of sales and of goods produced during the boom, nor decrease in proportion to the decreasing volume during the depression. If that is the case, they will also serve as a compensating element. But it is again very unfortunate that just the opposite is probable, in view of the fact that rising prices (boom period) may induce the carrying of larger stocks and vice versa. Though we cannot be so sure in this case as in the case of replacement demand, it will not be an error to assume that the varying volume of stocks is an intensifying rather than a compensating factor. How both factors can work together, bringing about disastrous results, may be gathered from the fact that in the United States the production of automobiles (a durable consumption good to which the same principles must be applied) decreased from 5,621,715 in 1929 to 1,431,494 in 1932, while the number of registrations declined only from 26,545,281 to 24,136,879. Thus a decline of nearly 75 per cent. in annual production corresponded to a decline of only a little over 9 per cent, in the total number in use.26 (3) A very important qualification must be made with regard to the possible existence of excess capacity and of surplus stocks during the upward-swing of the cycle. As long as the increase of general economic activity can be based on excess capacity and surplus stocks, the mechanism of intensification will not begin to work and so the otherwise unavoidable reaction may be avoided. Now, this is not a mere hypothetical assumption. It is usually the actual situation during the first stage of the upward-swing, though not so much for surplus stocks as for excess capacity. This is one of the main reasons why the upward-swing of the business cycle must be sharply divided into two phases, the first being of a compensatory and balancing character, the second of a self-inflammatory and unbalancing character.

Particular importance is, moreover, to be attached to the circumstance—which D. H. Robertson and Aftalion especially have emphasized—that the expansion of the productive equipment takes time. Before the products of the expanded productive equipment come on to the market and flood it, several months elapse during which the over-investment may develop to gigantic dimensions unobserved. It is evident that the length of the boom is connected to some extent with the period of time necessary for the construction of the productive plant—the “period of gestation” in Mr. Robertson’s terminology.

Over-investment, conducive of general economic disequilibrium, may develop in any economic system, provided that the volume of “saving” (in the broadest sense of a relative curtailment of current consumption, i.e., “lacking” in Mr. Robertson’s terminology)27 is allowed to expand, in quantity and in speed, at a rate which is no longer compatible with economic equilibrium. There is no maximum rate of saving as such which must not be exceeded if disequilibrium is to be avoided. In this long-run sense a problem of “over-saving” certainly does not exist. But a problem of “over-saving” does appear if the rate of saving rises so suddenly and in such a degree that it leads to over-investment. The balancing forces of the economic system can take care of a rise of the rate of saving if it does not exceed a certain maximum of speed and quantity; beyond that point the equilibrium will give way.28 The question then raised is this: how is such a sudden and substantial rise in the rate of saving conceivable in our economic system?

In answering this question, the crucial point is that the normal source for the formation of capital in our economic system, viz., voluntary savings by individuals laying aside a part of their incomes, is unlikely to give rise to a sudden and substantial increase in savings. It has to be observed, however, that once the up-swing of the cycle has been started certain forces are set in motion which stimulate a substantial increase of voluntary savings. Apart from the favourable effect of the increase in the national income on the volume of savings during the up-swing, we have to recall what has been said in § 12 about the change in the social structure of incomes during the up-swing, a change characterized by an expansion of profit incomes and variable incomes relatively to fixed incomes. This change is equivalent to a rise of those incomes which are more liable to be saved rather than spent. In addition to this, account has to be taken of the large corporate surpluses (entrepreneurial formation of capital or “self-financing”) which are apt to develop during the boom, adding enormously to the aggregate of savings. This source of saving has risen to prime importance during the last decades along with the development of industrial monopolies and large corporations, with the policy of stabilizing dividends, and with certain degenerate tendencies in the financial structure of industry and banking.29 The importance of this factor is enhanced by two further circumstances: (1) corporate surpluses are usually larger in the industries producing capital goods than in those producing consumption goods so that the tendencies towards over-investment are accordingly reinforced; (2) corporations have a well-known inclination to reinvest their surpluses in their own plants instead of investing them on the general capital market so that the rate of interest has to this extent lost its regulating influence.30 This tendency, since it leads to over-expansion in special trades (for instance, the copper industry in the United States or the cement industry in Germany after the war) reveals an additional source of trouble. So we see that the entrepreneurial formation of capital (corporate surplus) may become an important means of enlarging the aggregate of savings and contributing to a tendency towards over-investment.31

But even this, I think, is not sufficient to raise the rate of saving so suddenly and so substantially as regularly to set in motion the process of over-investment. There are, moreover, other characteristics of the boom which, being of a monetary nature, cannot be explained in this way. I would concede that this factor, like the change in the social structure of incomes, is of great importance for reinforcing the process once set into motion, but not more. I believe that the rise of savings and investment brought about by these two factors will generally be capable of assimilation by our economic system without leading to grave maladjustments in the system as a whole. In order to reach dimensions liable to break up the economic equilibrium, savings and investments must be forced up by a more powerful mechanism. For this it is necessary that some kind of coercion be exerted which releases the production of capital goods from the link with the community’s voluntary decisions to save, and forces the proportional shrinkage of the production of consumption goods above the level to which the community is prepared to submit voluntarily through its savings. This coercion may take place with the brutal overtness of Russia to-day under the rule of the Five-Year Plan which represents to the trade-cycle theorist a gigantic attempt with the aid of government authority to free the tempo and extent of investment from the limitations imposed by the rate of savings—consumption being ruthlessly held down by means of State force. This throws further light on the probability mentioned already that in Russia also the steepness of the investment curve will find its counterpart in the sharp descent of the curve of reaction, only with the difference that the reaction in Russia will assume other forms than in the capitalistic countries. It is in any case useful to realize that what is being carried out in Russia differs from the type of boom characterized by overcapitalization in the capitalist countries in method and extent only, and not in kind, and bears a likeness to it even so far that all warnings of an inevitable reaction are thrown to the winds. In the capitalist economy the place of authoritarian force is taken by credit expansion.

As will be seen in the next section, the expansion of credit also involves “forced saving,” though of a totally different kind. The difference may perhaps be expressed by saying that in our economic system it is monetary “forced saving” which sets the wheels of over-investment in motion, while in Soviet Russia it is authoritarian “forced saving.” Whereas in Russia the coercive machinery is represented by the G.P.U. with its rifles and dungeons, in capitalism it is represented by the banking system with its cheques and overdrafts. This capitalistic machinery of credit expansion serves two purposes: in the first place, it provides the entrepreneur waiting to invest with the necessary additional credit and, in the second place, by raising profit expectations, it increases the desire to invest, of which the driving force is here, in contrast to the socialist State, governed by individual decisions based on profit expectations. This is, in fact, the way in which the process of cyclical movement regularly takes place in the capitalist world.

In the foregoing analysis, the reader has been, as far as possible, spared any allusion to the fierce controversy at present raging round many, if not most, of the points discussed above. This controversy has become so highly technical and, to a large extent, even confused, that some detachment from it, at least for the moment, would seem to be indicated in order to regain clarity on the main issues, even at the cost of some over-simplification here and there. At this juncture, however, it becomes indispensable to compare our results with certain other theories of the present time and to attempt, if necessary, some classification. The point of view of the present author will, perhaps, become clearer in consequence. With this end in view, it will suffice to mention two theories which, seeming to a large extent mutually exclusive, have lately become more and more the centres of discussion : the theories of J. M. Keynes and F. A. von Hayek.

The central theses of Mr. Keynes,32 which he develops by the aid of a number of ingenious though debatable equations, runs as follows: The real sources of rhythmic disturbances are not changes of the rate of saving or of the rate of investment but recurrent discrepancies between the two rates, in such a way that a rate of investment greater than the rate of saving engenders the boom, and a rate of saving greater than the rate of investment engenders the depression. Equilibrium can be maintained only by the equality of the rates of saving and of investment, but this is also a sufficient condition. Of these two rates the rate of saving is more steady in character, while the rate of investment, is subject to jerky fluctuations. The essence of his theory is given by Keynes in this classical passage33 : “It is enterprise which builds and improves the world’s possessions. Now, just as the fruits of thrift may go to provide either capital accumulation (if savings are invested—R) or an enhanced value of money-income for the consumer (if savings are not invested—R), so the outgoings of enterprise may be found either out of thrift or at the expense of the consumption of the average consumer. Worse still;—not only may thrift exist without enterprise, but as soon as thrift gets ahead of enterprise, it positively discourages the recovery of enterprise and sets up a vicious circle by its adverse effects on profits. If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. . . . Now, for enterprise to be active, two conditions must be fulfilled. There must be an expectation of profit; and it must be possible for enterprisers to obtain command of sufficient resources to put their projects into execution. Their expectations partly depend on non-monetary influences—on peace and war, inventions, laws, race, education, population and so forth. But . . . their power to put their projects into execution on terms which they deem attractive, almost entirely depends on the behaviour of the banking and monetary system.” To this the present author would whole-heartedly subscribe, adding that it contains a truth which could hardly be put more eloquently. When Keynes makes the rise of the rate of investment above the rate of saving (which, in his definition, excludes “forced saving”) responsible for the boom, he says essentially the same thing as was said in the course of our preceding analysis where it was stated that it is usually the adding of “forced savings” to normal saving which raises investments to a dangerous height. Though the practical result is the same, the approach is different, since in our analysis it is not the rise of the rate of investment relative to the rate of saving which is the real cause of instability but the absolute rise of investments no matter whether financed by voluntary or forced savings. For all practical purposes this amounts to the same thing, so far as the explanation of the capitalistic boom is concerned.

But the different approach of Keynes has two consequences. The first consequence is that in his analysis the main emphasis is put on a point which, under certain circumstances (i.e., when the absolute rise of investments is not brought about by a disparity between savings and investments, or, that is, by credit expansion), may be only of minor importance. So Mr. Keynes has little to say about the general possibilities of over-investment engendered by the acceleration principle, especially in a socialist system. This point is connected with the second consequence of the Keynesian approach that, making no use of the acceleration principle, he is rather vague about the disruption of the structure of production by over-investment and is evidently inclined to deny the necessity of a painful process of readjustment brought about by the crisis. This seems to me the weakest point in the whole analysis of Mr. Keynes. Where he comes out strongest, on the other hand, is in his analysis of the cumulative process of depression which, in my opinion, can indeed be no better stated than in the terms of the saving-investment approach elaborated by him. It seems to me that this is the main and the most valuable contribution of Mr. Keynes which can and must be highly appreciated even by those who prefer other explanations for the boom period.

Just the opposite is true in the case of the equally important contributions to the problem of crises and cycles of Dr. v. Hayek.34 As far as the explanation of the depression is concerned, Dr. v. Hayek’s endeavours seem to be unsuccessful to the point of being positively misleading, but his analysis of the boom period on the other hand contains elements which represent a real advance. The gist of his theory is that, while any amount of investments financed out of voluntary savings tends to leave the structure of production intact, it is a rise of investments financed out of forced savings which puts the structure of production out of balance so that a subsequent readjustment becomes inevitable. We cannot enter here into the very intricate details of his reasoning which are connected up with some rather controversial propositions of the theory of capital of the Viennese school (Böhm-Bawerk, Mises, Strigl35 and others). Let it suffice to remark that, by emphasizing the rôle of forced savings (credit expansion) as the driving force of overinvestment, Dr. v. Hayek’s theory amounts, in the last analysis, to the game thing as Mr. Keynes’ theory and our own analysis, at least for all practical purposes. But below the surface there are substantial differences. In our analysis, over-investment by forced savings appears as the special form in which, in our present economic system, the general source of instability, i.e., over-investment no matter how financed, becomes a practical possibility. In Dr. v. Hayek’s analysis, over-investment by forced savings appears as the sole case in which over-investment as a factor of instability is conceivable. To be more explicit, we must say that, in Dr. v. Hayek’s view, the real source of trouble is not too much investment, but too little voluntary saving.

Dr. v. Hayek’s theory is, indeed, the most uncompromising example of an under-saving theory of business cycles. The same amount of investments which, if financed by forced savings, spells disaster would, according to this theory, be harmless if it were financed by voluntary savings or even if the forced savings were replaced later by voluntary savings. In our view, it is the steep rise of the absolute amount of investments which matters, not the fact that our economic system must rely on credit expansion to make this rise possible. In our view, therefore, even a socialist state has to face the same problem if investments are sped up by authoritarian forced savings, a statement which is contrary to Dr. v. Hayek’s analysis. He must, consequently, hold the belief that a socialist system is not exposed to this kind of disturbance. But there are other consequences too. While in our analysis the ultimate breakdown of the boom is explained by the acceleration principle, in Dr. v. Hayek’s theory it is the shortage of capital which puts an end to the boom, and this shortage of capital must come sooner or later if investments are being financed by credit expansion. He makes no use of the acceleration principle, and even rejects it, explicitly, by saying that the top-heavy structure of production could be maintained if so much more were saved as to increase the capital equipment in the higher stages to such a magnitude that its replacement demand would use fully the capacity of the lower stages.36 But since it is indisputable that the top-heavy structure has been brought about by a general rise of investments no matter how financed, it is difficult to understand how more savings and more investments could restore the balance instead of postponing the ultimate breakdown at the cost of intensifying it. In this sense, the shortage of capital at the end of the boom is an indubitable calamity, but, as was said earlier in this section, it is no real explanation, since it is the inevitable result of the whole process of the boom. All this is, it must be repeated, a philosophy slightly reminiscent of the legendary “victory at arm’s reach” and “dagger-stab in the back” in Germany after the war.37

Though this and a number of other propositions are highly debatable the merits of Dr. v. Hayek’s work can hardly be overrated. He has given a new stimulus to economic thinking on all these problems by diverting attention to questions hitherto unseen and by the brilliance and profoundness of his attack,38 even in those points where his analysis is the most provocative of contradiction.

§ 15. MONEY AND CREDIT AND THE CYCLE.

The part played by changes on the money and credit side of the economic system has already come into prominence many times, and especially in the last section. It is in fact such an outstanding feature that a group of trade-cycle theorists who have recently become increasingly influential—the representatives of the monetary or credit theory of the trade cycle—see the ultimate causes of cyclical movements in the changes taking place during the cycle on the money and credit side, and they emphatically declare that cycles and crises are a mere monetary and credit phenomenon.39

That the part played by monetary factors must be very important is to be inferred from the mere observation that the upswing of the cycle is regularly marked by a price rise, in spite of the fact that it is at the same time a period of increasing production of goods, so that we should really expect a tendency to falling prices. It follows that the upward swing must be characterized either by a rise in the volume of money and credit or by an increase in the velocity of circulation or by both at once. This theoretical deduction is confirmed by experience. Conversely, the depression is apparently a period of diminished volume of money and diminished velocity of circulation of money (and we have for present purposes to include under this the so-called book money represented by movements in the demand deposits of the banks). Expressed in another more concise way: the upswing is to be envisaged as a kind of inflation and the depression as a kind of deflation. All that we experienced on a large scale in the postwar inflation in Germany is here repeated on a small scale just as the other way round we can look upon the post-war inflation period as one great boom period whose unavoidable end was continually postponed by new and stronger doses of the inflation drug. All that was observable in this record inflation we have only to reduce to a smaller scale in order to obtain the typical characteristics of every boom: the general rise in prices, the whetting of the spirit of enterprise and speculation, the unhealthy expansion of productive plant, the general desire to buy, the increase in the volume of business, the desire to get out of money into goods, the tendency to passivity in the trade balance, &c. That the present economic depression is conversely to be conceived of as a deflation has already become familiar to everybody.

This contention seems to contradict the well-known fact that the most recent American boom which sowed the seeds of the heaviest of all economic depressions was not characterized by a rise in the general price level. This was presumed to be a sign that no reaction was to be feared and that we could count on “eternal prosperity.” That this reaction has nevertheless followed, and in the most severe form, leads to the conclusion that the American boom of the years 1926-1929 was not very different in its essentials from an ordinary boom and that the inflationary expansion of the economic system can scarcely have been absent from it. In fact, although the volume of cash rose only slightly in that period, the volume of credit rose to an enormous extent. A rise in the general price level did not occur in spite of this enormous credit expansion for the reason that at the same time the prices of commodities were being pressed downwards by the fall in costs due to the progress of technique and organization. In other words: if at that time enormous quantities of additional credit had not been pumped into the American economic system, prices would have fallen considerably. The fall of average production costs in industry and agriculture realized in that period was so large that a rise in the price level was all the time prevented in spite of the fact that additional credits were always being pumped into circulation. The opinion that the credit inflation would thereby be rendered harm-less turned out to be fatal. To maintain stable a price level which in ordinary circumstances would have had to fall on account of a general lowering of production costs, amounts to the same thing as pushing prices up by an unconcealed credit inflation when production costs have remained unchanged. The important point is then not that the general price level rises, but simply the circumstance that additional quantities of money and credit are supplied to the economic system, calling forth dangerous disturbances in the structure of production. The monetary theory thus formulated is capable of explaining even the otherwise incomprehensible American boom. It is indeed the only trade-cycle theory which can really explain it satisfactorily.40 The conclusion then is that in order to set in motion the boom mechanism which undeniably leads to a breakdown, it is not at all necessary for there to be an absolute credit inflation (in the sense of an expansion of credit leading to a general rise in the prices of commodities) but that a relative credit inflation is quite sufficient.

The increase of money, which the monetary theory of the trade cycle designates as the cause of the upswing, is essentially an increase in credit money which comes from the central note-issuing banks and banks doing current-account deposit business. An understanding of the monetary theory of the cycle presupposes above all a knowledge of how such an increase of credit money—“credit creation”—can come about. This process cannot be described here in detail,41 but it may be more easily intelligible if we point out what an extremely large proportion of transactions are effected without the use of cash (cheques, clearing), that is by disposing over demand deposits (current accounts), so that a superstructure of credit is built on the cash basis. The size of this superstructure is dependent on the width of the cash basis and on liquidity considerations of the banks, and it can therefore be subject to substantial fluctuations. This means that our credit system is elastic and that within certain moderately wide limits it permits of arbitrary changes in the volume of credit money. These changes are according to the monetary theory of the cycle identical with the cyclical movements. Thus the volume of credit rises to the detriment of bank liquidity in the boom period and falls accompanied by an improvement in liquidity in the depression. The leading rôle in this connexion is usually played by the central note-issuing banks.

For a complete understanding of the monetary theory of the cycle it is essential to realize that the pivot of the whole mechanism is the rate of interest. In so far as the banks—led by the central note-issuing bank via its discount policy—lower or raise the rate of interest, there ensues an expansion or contraction of credit. The decisive factor is not the absolute height of the banks’ interest rate, but the discrepancy between this and that rate of interest (the real rate of interest in Wicksell’s sense42 or the equilibrium rate) which would establish itself if the volume of credit in the community were built up solely out of real savings and not out of additional credits besides. A credit inflation can therefore very well arise by the fact that the banks leave their interest rate unchanged or do not raise it far enough at a moment when the equilibrium rate in the economic system—which is only a fictitious figure reflecting roughly the average rate of profits anticipated from capital investment—has risen. This is, however, exactly what regularly happens in the boom period. If at the commencement of the boom the profit expectations of the economic system rise but the banks maintain their previous rate for credit advances or do not raise it sufficiently, then the automatic consequence is an increase in the demand for credit, owing to the widening of the gap between the rate of interest and profits on capital. In this case, therefore, no active intervention of the banks is necessary in order to call forth an increase in the demand for credit. It is sufficient if they do not follow or do not follow quickly enough the changes in average profit expectations (subjective real rate of interest). This is the situation that repeats itself with the beginning of every boom.

The credit expansion setting the boom going proceeds by way of the interest rate being “too low.” The too low interest rate invites a general increase in investment which then leads to the mechanism of the boom drifting on towards its ultimate débâcle as was described in the preceding section. At the same time the additional credits are the source out of which the increased capital needs of the boom are in the main satisfied. The chain of reasoning is now complete: the expansion of credit in the boom expressing itself in the too low interest rate leads to an over-expansion of the economic process and by introducing a general over-investment disrupts the equilibrium of the economic system. It allows more to be invested than is saved and makes available the necessary increase in money capital from credits which do not originate from savings but are created out of nothing through the banking system. The restriction of direct consumption necessary for every increase in investment which is undertaken voluntarily in the case of real savings, is here replaced by the shrinkage of consumption imposed by the (relative) price rise, consequent on the credit inflation, on all those whose incomes are not adjusted rapidly enough to the rise in prices (monetary forced saving).43 Through the additional credit there is made possible a shift in the economic system in the direction of an expansion of production, the “carrying out of new productive combinations of factors of production” as Schumpeter puts it, and “room” is “squeezed out” for the production of new goods at the cost of consumption.

The demonstration that the credit expansion of the boom leads to over-investment provides at the same time a proof that the capital formation induced by credit creation, and the extension of production that it sets going, leads to a painful reaction expressing itself in the crisis and depression. This reaction can indeed be postponed by a further increase of the credit supply but only at the price of a corresponding aggravation of the ultimate reaction. An “eternal boom” is therefore out of the question. The whole process of economic advance is, it is true, given a sharp jerk forward in the boom, but only to spring back again in the crisis and depression. The crisis breaks in the moment when the power of credit creation of the banks can no longer keep up with the continually increasing capital requirements of the economic system: there takes place, so to speak, a race between these two factors in which the banking system must finally succumb unresistingly if it wants to maintain sufficient liquidity to meet the increasing demands of the system for cash in the boom. The central note-issuing bank usually gives the signal for this by raising its discount rate.

The statement that the immediate cause of the breakdown is the necessity for the banking system ultimately to defend its liquidity position against the continuously growing demand for additional credits, needs to be carefully interpreted. Thus stated, it gives the impression that the machinery of the boom comes to a halt for a mere technical reason, i.e., because of the monetary exigencies imposed by the gold standard. Many writers—even Wicksell himself is not entirely free from this error—have, indeed, contented themselves with this explanation given in purely monetary terms. But it is very unsatisfactory and far too narrow, for it leaves unanswered the question as to what will happen in a closed system without the “golden brake on the credit machine.” Is it not another curse of the gold standard (or of any other currency with international affiliations and stable exchange rates) that it condemns us to cut short the road to eternal prosperity and to strangle the boom when everything is going at its best? The answer to this is, of course, that the only alternative to the “golden brake” (or its equivalent) would be a fully fledged inflation which, if no other brake were in due course to be applied, would end where the German inflation ended, without avoiding the ultimate crash. This must be looked at against the background of the “real” mechanism of intensification (principle of acceleration) described at full length in the preceding section. For the same reason also an investment boom financed by authoritarian forced saving or, if such a thing is conceivable, by voluntary savings, could not escape the same fate since in this case also the progressively growing scale of investments would necessitate a progressively growing scale of savings until the saving capacity of the nation were exhausted and, consequently, a correspondingly painful readjustment became necessary. In other words, the monetary aspect of the breakdown of an investment boom financed by credit expansion (monetary forced saving) is only a special form of the breakdown corresponding to the monetary causation of the boom. To be sure, this special form is also the usual and typical form characteristic of our economic system, but for reasons already indicated it must not be forgotten that it is a species belonging to a larger genus. The monetary theory of business cycles—even apart from its limited validity—can claim to be no more than a sort of Euclidean geometry among other non-Euclidean geometries.

In spite of the keenness and acuteness with which it has been added to and refined in the last few years, this exposition of the monetary theory of the trade cycle still remains full of unsolved or not entirely satisfactorily solved problems. To these belongs first and foremost the question as to what causes the banks to embark again and again on a credit expansion: is it a matter, as Mises thinks, of the effect of a certain ideology, or, as Hayek believes, of a process into which the banks are forcibly drawn? The probability is that the latter of these two contentions is right, but this does not mean that no effective limitation of credit expansion and therewith of over-investment is possible.

To sum up : the central idea of the monetary theory of the trade cycle is that the periodic expansion of credit regularly brings about that dislocation of the economic process which expresses itself in over-investment and its consequences. It would be too much to contend that this is the only circumstance that can lead to an excessive increase of investment, but experience and reflection seem to show that this is undeniably the usual way in which the disruption of the economic equilibrium takes place. In this sense the monetary theory of the trade cycle is perhaps far superior to any other.

The monetary theory of business cycles has the invaluable merit of having exposed the real driving force without which the acceleration of investments in our economic system could not grow to such dimensions as lead up the hill of the boom and then down into the ditch of the crisis. But the account we have given so far of this theory would be not only incomplete but dangerously misleading if we did not finally introduce a very important modification which has a bearing on the present situation of advanced depression but which is omitted in most statements of this theory. All that has been said on credit expansion involving (by rising prices) forced savings, and leading in consequence to unhealthy boom conditions, is true only in the case of an inflationary credit expansion.

But surely not every credit expansion is inflationary. Whether a credit expansion is inflationary or not cannot be measured by the behaviour of the price level, as was demonstrated above by the example of the recent American boom. But the case is different if credit is being expanded when there is heavy unemployment of factors of production brought about by a previous credit deflation. This is exactly the situation of the advanced depression to-day. In this case the warnings against credit expansion are really ill-timed and dangerously apt to retard the process of recovery which can only be initiated by credit expansion breaking the vicious circle of depression and reabsorbing the idle factors of production. Since in this case the increase of purchasing power would be at once accompanied by an increase of current output, no appreciable rise of prices, no forced saving in the strict sense and, consequently, no over-investment would occur. Credit expansion would tap the unused reserves of productive capacity corresponding to the deficit of purchasing power brought about by deflation and hoarding, and thus open up a source of capital without the dangerous recourse to forced saving. In contrast to the inflationary credit expansion at the later stage of the upward swing when the reserves of productive capacity are exhausted, the earlier credit expansion is compensatory, not inflationary. This compensatory credit expansion must be clearly distinguished from the former, lest the merits of the monetary theory of business cycles be diminished by sweeping exaggerations of its austere message and its deserved reputation be compromised by unfounded implications. It is a distinction which will be understood better after the process of the advanced depression (secondary depression) has been explained. This will be our task in the next section.

The monetary theory of business cycles, as so far expounded, centres around the idea that it is variations in the quantity of circulating media which set the process of alternating booms and depressions in motion. The widening or the narrowing of the money stream in total is declared to be the essential thing. This very important aspect must not, however, lead us to overlook the possibility that the qualitative distribution of the money stream may also become an additional factor of instability. Thus it might not be unimportant whether the flood of additional credits goes into commercial loans, into the real estate markets, into the export or import business, into instalment selling, or into stock exchange speculation. This question gained great topical interest in connexion with the last American boom period up to 1929. It has been already remarked that this period is full of riddles, and one of these riddles is the fact that this period which has been followed by the severest crisis in history shows, on the whole, a price level which was slightly sagging rather than rising. How, then, can there have been inflation? The answer to this question has been given in the text above where it was stated that, owing to decreasing costs following on technical progress, prices would have fallen if an enormous amount of additional credit had not been pumped into the economic system. Hence there was inflation, even if only of the relative kind. But it can be perfectly well argued that the quantitative effect of this inflationary credit expansion was considerably aggravated by an abnormal qualitative distribution of credits. One case is the great expansion of instalment credits which gives the impression as if the Federal Reserve system was trying to administer the heroin not only per os but also per rectum. Indeed, hardly anything was more disquieting than the sanguine light-heartedness which prevailed at that time in the United States in the sphere of instalment selling. Another instance is the real estate market which was also grossly over-supplied with credits. The worst and most conspicuous case, however, was the stock-market speculation which was the leader on the road to disaster. For purposes of illustration, it may be mentioned that the volume of brokers’ loans rose from 1921 to 11929 by about 900 per cent.44 It cannot possibly be denied that to conduct a large part of the additional credits over the securities market was a particularly dangerous procedure, for a number of reasons among which the disastrous international repercussions were not the least important. We may conclude, then, that the last American boom is a striking example of how the disequilibrating effects of variations in the volume of credit may possibly be greatly aggravated by peculiarities in the qualitative composition of the stream. But it must, of course, not be overlooked that this can only be an additional factor of instability and presupposes that an inflatory credit expansion is already going on. Without this, misdirections of credit can hardly give rise to a general economic disequilibrium. The same must be said about Irving Fisher’s “debt-deflation” theory of cycles45 which implies that it is over-indebtedness incurred during the boom which starts the crisis. Over-indebtedness could not occur without an inflationary expansion of credit, or, to be more explicit, it is only another word for it, since expansion of credit means, on the reverse side, expansion of debits, i.e., a growing volume of indebtedness.

§ 16. THE SECONDARY DEPRESSION.

The upshot of all that we have so far said is that the causation of the crisis and of the depression must be traced back to the mechanism of the boom. We understand now not only why the boom simply comes to a halt but also why it is usually followed by a painful process of contraction and liquidation. A satisfactory explanation of the boom implies, therefore, the explanation of the crisis as well. For this reason the theory of crises and cycles is essentially a theory of the boom. In the crisis, what has been sown during the boom has to be reaped; a readjustment of the disjointed economic system cannot be avoided. This is a point which must be emphasized strongly. But it is also a point which must not be driven too far. As the dramatic development of the present crisis abundantly proves, there is no denying the fact that the depression may, under certain circumstances, grow to dimensions quite out of proportion to the preceding boom, so that it loses more and more its function of readjustment and degenerates into a secondary depression void of any function whatsoever except to test the strength of the patience of the people in enduring a cumulative process of senseless and murderous economic destruction. Instead of restoring the economic equilibrium disrupted by the boom, the depression may lead, after a while, to a new disequilibrium which, caused by the process of the chronic depression itself, has nothing to do with the old set of disturbing factors. To explain this, a special theory of the depression becomes necessary. Its task is to describe how the original process of liquidation and adaptation in the primary depression comes to set in motion a cumulative process of recession, the conditions of disequilibrium being continuously reproduced on an ever-declining level of economic activity.

To begin with, the primary depression is characterized by a process of general economic contraction which is, broadly speaking, equivalent to a process of deflation. This deflation is the unavoidable reaction to the inflation of the boom and must not be counteracted, otherwise a prolongation and aggravation of the crisis will ensue as the experiences in the United States in 1930 have shown. But the deflation connected with the secondary depression is quite different in nature. Its raison d’être no longer lies in the impossible situation created by the preceding boom. It results from a set of causes which only come into being as a result, and during the course, of the secondary depression. Neither the primary deflation nor the secondary (“induced”) deflation has anything in common with that sort of deflation which has been practised several times in monetary history as a policy of wilfully diminishing the volume of currency in order to raise the purchasing power of money. Like the inflation of the boom period, the deflation of the depression is the passive endurance of a process rather than an active policy, but, unlike the primary deflation which is a necessary reaction to the boom inflation, the secondary deflation is an independent process which we can freely combat. And unlike the boom inflation which undoubtedly has the positive function of accelerating economic development, the secondary deflation, being void of any positive function, not only can but should be combated.

The important thing now is to realize that this secondary deflation has a very complicated structure which must be thoroughly grasped in order to avoid widespread misconceptions which are apt to lead business-cycle policy at this time dangerously astray. For this reason the term “deflation” must be applied with caution to this phenomenon. We have already said that it would be an error to think of it as being a result of a policy aimed at wilfully diminishing the volume of currency. It would be wrong to suppose that this secondary deflation has been launched by anybody on purpose though it is perhaps fostered by all kinds of ill-advised measures. It would be equally wrong, however, to connect the secondary deflation primarily with the behaviour of the general price level.

The secondary deflation is, of course, accompanied by a fall of the price level, but this is only a part, and not even the most important part, of a more general process, and the fall of prices is by no means a true measure of the whole extent of the process. To think otherwise and to define the secondary deflation in terms of the general price level is only to repeat in the opposite direction the erroneous conception of the boom as a price-level phenomenon, a conception which did so much harm during the last American boom. This obnoxious habit of thinking preferably in terms of the general price level may be aptly denounced as a “price-level complex.” We shall see later on that this habit has recently led, in the United States, to practical consequences hardly less disastrous than those experienced during the boom. The boom as well as the depression are not so much phenomena of price levels as phenomenon of quantities instead of one of prices, the same will be true production of capital goods). The sensational fall of prices of raw materials and agricultural products which has occurred during the present depression must not be allowed to conceal the fact that the general decline of prices is merely a rather weak reflection of the process of general economic contraction, as expressed in the statistics of production, incomes and unemployment. The obvious reason is that the effect on prices of the contraction of demand is to a great extent balanced by the contraction of the volume of production, with the marked exception of the greater part of the production of raw materials and agricultural products. In these latter cases the volume of production has been adapted very inadequately to the shrinking demand and in some instances an expansion of production has even occurred. Since the downward trend in the secondary depression has, on the whole, been primarily a phenomenon of quantities instead of one of prices, the same will be true of the upward trend. Anticipating the further treatment of this question, we may draw the conclusion at this point already that the process of contraction of the secondary depression cannot be counterbalanced by reflation (meaning a policy aimed at raising the general price level), but by re-expansion, apart, once again, from the special problem provided by the markets in raw materials and agricultural products. In other words, the policy of credit expansion at this time can be carried fairly far without bringing about a marked rise of the general price level, a statement which resumes a trend of thought which the reader will recall from the end of the last section.

If the fall of the price level is a very incomplete and inadequate index of the secondary deflation, what else is this mysterious and elusive thing? If we next turn to the behaviour of the volume of currency, we shall find that this also provides no real clue, and that for two reasons: firstly, because the volume of currency (cash) represents only the base of our modern money system, and secondly, because the shrinkage of the demand for cash engendered by the economic contraction is, to a large extent, compensated by the increased demand for hoarding and for the strengthening of the liquidity of the banks.46 Consequently, the shrinking volume of currency is also only a weak reflection of the general economic contraction.47 The only adequate way of characterizing the secondary deflation is to point to the contraction of the total demand, especially as it is expressed by the contraction of credit money (the main symptoms being the immobility of banking accounts, the shortening of the banks’ balance-sheets, the shrinkage of the clearing-house figures, &c.). This contraction of the total demand—which goes on behind the curtain of a more constant volume of currency—is the essential thing, the prime mover of the secondary depression. It is closely connected with the contraction of incomes and, also, though not so closely, with the contraction of costs, and ends in the general contraction of production which, in turn, reacts towards a contraction of demand and incomes. This mechanism of the secondary depression operates through a double “lag” which is self-maintaining as long as the vicious circle of the depression remains unbroken: firstly, the contraction of production tends to lag behind the fall of prices since it means a contraction of incomes and demand, and, secondly, the contraction of costs tends also to lag behind the falling prices. In the first case, it is the disproportion between supply and demand, and, in the second case, it is the disproportion between costs and prices, i.e., the lack of profitability, which tends to be continuously maintained.

But why this continuous contraction of demand? Why do not the forces which are always working for economic equilibrium reassert themselves? To put the matter briefly, the whole trouble may be ascribed to the disastrous destruction of that harmony between the process of the formation of incomes and the process of the utilization of incomes which constitutes an essential condition of general economic equilibrium. The discrepancy tends to become cumulative and leads to a continuous fall of demand on commodity markets, which in turn tends to bring about a yet further fall. The stream of money flowing to economic units—business firms and private households—and flowing out again is interrupted. Sums which flow in do not flow back to commodity markets, or else they flow back either only partially or after long delay. For purposes of illustration reference may be made to the large number of firms which are holding themselves as liquid as possible instead of using their funds for replacing old machinery let alone for making additional investments, or to those households which are actually hoarding money or leaving their banking accounts idle.48 A special form of this process of sterilization of purchasing power is the preference on the part of the public for accumulating funds on banking accounts rather than investing them on the securities markets, a preference which is tantamount to preferring liquidity and security to profit. This “bearishness” (Keynes) of the public towards investment in securities is a very important part of the whole machinery of the secondary depression which must be taken into account by any rational policy of initiating the recovery.

In all these cases money is being saved in a form, and under circumstances, which largely prevent it from being invested, so that the rate of saving is continuously greater than the rate of investment. As long as this is the case, savings not only add nothing to the wealth of the community but are positively harmful for economic welfare. Saving in this case is not only “abortive” (Robertson) but downright destructive—always in the relative sense that the money saved finds no outlet in new investments. Or in other words: money is withheld from expenditure on consumption goods, without any compensation for this non-consumption taking place in the form of investments in capital goods. The general contraction of demand is, then, tantamount to an excess of savings over investment. By force of logic, these two things must be identical.49

Now, every attempt on the part of producers to get rid of their surplus production, resulting from the fall of demand, by lowering prices and costs and by curtailing output will necessarily be self-frustrating. For it will lead to a new fall in demand so long as the discrepancy between the formation of income and the utilization of income (i.e., saving and investment) is not overcome, either by an increase of investment or by a decrease of saving. The general economic contraction brought about by this process of secondary deflation completes the vicious circle by impairing the chances of increased investment; and that for two reasons. In the first place, the general “crisis of confidence” which now breaks out serves as a kind of death-blow to the willingness of entrepreneurs to undertake new investment, while, secondly, this crisis of confidence is very apt to lead to the most fatal disturbances in the money and credit system. It may be remembered that, ever since the international liquidity crisis of 1931, the banking system in many countries has remained for a long time in a state of paralysis in which its willingness to finance new investment has been almost negligible. It is not difficult, moreover, to understand that the process of economic contraction is very apt to undermine the financial status of the banks by freezing and reducing the value of their assets, and this unfavourable development on the debit side tends also to impair the credit side of the banks’ balance-sheets, as it is conducive of fright among the depositors so that the financial position of the banks is pinched from both sides. In this way a situation may ensue which gives the superficial appearance as if there were still something inherently unsound in the banking system as an inheritance from the (primary) crisis, a vestige of the debaucheries of the boom which must be cured by a strong medicine before any new expansion can set in. But, as our reflections show, banking difficulties at an advanced stage of the depression may just as well be caused by the vicious circle set in motion by the excess of savings over investment. This was undoubtedly the situation in Germany in 1932, and it seems that some disturbances in the financial situation in France and in Switzerland in recent times ought to be interpreted in the same way. In other words, it is quite arguable that if the right moment for turning the tide of the depression by new credit expansion is missed, a relapse to a situation similar to the primary crisis may ensue. On top of all this, serious congestions in the monetary circulation may add to the difficulties, and the aggravation of the confidence crisis, together with the drop of prices and the progressive disintegration of the world’s economic system, may make every idea of new investment seem nothing short of foolish.

Especially important in this connexion is the weak condition of the securities markets. For if equilibrium is to be restored by an increase of investment (which is one of the two alternatives, the other being a decrease of saving), it can be possible only on two conditions. In the first place, the banking system must be prepared to grant new credits, a stage that may, at this time, be fairly said to have been reached in the leading countries. But the various unsuccessful attempts made in the United States at pumping additional credits into the arteries of the national economy have proved that the willingness of the banking system to give new credits does not in all circumstances suffice to bring about a credit expansion. To this end, a second condition must be fulfilled, viz., the existence of entrepreneurs who are willing to take new credits for investment purposes so as to render the credit expansion really effective by enlarging the volume of circulating media instead of merely enhancing the liquidity of somebody. The American experiences have amply verified the surmise that even a rate of interest which approaches zero may be insufficient, in the conditions of the secondary depression, to induce entrepreneurs to enter upon new investment. If in such a situation the elasticity of demand for credit becomes almost absolutely rigid, attempts at credit expansion will not lead to the desired expansion of the total demand for commodities, but merely to an increase of general liquidity.

Now the reluctance of entrepreneurs to enter upon new investment is due not only to the confidence crisis, to the recession of prices, and to the over-investment of the previous boom, but also to the fact that entrepreneurs do not dare, for the purpose of long-term investment, to have recourse to short-term credits—almost the only available method of financing new investment at this stage—unless a marked recovery of the stock exchange points to the possibility of an early funding of the preliminary advances of the banks. That is the reason (apart from the immediate psychological effects) why rising stock markets are a necessary condition for general recovery and why every measure and every event which has the effect of driving the public away from the stock markets constitutes a serious blow to recovery. And for the same reason it is the acid test for every recovery programme whether it succeeds in “priming” the securities markets, or not.50 Again, it must not be forgotten that a rising stock market provides a tremendous relief also to the banks by improving their liquidity and by enhancing thereby their willingness to enter upon new credit expansion. This is done in two ways: (a) by offering the banks an opportunity for turning their own securities into cash, and (b) by doing the same for their debtors, thereby thawing their frozen assets.

The situation on the stock markets is a point which can hardly be overstressed if a real understanding of the present depression and its course is desired. For it seems that in this respect things have taken, during the preceding boom and the subsequent depression, a course which has become a special feature of the post-war development, especially in the United States, where, in the absence of those political disturbances which account for some of the worst aspects of the depression in Europe, the malignant progress of the depression demands a special explanation. One of the reasons accounting for the American crash seems to be precisely the abnormal situation on the securities markets.

Many factors have contributed to this, the frenzied speculation of 1929 being one of the most obvious. Among these factors, however, the fact deserves greater attention than it has so far received that after the war a larger proportion of capital to be invested than before the war has gone into time deposits (or savings accounts) instead of being invested by the public directly in securities. This may be inferred from the fact that in many countries the ratio of time deposits to demand deposits has markedly increased, most of all in the United States where, for the United States as a whole, the percentage of time deposits to total deposits has risen from 23 in 1913 to 45 in 1932 while, for the U.S. National Banks, the corresponding rise has been even from 9 to 47.51 In order to grasp the significance of this change-over in favour of time deposits, one has to take into account the further fact that there corresponds to this change on the liabilities side a change also, in large measure, on the assets side, viz., the equally excessive enlargement of banks’ investments in securities. In other words, the public is investing its money in securities indirectly by way of the banks, thereby combining security with a high degree of liquidity and also—if the banks are paying good interest on time deposits as they have done in the United States, in Germany and elsewhere—with a reasonable degree of profit. The banks are bearing the risk of possible depreciation of the securities held in stock, but—unfortunately even South-American bonds included!—this risk seemed so small during normal times that in the United States there even came into being a new school of Bank Liquidity which preached this sort of investment as the last word in the art of banking.52 In the light of later experiences we may safely say now that this development was unsound and dangerous, so much so that the name “deposits disease” does not seem altogether inapt. When during the depression the confidence in the banks began to crumble and deposits were withdrawn the American banks had to sell out their securities on a weak market, thereby causing a collapse on the stock exchange to an absolutely abnormal extent out of all proportion to the mere influence of speculation. In contrast to the United States and several other countries, France is the outstanding example of a country which has remained absolutely free from the “deposits disease,” the percentage of demand deposits having even slightly increased between 1913 and 1932. This notable fact is a very telling expression of the investment habits of the French population and of the kind of banking institutions corresponding to them. Since the great commercial banks of the type of the Crédit Lyonnais pay practically no interest on deposit accounts they offer no incentive to the public seeking investment for their disposable capital. It seems to the present writer that this accounts, to a large extent, for the fact that France has been relatively free from the kind of financial disturbances which have shaken American economic life to the core.

After this outline has been given of the destructive machinery of the secondary depression, it is a pertinent question to ask: where does it end? Bitter experience has taught us in recent times that, in the course of such a process, production may shrink to seventy, sixty or even fifty per cent, of the original volume, and we may well ask whether there is any mechanism operating to prevent a shrinkage to ten per cent, or less. In pure theory such a monstrous thing is not entirely inconceivable. But we may congratulate ourselves that a kind of automatic safety brake is provided against this final catastrophe. In order to understand this, it has to be recalled that the depression can be stopped only in two ways, either by an increase of investment up to the level of saving or by a decrease of saving down to the level of investment. As regards the first alternative, it is surely possible that during the course of the depression something may occur which gives an incentive to new investments. The satisfaction of replacement demand cannot be deferred for ever, and here or there a new line of investment may even seem profitable, although the mechanism of the secondary depression works strongly against this. There are even certain industries whose profitability is likely to be enhanced as the depression progresses.

Leaving aside the industry of manufacturing books on crises and cycles, there are two big industries likely to prosper inversely to the depression, the armaments industry and the gold-mining industry. It is a remarkable fact that throughout the present depression the shares of the great armaments firms have not only kept their level but soared continuously at a time when almost all other shares were sagging, and it is surely not a too far-fetched idea to suppose that the rising prosperity of this branch of industry owes much to the political repercussions of the general economic and social atmosphere created by the protracted depression, especially in certain countries. What has been achieved recently in the way of economic recovery is, indeed, due, to no small extent, to the boom in all kinds of war materials. Certainly the temporary German recovery after 1933 must be largely ascribed to this factor, and it is no secret that countries like Sweden have greatly profited therefrom. But while in the case of the armaments industry the influence of the depression depends on many and uncertain intermediary factors, the favourable effect on the gold-mining industry is direct and quasi-automatic and this for a simple reason. “So long as there exists at least one country on a full gold standard, an essential condition of which is freedom to buy gold from or sell gold to the central institution at a fixed price, there is literally an unlimited demand for the commodity at that price. In other words, not only is a minimum price for the product of the industry guaranteed, but there is, besides, no limit to the amount the market will take. Added to this, the effective minimum price, translated into terms of the producing countries’ currencies, has risen substantially in recent years, without a corresponding rise in costs, in consequence of widespread departure from the gold standard. Happily, prosperity in any one industry cannot fail to contribute to recovery in others, and in this respect gold producing is not exceptional.”53 The world’s gold production has, in fact, increased from 1930 to 1934 by about one-third.

But if all this fails to turn the tide, then, in the last resort, the automatic safety brake comes into action. As economic contraction proceeds, there finally comes a moment when, even without any increase in the rate of investment, equilibrium is restored owing to the rate of saving having been pushed down to the level of the rate of investment. This occurs when, on the one hand, general impoverishment forces people to consume savings and, on the other hand, the increasing budget deficit cannot possibly be covered any longer either by reducing expenditure or by raising taxation, except at the expense of a revolution. At this moment the crisis has quite definitely touched bottom. Making due allowances for the necessary qualifications to this statement with which we shall deal later, and fully recognizing all its dangerous implications, we must not ignore the truth contained in the bold conclusion that the one situation in which a budget deficit cannot possibly be avoided is precisely the situation where it is highly salutary. This proves that those are, after all, right who maintain that even the severest crisis will cease in the end—provided that the political and social framework will stand the heavy pressure. Even if we do nothing, the natural course of things will bring about its own solution though in the cruel way in which nature likes its solutions—with several thousands more having recourse to the gas-hose, several hundreds more being killed in civil warfare, and (consequent on the general destitution and exasperation) with the hysteria of the masses and their leaders increasing to such a degree as to shake State and society to their foundations. But the question why we should cross our arms in resignation is the more pertinent since the political convulsions arising from this process may lead to a very dangerous turn in economic policy which is apt to make the economic crisis a real crisis of our entire economic and social system. It would be easy to write the world’s history of the last years largely in terms of this analysis.

There remain two final questions relating to the phenomenon of the secondary depression. After having answered the question as to where it ends, it seems an equally legitimate question to ask where it begins. This question is the more important since, in contrast to the primary depression, an opposite course of action is indicated during the secondary depression. While it is wrong to obstruct the inevitable course of the primary depression by new injections of additional credits, this is just the remedy for curing the secondary depression. What are, then, the symptoms that tell us exactly where the primary depression turns into the secondary depression? No cut-and-dried answer to this question seems possible, since a more or less broad period of a doubtful nature divides the two phases, a period in which the right policy seems to be to stay on the safe side and to await events. But there are some broad principles which can be used for diagnosing the appearance of the second phase. The simplest is the mere elapse of time after which it may be reasonably expected that the primary depression has fulfilled its purging mission. It would reveal an incomplete understanding of the process of the secondary depression if we were to take the appearance of fresh disturbances as a sure sign that the process of salutary purging has not yet come to an end. For as the depression progresses it always breeds new disproportions. If production shrinks to 50 per cent., there will scarcely be any investment which does not turn out to be a “faulty investment,” there will hardly be any wages which are not too high, and there will hardly be any bank or industrial firm which does not get into serious trouble. But, still, this is all rather vague. More conclusive is the symptom of persistent mass unemployment which may be taken as an indication that the primary depression has quite outgrown the dimensions imposed by its function of readjustment, and most conclusive of all will be the fact that the depression has also engulfed the industries producing consumption goods. This statement will be easily understood after the analysis given in the last sections.

The second of these final questions is a rather disquieting one. How are we to interpret the experiences of the secondary depression of to-day in the light of past experiences and of a more distant future? Is this depression of the nature of an historical accident and therefore an exception to the rule, or is it just the other way round, viz., that it is rather the milder form of the pre-war depression that is the exception? Is it not arguable that the tendency to degenerate into a secondary depression may be inherent in every primary depression, and that it is just a miraculous accident if this tendency does not become manifest? Possibly there existed before the war powerful forces which pulled the cart promptly out of the ditch by providing irresistible incentives for new investments and thus quickly absorbing excess savings? Perhaps imperialistic expansion? Or the pressure of a growing population? To argue in this way has always been the habit of staunch Marxists, but it is no wonder that the recent experiences of the present depression have rallied an even wider circle of followers to this view. Some of these even go to the length of asserting that there is a permanent tendency for investment to be outrun by savings and therefore a tendency towards a chronic depression which is only interrupted by short-lived fits of concentrated investment. According to these gloomy pessimists—mostly sanguine inflationists in disguise, if not actually prophets of the end of capitalism—our economic system is headed for a sort of economic “entropy” where all economic energy will be paralysed by a suffocating excess of savings—unless there are huge earthquakes, big wars, and other pleasant things.

Enough has been said on these points to make a refutation of such wild surmises hardly necessary. It all boils down to the question as to whether it is conceivable that savings can ever become so abundant that we do not know what to do with them even at a rate of interest approaching zero. To this question, of course, only one answer is possible. Over-saving as such is an inconceivable thing, belonging to the same species as other economic scares like over-production. As long as the last peasant is not provided with a harvester, and the last suburban proletarian with a villa and a Rolls Royce, as long as not all the railways of the world are electrified, all countries covered with magnificent automobile roads and all cities of the world blessed with underground railways, it is futile to discuss this point. To designate booms as periods where the pressure of excess savings is temporarily relieved by adequate investments is really a very curious misrepresentation of actual facts. As we know, it is just the excess of investments over savings which is the essence of the booms. The very fact that recourse has to be had to forced savings (credit expansion) in order to finance the huge investments of the boom period and so to set in motion the familiar process leading to the crisis abundantly proves how utterly undeserving of discussion this view is.

But all this does not dispose of the possibility that, once overinvestment has set in motion the process leading from the boom to the depression, our economic system may tend to fall into the coma of the secondary depression unless strong incentives of an extraordinary character drag it promptly out again. This is certainly a question worthy of discussion. It has happened in the recent case, and it has happened several times before in the history of depressions. But all this is neither here nor there. The real point is whether the “strike of entrepreneurs,” which is virtually at the bottom of the secondary depression, is likely to be of any significance under ordinary circumstances or whether the opposite is true. It would be rash to give any peremptory answer to this question since it is a question of greater or lesser probability into which many psychological factors enter. All we can say is that it is indeed not likely that things are exactly as the pessimists would make us believe—unless an unusual constellation of circumstances contrives to bring about that set of abnormal psychological reactions in which the secondary depression thrives. That is just what has happened to-day. It is the personal view of the present author that capitalism, as such, is essentially inimical to economic inertia. By virtue of its basic principles it has, like nature, a horror vacui which leaves no gap unfilled. It takes a great deal to kill this stupendous vitality inherent in capitalism, but in the last five years the world has managed somehow, if not actually to kill it, at least to knock it half-conscious, so that the wonder is not that so much of the previous vitality has gone, but that so much still remains. But even if this view should be incorrect and if the recurrence of deadlocks should become a regular feature of capitalism in the future, it would be wiser to apply some judicious measures to help capitalism along than to scrap it altogether.

Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn.54 His real name was N. Johannsen under which his later publications are known.55 He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson.56 Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,”57 though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time.58 In subsequent years the present writer tried on several occasions to elaborate his point of view.59 It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England,60 of Professor Ohlin in Sweden,61 of Professor Viner in the United States,62 of Professor Haberler and Dr. Mahr in Austria,63 and of Professor Verrijn Stuart in Holland.64 It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.

§ 17. SUMMARY.

The lack of agreement among the various theories of the business cycle is, as Mitchell rightly remarks, less a disagreement over fundamentals than one over arrangement and emphasis. This is explained by the fact that the laws of economic movement cannot be described and analysed without pursuing all those numerous forces which determine the course of the economic process: production and consumption, the distribution of income and its expenditure, saving and investment, optimism and pessimism, natural and social forces, commodity and money influences, prices and costs. Consequently every simple explanation of the business cycle must be incomplete and therefore false. On the other hand, however, the theory would be lacking in form and superficial if it sought to give equal value to all the forces influencing economic phenomena. A classification of these forces is the more indispensable since some of them stand out as those which can claim the rank of a real cause while others subside into the background as forces which either only give the first impetus (which would remain ineffective without the “causes”) or provide the frame within which the “causes” unfold their effect. A satisfactory explanation has therefore three tasks: to enumerate the initiating forces, to establish the real causes of the cyclical movement, and to describe the mechanism of the movement through boom and depression. The first problem has been solved by reference to discoveries, natural and political events, changes in sentiment, and all the other circumstances which may give the first impulse to a boom. As regards the second problem which consists in tracking down the ultimate causes of cyclical movements, the choice can only fall on the monetary factors which were described in the preceding section. The last problem can only be dealt with by describing those processes which—reinforced by the dislocations in the distribution of income and in its expenditure, by changes in the structure of prices and costs, and by psychological and technical factors—culminate in the fluctuations in the scale of investment. The explanation in favour of which we have decided may be denominated a monetary over-capitalization theory: this sidetracks the futile dispute as to whether the monetary causation predominates over the non-monetary causation or vice versa.

This theory gives us the following schematic description of the cyclical process: In the depression, stocks are cleared, both households and business firms have held off their demand for goods for a long time, funds of money capital have accumulated and have caused the rate of interest to fall, the diseased parts of the economy have been cut out, elements of waste are eliminated, production costs generally are lowered. After the forces have in this way gathered in readiness for an economic boom, an impulse emerges from somewhere which releases the disposition for the increase of investment. This disposition grows by its own force to ever greater strength, partly out of psychological grounds and partly by reason of economic compulsion. But this increase in investment would not be possible if the economic system were not fed with additional credits proceeding by way of a relatively low interest rate. The over-capitalization made possible by credit expansion finally disrupts the equilibrium of the economy. It does not always end in a crisis but invariably ends in a depression during which by the painful process of recession and reconstruction a new equilibrium gradually establishes itself from which a fresh boom takes its start.

All these considerations lead to the conclusion that the theory of cycles and crises is essentially a theory of the boom. Once the boom and its real mechanism has been explained the explanation of the crisis and depression follows by itself. There is nevertheless still room for a special theory of the depression in so far as it may in certain circumstances acquire an independent character. This is the case when the depression acquires an obstinacy and an intensity which can no longer be designated as the mere reactions to the preceding boom, when it loses its real economic function of “readjustment” and degenerates into a process of economic contraction magnifying itself by its own force. To understand this, the depression must be conceived as a period in which the falling off of the will to invest, the fall in prices and costs, and the striving of the banks to write off their bad debts and increase their liquidity unite in a process of reciprocal reaction which leads to a shrinkage of the volume of credit and of production along with a glut of goods (deflation). This shrinking process can in certain unfavourable circumstances proceed further than the measure necessitated by the liquidation and readjustment function of the depression, and involve the economic system in a cumulative process of stagnation which lasts so long as the “slack,” in the form of reserves of productive resources, cost reductions and savings, arising out of depression, is not utilized for new investment. The primary depression which represents the necessary reaction of the economy to the disturbance of equilibrium by an excess of credit creation may be followed by a secondary depression whose real causes are to be sought in the circumstance that an independent and economically purposeless secondary deflation develops out of the unavoidable deflation of the primary depression. If in the primary depression the poison of the credit inflation is discharged, then in the secondary depression the new poison of the deflation penetrates the economic body. Undeniably the world has recently witnessed this second phase of the depression. The primary depression had fulfilled its economic function of readjustment but until quite recently the powers of self-healing which should now come into action had failed to appear and their place had been taken by a new further shrinkage.

If we wish to make use of the knowledge we have acquired about the causes of cycles and crises to explain the present world economic depression, then the first thing that we must realize is that the present depression is the result of a combination of the most varied factors and only this combination explains the unexampled acuteness and stubbornness of this the most severe of all depressions yet experienced.65 The origin of the depression is to be sought, like that of every former depression, in the over-investment of the preceding boom caused by credit expansion, so that to this extent it can be fitted into the historical rhythm of cyclical movements. The main seat of this unhealthy economic expansion was the United States whose credit expansion has already been described. From here the credit expansion spread over the whole world supported substantially by the monetary policy of the Bank of France and the Bank of England. Germany took part in the international credit expansion mainly via enormous imports of capital. These gave the incentive there also to an investment boom in which there lay a special danger, enhanced by the loan policy of the then Reichsbank President Schacht, by the fact that the foreign credits had the increasing tendency to take short-term form. If we want to go still further back, it is the World War and the destruction that it left behind it which must be designated as the ultimate great driving force behind this strenuous exertion of the nations as this enormous wave of the last investment boom may be described.

On the one hand, the war destroyed an enormous amount of the capital wealth of the world and, as a consequence of decidedly short-ssighted peace treaties, it disturbed the world economic equilibrium. On the other hand, besides speeding up technical progress, it stimulated men through necessity, economic pressure, and impoverishment, to develop their economic energies to the furthermost limits. So long as this stimulation lasted, the disturbance of equilibrium due to the war and the peace treaties was more or less suspended in its effect, being superseded by the hectic activity in making good the war destruction. But the ultimate collapse was bound to be the more terrific: the structural strains and disturbances brought about by the war combined their sinister effects with the unavoidable reaction to the boom, the latter in its turn being largely created by the same war. So there stands over the present world economic crisis with all its misery and destruction the shadow of the World War: it is essentially only a continuation of the atrocious drama which began in August 1914, and perhaps nothing has contributed so much to its aggravation as the circumstance that the world is to-day more distant than ever from real political and economic peace and that the harassing fear of new political adversities, in a moment when the consequences of the last war are shaking the stability of our social system, is paralysing the economic forces all over the world.

We repeat: in its essence and in its outcome the depression in the United States and in Germany—the two main seats of the depression—derived from the unhealthy economic expansion which was in turn caused by developments in the money and credit system. In accordance with the height of the investment wave the depression would have been severe even if no further aggravating circumstances had been present. But such circumstances happened to supervene to a disastrous extent.

As fate would have it, this economic depression coincided with an unusually severe agricultural depression which shook the agriculture of all areas and hit cereal-growing with exceptional vehemence. On top of all this there came all kinds of harmful State interference (tariffs, valorization, wage-manipulation, subsidies, &c.), reparations and other huge political debts, the carrying too far, both in tempo and in extent, of rationalization, disturbances in the mechanism of the international monetary standard, the dislocation of world markets through Russian dumping, wasteful expenditure by governments, the decrease of the elasticity of the economic system through the growth of monopolistic elements of every kind, and, finally, that cumulative aggravation of the depression of which we have already spoken.

 

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66 A good and up-to-date history of the doctrines on crises and cycles is still lacking. The only comprehensive monograph on the subject, to the best knowledge of the author, is : E. v. Bergmann, Geschichte der nationalökonomischen Krisentheorien, Stuttgart, 1895, but the point of view of this book is somewhat antiquated. Other references are : Alvin Harvey Hansen, Business-Cycle Theory, Its Development and Present Status, New York, 1927; J. Lescure, op. cit., pp. 313-414; W. Fischer, Das Problem der Wirtschaftskrisen im Lichte der neuesten nationalökonomischen Forschung, Karlsruhe, 1911; K. Zimmermann, Das Krisenproblem in der neueren nationalökonomischen Theorie, Halberstadt, 1927; Rolf Wagenführ, Die Konjunkturtheorie in Russland, Jena, 1929. Views of different writers on the present status of trade-cycle theory are assembled in the Festschrift for Arthur Spiethoff: “ Der Stand und die nächste Zukunft der Konjunkturforschung,” Munich, 1933.

67 Wesley C. Mitchell, op. cit., pp. 49-53.

68 Alvin Harvey Hansen, op. cit., pp. 1-10.

69 By far the best available book on all these questions of economic methodology is L. Robbins, An Essay on the Nature and Significance of Economic Science, 2nd ed., London, 1935.

70 Most distinguished work was done also by the Russian Institute for Cycle Research in Moscow established after the war, with men like Kondratieff, Wainstein, Oparin, and others among its staff. Unfortunately, this activity was abruptly stopped, several years ago, because the Government deemed it “reactionary,” and the staff was sent to Siberia or shot. It is in reverential commemoration of these fine men, some of them personally known to the present writer, that this note has been added.

71 Cf. O. Morgenstern, Wirtschaftsprognose, Eine Untersuchung ihrer Voraussetzungen und Möglichkeiten, Vienna, 1928.

72 The literature on this subject is mostly in German, for instance : F. Lutz, Das Konjunkturproblem in der Nationalökonomie, Jena, 1932 (a very commendable book); A. Löwe, “Wie ist Konjunkturtheorie überhaupt möglich?” Weltwirtschaftliches Archiv, October 1926, pp. 165-197; E. Carell, Sozialökonomische Theorie und Konjunkturproblem, Munich, 1929; E. Preiser, Grundzüge der Konjunkturtheorie, Tübingen, 1933. Some very relevant remarks are now also to be found in English in the English translation of F. A. Hayek’s book, Geldtheorie und Konjunkturtheorie (Monetary Theory and the Trade Cycle, London, 1933).

73 The best treatment may be found in the aforementioned book by F. Lutz of which the argument in question is the main theme.

74 See W. Röpke, “Sozialökonomische, Betrachtungen über den abnehmenden Bevölkerungszuwachs,” Economist (Dutch), September 1930, pp. 637-655.

75 This view is opposed to the widespread belief that the slackening rate of population growth is a factor of growing instability, a belief which has already been dealt with in chap. i. It must be added, however, that this question constitutes a rather intricate problem in which there are many points with which we have to reckon. Thus it has been shown in chap, i that the slackening rate of population growth may bring a number of industries—especially agriculture—into grave difficulties. Another question is the political effect of the slowing-down of population growth which may also have economic consequences. In this respect, the slackening rate of population growth works in two directions. On the one hand, by reducing the pressure of population, it diminishes the strength of one of the most active forces behind modern imperialism. On the other hand, if the growth of population slows down faster in one country than in another, this may produce a feeling of insecurity in the first country, and thus poison the atmosphere of international politics.

76 The best book on these questions, accessible to the English reader, is now Collectivist Economic Planning (ed. by Professor von Hayek), 2 vols., London, 1935. Of special interest therein is the treatment, given by Professor Brutzkus, of the problems and the experiences of Soviet Russia.

77 The problem of the Dynamics of the Socialist Economy will be resumed later on from a more theoretical point of view. Unfortunately, it has not, up to the present, been adequately dealt with in economic literature. Some remarks, running somewhat parallel to the argument presented here, may be found in Professor Aftalion’s book Les Crises Périodiques de Surproduction, vol. 2, pp. 405-411.

78 The first representative, of this theory seems to have been the astronomer Herschel (Philosophical Transactions of the Royal Society of London, 1801). It was he who gave Jevons the idea for his theory which connected up the periodicity of sunspots with the fluctuations of harvests and with the trade cycle (Investigations in Currency and Finance, London, 1884). To the same school belong : H. Dietzel, article “Ernten” in the Handwörterbuch der Staatswissenschaften, 3rd ed., and H. Moore, Generating Economic Cycles, New York, 1923. The most has been made of this argument recently by John H. Kirk, in his very interesting book, Agriculture and the Trade Cycle, Their Mutual Relations, with special reference to the Period 1926-1931, London, 1931. See also § 2 above.

79 Attempts have been made in this direction by L. Pohle (Bevölkerungsbewegung, Kapitalbildung und periodische Wirtschaftskrisen, Göttingen, 1902), and by M. B. Hexter (Social Consequences of Business Cycles, Boston and New York, 1925).

80 Literature on this subject : J. B. Say, Traité d’Economie Politique, first published in Paris, 1803; L. Miksch, Gibt es eine allgemeine Ueberproduktion? Jena, 1929; W. Röpke, “Kredit und Konjunktur,” Jahrbücher für Nationalökonomie und Statistik, March-April 1926, pp. 256-262; A. Aftalion, op. cit., vol. 1, pp. 274-286; vol. 2, pp. 261-351; Hans Neisser, “General Overproduction,” Journal of Political Economy, August 1934, pp. 433-465. Somewhat similar Anti-idiotica, as used in the text above, are administered by Professor Cannan, in his paper “Not Enough Work for All,” Economic Journal, September 1932 (reprinted in his book, Economic Scares, London, 1933).

81 Among the large number of publications dealing with this question mention should be made of : Alvin H. Hansen, “Institutional Frictions and Technological Unemployment,” Quarterly Journal of Economics, August 1931 (reprinted in his book Economic Stabilization in an Unbalanced World, New York, 1932.) For a different point of view, see Emil Lederer, Technischer Fortschritt und Arbeitslosigkeit, Tübingen, 1931, and A. Kähler, “The Problem of Verifying the Theory of Technological Unemployment,” Social Research, November 1935.

82 Modern representatives are, for example, J. A. Hobson, The Industrial System, London, 1909; E. Lederer, “Konjunktur und Krisen,” Grundriss der Sozialökonomik, part iv, 1, Tübingen, 1925, from p. 354; W. T. Foster and W. Catchings, Profits, Boston and New York, 1925; R. Luxemburg, Die Akkumulation des Kapitals, Berlin, 1913; Erich Preisser, Grundzüge der Konjunkturtheorie, Tübingen, 1933.

83 This remark has some bearing on the present situation. For there are to-day many who, while opposing the idea of an internal expansion of credit, believe in fighting against the depression by using the idle plant at home for the economic development of backward countries, without seeing the identity of the two cases. So far as the real nature of the economic process is concerned, it makes really no difference whether the unused capacity of the cement industry is used for slum-clearance at home or for building a water-dam in Tibet, though the one scheme may be preferable to the other for a number of other reasons. It may happen, however, that the water-dam project in Tibet might attract entrepreneurial initiative at a time when equally attractive objects for investment at home are wanting. This is the only small vestige of truth in the theory of Economic Imperialism.

84 Cf. E. F. M. Durbin, Purchasing Power and Trade Depression, a Critique of Under-Consumption Theories, 2nd ed., London, 1934 (a book with which the present writer is especially in sympathy); L. Robbins, “Consumption and the Trade Cycle,” Economica, November 1932; H. T. N. Gaitskell, “Four Monetary Heretics,” in What Everybody wants to know about Money, ed. by G. D. H. Cole, London, 1933.

85 An outstanding example is to be found in the numerous books of Messrs. Foster & Catchings (Profits, 1925; Business without a Buyer, 1927; The Dilemma of Thrift, 1928, and others).

86 For instance : F. A. Hayek, “The ‘Paradox’ of Saving,” Economica, May 1931; A. H. Hansen, Business-Cycle Theory, New York, 1927.

87 Represented by : A. C. Pigou, Industrial Fluctuations, London, 1927; F. Lavington, The Trade Cycle, London, 1925. Schumpeter also is in a certain sense to be included among this school—see his Theory of Economic Development: An Enquiry into Profits, Capital, Credit, Interest and the Business Cycle, translated by R. Opie, London, 1934, and “The Explanation of the Business Cycle,” Economica, December 1927. An analysis of the psychological factors in the business cycle is given in Röpke, Die Konjunktur, loc. cit., pp. 70-84.

88 M. v. Tugan-Baranowski, Studien zur Theorie und Geschichte der Handelskrisen in England, Jena, 1901 (first Russian edition 1894).

89 Spiethoff, Vorbemerkungen zu einer Theorie der Ueberproduktion, Schmollers Jahrbücher, xxvi, 1902; Cassel, The Theory of Social Economy, 2nd ed., London, 1932; Schumpeter, op. cit.; Aftalion, op. cit.; M. Bouniatian, Wirtschaftskrisen und Ueberkapitalisation, Munich, 1908; D. H. Robertson, A Study of Industrial Fluctuations, London, 1915. For the views of the present author, see W. Röpke, Kredit und Konjunktur, loc. cit.

90 J. M. Clark, “Business Acceleration and the Law of Demand,” Journal of Political Economy, March 1917, and also the same author’s books, Studies in the Economics of Overhead Costs, Chicago, 1923, and Strategic Factors in Business Cycles, New York, 1934. Consult also the discussion between C. and R. Frisch in the Journal of Political Economy, October, December 1931, and April 1932.

91 J. M. Clark, Strategic Factors in Business Cycles, op. cit., p. 36.

92 D. H. Robertson, Banking Policy and the Price Level, 3rd ed., London, revised 1932 (a small book of the greatest importance though somewhat difficult for the uninitiated reader).

93 There is a second meaning of “over-saving” relating to the situation during the depression when more is being saved than invested, so that saving leads to the disappearance of purchasing power from circulation and thus to its sterilization. This sort of “over-saving” is the driving force behind the cumulative process of depression about which more will be said in § 16. But its nature is quite different from that of the type of “over-saving” discussed above. Over-saving as discussed above means that too much is being saved compared to the power of the economic system to adapt itself to rising investments, while over-saving in the second sense means that savings exceed investments with deflationary effects.

94 Cf. Berle and Means, The Modern Corporation and Private Property, New York, 1933; O. W. Knauth, “The Place of Corporate Surplus in the National Income,” “Journal of the American Statistical Association, vol. xviii, 1922.

95 This theme has been developed more fully by the present author in his little book Die Theorie der Kapitalbildung, Tübingen, 1929. Cf. also R. Weidenhammer, “Causes and Repercussions of the Faulty Investment of Corporate Savings,” American Economic Review, March 1933.

96 The most has been made of this argument by Professor Francesco Vito in his interesting paper “Il Risparmio Forzato e la Teoria dei Cicli Economici,” Rivista Internazionale di Scienze Sociali, January 1934.

97 J. M. Keynes, A Treatise on Money, 2 vols., London, 1930.

98 Keynes, op. cit., II, pp. 148-149.

99 Cf. especially his book Prices and Production, 2nd ed., London, 1935. For a fuller understanding of Dr. Hayek’s ideas his numerous other publications must also be consulted (“Das intertemporale Gleichgewichtssystem der Preise und die Bewegungen des ‘Geldwertes,’” Weltwirtschaftliches Archiv, July 1928; “Kapitalaufzehrung,” Weltwirtschaftliches Archiv, July 1932; Monetary Theory and the Trade Cycle, London, 1933; “Capital and Industrial Fluctuations,” Econometrica, April 1934).

100 The most advanced book of this school on the theory of capital is now R. von Strigl, Kapital und Produktion, Vienna, 1934. This book is of special importance as it shows that it is possible on the base of the post-Böhm-Bawerkian theory of capital to explain the cumulative process of depression on lines not very dissimilar from those of Mr. Keynes. It must be said, therefore, that Dr. v. Hayek’s theory is by no means the logical consequence of this theory of capital based on the fundamental conception of the subsistence fund. It is now generally recognized that the post-Böhm-Bawerkian theory of capital is badly in need of a thorough revision in several of its fundamental conceptions. Especially, the idea of the “length of the production period” has, recently, become an object of a very critical attack by a host of writers in different countries (Howard S. Ellis, Frank H. Knight, O. Morgenstern, Gifford and others). Of still greater importance for trade-cycle theory is the dubious character of the Böhm-Bawerkian conception of the “subsistence fund.” Nobody can deny that this conception has a real meaning inasmuch as increased accumulation presupposes a restriction of consumption, but this meaning is by no means so clear as the post-Böhm-Bawerkian school supposes it to be. The idea that accumulation and consumption are mutually exclusive alternatives, in other words, that an increase in investment must always mean a corresponding absolute restriction of consumption looks rather defective in view of the palpable fact that, during the upswing, investment and consumption rise simultaneously. Even in this case, it is, of course, still true that accumulation means non-consumption, but the point is that this restriction of consumption is only relative while the absolute amount of consumption rises owing to the rise in total productivity resulting from the mobilization of idle productive reserves which has, in turn, been brought about by the increase in investment. Therefore, to some extent—i.e., to the extent to which idle productive reserves are again brought into profitable use—an increase in investment stimulates an increase of the subsistence fund. If this reasoning is correct, the subsistence fund ceases to be an independent variable whenever the extraordinary conditions of depression have created a large increase of “idle capacity.” Then, to reiterate, we have really a case not only of eating the cake and having it but of having still more of it while eating, though it is still true that the bit we eat we cannot have at the same time. Without this, neither the nature of capitalism nor its history can be really understood. It is important to note, however, that this applies only to the first phase of the upswing (the compensatory phase) not to the second (inflationary) phase in which the reserve of idle capacity is already exhausted. In the latter phase, accumulation and consumption become, indeed, strictly alternative in character.

101 F. A. von Hayek, “Capital and Industrial Fluctuations,” Econometrica, April 1934, p. 155 (reprinted in the new edition of his book Prices and Production, p. 140).

102 Dr. von Hayek’s theory has been criticized on rather similar lines by Alvin H. Hansen and Herbert Tout, “Investment and Saving in Business Cycle Theory,” Econometrica, April 1933. The views of these authors seem to coincide particularly closely with the views of the present writer.

103 It is interesting to observe that in his most recent publication (“Preiserwartungen, monetäre Störungen und Fehlinvestitionen,” Nationalokonomisk Tidsskrift, LXXIII, pp. 175-191) Professor von Hayek comes rather near to the view expressed in the text.

104 The origin of the monetary theory of the cycle can be traced back to the English monetary theorists of the first half of the nineteenth century (the Currency school). More modern representatives are: R. G. Hawtrey, Currency and Credit, 2nd ed., London, 1923; L. von Mises, The Theory of Money, London, 1934 (first published in 1912 in German); F. A. von Hayek, op. cit.; L. A. Hahn, Volkswirtschaftliche Theorie des Bankkredits, 3rd ed., Tübingen, 1930; Irving Fisher, The Purchasing Power of Money, New York, 1911 (recently Professor Fisher has suggested a different explanation of cycles, the “debt-deflation” theory).

105 F. A. v. Hayek especially has done much to refine the monetary theory of the trade cycle. See also J. Akerman, Some Lessons of the World Depression, Stockholm, 1931, and F. Machlup, Börsenkredit, Industriekredit und Kapitalbildung, Vienna, 1931.

106 The process is now clearly explained in any text-book on economics, banking or money (especially recommendable is Hartley Withers’ Meaning of Money). A fuller treatment may be found in the following books: R. G. Hawtrey, op. cit.; J. M. Keynes, A Treatise on Money, pp. 23-49 : C. A. Philipps, Bank Credit, New York, 1920; W. F. Crick, “The Genesis, of Bank Deposits,” Economica, June 1927, and F. A. von Hayek, Monetary Theory and the Trade Cycle, London, 1933. Without an understanding of this process and of its limitations, no real insight into the working of our banking system and, consequently, of our entire economic system seems possible, to say nothing of the mechanism of business cycles. There may still be many people who can no more believe the story of the genesis of bank money than they can believe the genesis of the Bible, but on the whole it now seems to be generally accepted. A last but hopeless attempt at disproving it has recently been made by M. Bouniatian, Crédit et conjuncture, Paris, 1933.

107 Wicksell, Geldzins und Güterpreise, Jena, 1898, and also his Lectures on Political Economy, vol. ii, London, 1935. The pioneer work done by Wicksell has given rise to an extensive literature refining and modifying his propositions (L. Mises, op. cit.; Hayek, Monetary Theory and the Trade Cycle; F. A. Fetter, “Interest Theory and Price Movements,” American Economic Review, Supplement, March 1927; J. A. Schumpeter, op. cit.; G. Halm, “Das Zinsproblem am Geld- und Kapitalmarkt,” Jahrbücher für Nationalökonomie und Statistik, 1926; W. Röpke, “Kredit und Konjunktur,” Jahrbücher für Nationalökonomie und Statistik, March-April 1926; G. Myrdal, “Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse,” in Beiträge zur Geldtheorie, edited by F. A. von Hayek, Vienna, 1933).

108 The dislocations proceeding in the economic process are gone into in detail by Pigou, Industrial Fluctuations, loc. cit.; Hayek, Prices and Production; R. Strigl, “Die Produktion unter dem Einflusse einer Kreditexpansion,” Schriften des Vereins für Sozialpolitik, vol. 173/2, Munich, 1928, pp. 185 ff. (in this latter collection there are also other pertinent contributions).

That the shrinkage of consumption may, in the compensatory phase of the upswing be only relative in character has been demonstrated in the previous section (p. 109, footnote).

109 Cf. C. Reinold Noyes, “The Gold Inflation in the United States, 1921-1929,” American Economic Review, June 1930.

110 I. Fisher, Booms and Depressions, New York, 1932.

111 Cf. chap, iii, pp. 57-58

112 It must be noted, moreover, that at this period the volume of cash will represent a larger percentage of the total volume of circulating media (i.e., including credit money) than formerly. In other words, the proportion between cash and credit money has now been changed in favour of cash. It follows from this that the reversal of the process of depression will lead to an increase of credit money rather than of cash, a conclusion which may go far to correct certain fanciful ideas about the process of recovery, and to strengthen the nerves of the public against the bogy of inflation so dear to many economic puritans.

113 That the hoarding of cash means sterilization of purchasing power is evident. But it is not always understood how money held in bank deposits can also lead to sterilization of purchasing power. The important point is that the extent to which sterilization takes place will depend on how far these bank balances are idle or active, i.e., what is the rate of turnover of the accounts. Now, it is characteristic of the secondary depression that the rate of turnover of banking accounts slows down tremendously for the reasons enumerated in the text above, one of the contributing factors being the inflow into the banks of money which would otherwise have been invested on the securities market. While this “catalepsis of banking accounts,” the common disease of chronic depressions, afflicts the banking system, the latter has—except for saving accounts proper—to maintain a high degree of liquidity and, for a number of reasons, actually endeavours to increase its normal degree of liquidity. In other words, whereas banking accounts are now largely inactive, exerting no demand and moving no goods, the banks can and will dispose of this inert purchasing power only to a limited degree. For these reasons it is evident that inactive demand-deposits possess a deflationary character.

In this connexion it must also be noted that as long as savings exceed investment, savings will largely evaporate in covering the losses of entrepreneurs incurred in the course of the secondary depression. This is, ultimately, a factor retarding the depression, but it takes some time to do so and involves a number of frictions. It must be clearly recognized that savings are in this way largely used to make good the losses they have caused which is not exactly what they are meant for.

114 Mr. Keynes has succeeded in making this process particularly clear in his picturesque example of the banana plantation where a Thrift Campaign breaks out (Treatise, i, pp. 176-178). But see Mr. Robertson’s objection in Economic Journal, 1931, p. 399.

115 See chap, ii, pp. 24-25.

116 See the Memorandum of the League of Nations on Commercial Banks, Geneva, 1934.

117 The so-called “Shiftability Theory” of bank liquidity, developed especially by Waldo F. Mitchell, The Uses of Bank Funds, Chicago, 1925. Cf. Br. Suviranta, “‘The Shiftability Theory’ of Bank Liquidity,” in Economic Essays in Honour of Gustav Cassel, London, 1933, pp. 623-635.

118 Quoted from the Monthly Review of the Midland Bank, April-May 1935.

119 J. J. O. Lahn (N. Johannsen), Depressions-Perioden und ihre einheitliche Ursache, Brooklyn, 1903. The present writer found this obscure pamphlet while rummaging among old books in the University of Constantinople. Mr. Johannsen died in 1928 before the great depression drew attention to his early contribution to the problem of the secondary depression.

120 N. Johannsen, A Neglected Point in Connection with Crises, New York, 1908, and later post-war pamphlets. All these publications are mainly variations of the theme contained in the pamphlet of 1903.

121 D. H. Robertson, Banking Policy and the Price Level, London, 1926.

122 J. M. Keynes, Treatise, II, p. 100n.

123 See the author’s articles “Praktische Konjunkturpolitik, die Arbeit der Brauns-Kommission,” Weltwirtschaftliches Archiv, October 1931, and “Trends in German Business Cycle Policy,” Economic Journal, September 1933.

124 Especially in his contribution to the Festschrift für Gustav Cassel, “Die sekundäre Krise und ihre Ueberwindung” (Economic Essays in Honour of Gustav Cassel, London, 1933, pp. 553-568). See also his article “Die Nationalökonomie des ‘New Deal,’” Zeitschrift für Nationalökonomie, 1934, vol. 5, No. 5.

125 In various writings mostly published in the Economica and in the Economic Journal.

126 Bertil Ohlin, “Ungelöste Probleme der gegenwärtigen Krisis,” Weltwirtschaftliches Archiv, July 1932; articles in the Index (Stockholm), and his book Penningpolitik, Offentliga Arbeten, Subventioner och Tullar Som Medel mot Arbetslöshet, Stockholm, 1934

127 Jacob Viner, Balanced Deflation. Inflation or more Depression, Minneapolis, 1933.

128 Alexander Mahr, Hauptprobleme der Arbeitslosigkeit, Vienna, 1931. Professor Haberler’s contributions are contained mostly in unpublished manuscripts.

129 G. M. Verrijn Stuart, “Das Reflationsproblem im Lichte der Theorie des ‘neutralen’ Geldes,” Economic Essays in Honour of Gustav Cassel, pp. 605-622.

130 The best analysis of the present depression is now to be found in Professor Robbins’ brilliant monograph The Great Depression.

• 1The author has given to this question a fuller and somewhat different treatment in his article “Die säkulare Bedeutung der Weltkrisis,” Weltwirtschaftliches Archiv, January 1933.
• 2A. N. Whitehead, “Science and the Modern World,” New York, 1926, p. 75. Cf. also L. Robbins, “An Essay on the Nature and Significance of Economic Science,” 2nd ed., London, 1932, p. 51.
• 3This important subject has been dealt with at greater length by the author in his article “Kapitalismus und Imperialismus,” Zeitschrift für schweizerische Statistik und Volkswirtschaft, 1934, pp. 370-386.
• 4The same will be shown later on when we come to consider the possibilities of nationalist monetary policies.
• 5The whole process has been demonstrated by the author for the case of Germany in his book German Commercial Policy, London, 1934.
• 6Even the much discussed case of the great commercial banks in Central Europe (the Creditanstalt in Austria, the Darmstädter und Nationalbank in Germany, &c.) is no real exception though it certainly comes nearer to supporting the argument in question, the averting of the crash really having been a social necessity. But here two points are to be considered. First, the socialization of deposit banks, though hardly to be recommended, cannot be said to jeopardize capitalism, any more than the socialization of the other money-providing institution, i.e., the central banks. Secondly, there is no reason why the governments who kept those banks afloat should, after some necessary changes of the banking system, not go out of the business of banking again after a while.
• 7The idea developed above may be explained in yet another way. It is generally recognized that the world economy as compared with the national economy labours under two distinct disadvantages. The first is that there is no international legal system enforced by a World State; the second is that there is no worldwide monetary system. In spite of these two disadvantages, world economy has been able to develop during the last century because it has been possible to find substitutes for the institutions that are lacking. The lack of an international legal system based upon a World State has been compensated by a system of long-term international contracts and by a high degree of loyalty in keeping them. The lack of a world-wide monetary system has been mitigated by the gold standard. Both these substitutes are creations of the Liberal Era.
• 8Article, “Krisen,” Handwörterbuch der Staatswissenschaften, 4th ed., vol. 6.
• 9Especially the leading authority on all these questions : W. C. Mitchell, Business Cycles. The Problem and Its Setting, New York, 1928, chap. iv.
• 10For a careful examination of the problem see L. H. Bean, Post War Interrelations between Agriculture and Business in the United States, a study published by the U.S. Department of Agriculture, 1930. Cf. also C. v. Dietze, Agrarkrisen, Konjunkturzyklen und Strukturwandlungen, in presentation to L. Elster, Jena, 1931; M. Sering, Internationale Preisbewegung und Lage der Landwirtschaft in den aussertropischen Ländern, Berlin, 1928; G. F. Warren and F. A. Pearson, The Agricultural Situation, New York, 1924; W. Röpke, “Das Agrarproblem der Vereinigten Staaten, II. Die gegenwärtige Lage der Landwirtschaft,” Archiv für Sozialwissenschaft und Sozialpolitik, vol. 59, 1928, from p. 96; S. C. Pervushin, “Cyclical Fluctuations in Agriculture and Industry in Russia 1869-1926,” Quarterly Journal of Economics, vol. 42, May 1928; E. Altschul, “Agrarwirtschaft und Industriezyklus,” Wirtschaftskurve der Frankfurter Zeitung, 1931, No. iv, from p. 394; A. H. Hansen, “The Business Cycle and its Relation to Agriculture,” Journal of Farm Economics, 1932, from p. 59; Timoshenko, The Rôle of Agricultural Fluctuations in the Business Cycle, Ann Arbor, 1930; W. Abel, Agrarkrisen und Agrarkonjunkturen in Mitteleuropa vom 13. bis zum 19. Jahrhundert, Berlin, 1935.
• 11In the exact assessment of this rôle there is still a great deal of divergence of opinions. One holds (for instance, Spiethoff, Boden u. Wohnung, 1934) that building reaches its peak at the end of the depression and in the early stages of the recovery. This also seems the view of J. M. Clark, Strategic Factors, &c., pp. 27-33. Other authors (especially A. Aftalion, Les Crises Périodiques de Surpro-duction, Paris, 1913, vol. 1, pp. 127-131) believe that building is essentially a boom industry. In the opinion of E. Wagemann, the Director of the Institut für Konjunkturforschung in Berlin, residential construction is essentially a depression industry, while public building has been concentrated in the past in times of boom (E. Wagemann, Einführung in die Konjunkturlehre, Leipzig, 1929, pp. 124-126). Wagemann’s view seems to be confirmed by experience and reflection, though it must be admitted that the problem is a complicated one. In English literature, it seems to have been curiously neglected. Cf. A. K. Cairncross, “The Glasgow Building Industry (1870-1914),” The Review of Economic Studies, vol. 2, October 1934, and W. H. Newman, The Building Industry and Business Cycles, Chicago, 1935.
• 12Cf. Soltau, “Statistische Untersuchungen über die Entwicklung und Konjunkturschwankungen des Aussenhandels,” Vierteljahrshefte zur Konjunkturforschung, Ergänzungsheft 2, 1926.
• 13The fact that the crises of the pre- and early capitalist period were generally such non-cyclical crises, arising out of political or natural catastrophes or adventurous speculations, will be specially emphasized in the next chapter.
• 14Thus A. Aftalion, Les Crises Périodiques de Surproduction, Paris, 1913, vol. 1, p. 12, and J. Lescure, Des Crises Générales et Périodiques de Surproduction, 3rd ed., Paris, 1923, p. 2.
• 15W. C. Mitchell, ibid., pp. 378-381.
• 16Even stock-exchange crises and financial stringency may emerge without connexion with the trade cycle. Examples : Germany, 1877; England, 1878; Argentine, 1891; United States, 1896; China, 1912, &c.
• 17Thus W. Sombart in “Versuch einer Systematik der Wirtschaftskrisen,” Archiv für Sozialwissenschaft, vol. 19, 1904; A. Spiethoff, op. cit.; M. Bouniatian, Les Crises Economiques, Paris, 1922, from p. 31.
• 18For a fuller account of the American crisis of 1933 see T. E. Gregory, Gold, Unemployment and Capitalism, London, 1933, pp. 146-161.
• 19H. Schumacher, Die Ursachen der Geldkrisis, Dresden, 1908; Sprague, The History of Crises under the National Banking Acts, Washington, 1911; A. Andrew, “Substitutes for Cash in the Panic of 1907,” Quarterly Journal of Economics, vol. 22, 1908.
• 20It is known that the Deutsche Bank effectively prevented a run of deposit creditors at the beginning of the Great War, on Helfferich’s advice, by answering the first rush with the opening of new counters for the paying-out of accounts and thereby at once stopping the panic.
• 21Monthly Review of the Midland Bank, April-May 1935, p. 4.
• 22Represented by : A. C. Pigou, Industrial Fluctuations, London, 1927; F. Lavington, The Trade Cycle, London, 1925. Schumpeter also is in a certain sense to be included among this school—see his Theory of Economic Development: An Enquiry into Profits, Capital, Credit, Interest and the Business Cycle, translated by R. Opie, London, 1934, and “The Explanation of the Business Cycle,” Economica, December 1927. An analysis of the psychological factors in the business cycle is given in Röpke, Die Konjunktur, loc. cit., pp. 70-84.
• 23M. v. Tugan-Baranowski, Studien zur Theorie und Geschichte der Handelskrisen in England, Jena, 1901 (first Russian edition 1894).
• 24Spiethoff, Vorbemerkungen zu einer Theorie der Ueberproduktion, Schmollers Jahrbücher, xxvi, 1902; Cassel, The Theory of Social Economy, 2nd ed., London, 1932; Schumpeter, op. cit.; Aftalion, op. cit.; M. Bouniatian, Wirtschaftskrisen und Ueberkapitalisation, Munich, 1908; D. H. Robertson, A Study of Industrial Fluctuations, London, 1915. For the views of the present author, see W. Röpke, Kredit und Konjunktur, loc. cit.
• 25J. M. Clark, “Business Acceleration and the Law of Demand,” Journal of Political Economy, March 1917, and also the same author’s books, Studies in the Economics of Overhead Costs, Chicago, 1923, and Strategic Factors in Business Cycles, New York, 1934. Consult also the discussion between C. and R. Frisch in the Journal of Political Economy, October, December 1931, and April 1932.
• 26J. M. Clark, Strategic Factors in Business Cycles, op. cit., p. 36.
• 27D. H. Robertson, Banking Policy and the Price Level, 3rd ed., London, revised 1932 (a small book of the greatest importance though somewhat difficult for the uninitiated reader).
• 28There is a second meaning of “over-saving” relating to the situation during the depression when more is being saved than invested, so that saving leads to the disappearance of purchasing power from circulation and thus to its sterilization. This sort of “over-saving” is the driving force behind the cumulative process of depression about which more will be said in § 16. But its nature is quite different from that of the type of “over-saving” discussed above. Over-saving as discussed above means that too much is being saved compared to the power of the economic system to adapt itself to rising investments, while over-saving in the second sense means that savings exceed investments with deflationary effects.
• 29Cf. Berle and Means, The Modern Corporation and Private Property, New York, 1933; O. W. Knauth, “The Place of Corporate Surplus in the National Income,” “Journal of the American Statistical Association, vol. xviii, 1922.
• 30This theme has been developed more fully by the present author in his little book Die Theorie der Kapitalbildung, Tübingen, 1929. Cf. also R. Weidenhammer, “Causes and Repercussions of the Faulty Investment of Corporate Savings,” American Economic Review, March 1933.
• 31The most has been made of this argument by Professor Francesco Vito in his interesting paper “Il Risparmio Forzato e la Teoria dei Cicli Economici,” Rivista Internazionale di Scienze Sociali, January 1934.
• 32J. M. Keynes, A Treatise on Money, 2 vols., London, 1930.
• 33Keynes, op. cit., II, pp. 148-149.
• 34Cf. especially his book Prices and Production, 2nd ed., London, 1935. For a fuller understanding of Dr. Hayek’s ideas his numerous other publications must also be consulted (“Das intertemporale Gleichgewichtssystem der Preise und die Bewegungen des ‘Geldwertes,’” Weltwirtschaftliches Archiv, July 1928; “Kapitalaufzehrung,” Weltwirtschaftliches Archiv, July 1932; Monetary Theory and the Trade Cycle, London, 1933; “Capital and Industrial Fluctuations,” Econometrica, April 1934).
• 35The most advanced book of this school on the theory of capital is now R. von Strigl, Kapital und Produktion, Vienna, 1934. This book is of special importance as it shows that it is possible on the base of the post-Böhm-Bawerkian theory of capital to explain the cumulative process of depression on lines not very dissimilar from those of Mr. Keynes. It must be said, therefore, that Dr. v. Hayek’s theory is by no means the logical consequence of this theory of capital based on the fundamental conception of the subsistence fund. It is now generally recognized that the post-Böhm-Bawerkian theory of capital is badly in need of a thorough revision in several of its fundamental conceptions. Especially, the idea of the “length of the production period” has, recently, become an object of a very critical attack by a host of writers in different countries (Howard S. Ellis, Frank H. Knight, O. Morgenstern, Gifford and others). Of still greater importance for trade-cycle theory is the dubious character of the Böhm-Bawerkian conception of the “subsistence fund.” Nobody can deny that this conception has a real meaning inasmuch as increased accumulation presupposes a restriction of consumption, but this meaning is by no means so clear as the post-Böhm-Bawerkian school supposes it to be. The idea that accumulation and consumption are mutually exclusive alternatives, in other words, that an increase in investment must always mean a corresponding absolute restriction of consumption looks rather defective in view of the palpable fact that, during the upswing, investment and consumption rise simultaneously. Even in this case, it is, of course, still true that accumulation means non-consumption, but the point is that this restriction of consumption is only relative while the absolute amount of consumption rises owing to the rise in total productivity resulting from the mobilization of idle productive reserves which has, in turn, been brought about by the increase in investment. Therefore, to some extent—i.e., to the extent to which idle productive reserves are again brought into profitable use—an increase in investment stimulates an increase of the subsistence fund. If this reasoning is correct, the subsistence fund ceases to be an independent variable whenever the extraordinary conditions of depression have created a large increase of “idle capacity.” Then, to reiterate, we have really a case not only of eating the cake and having it but of having still more of it while eating, though it is still true that the bit we eat we cannot have at the same time. Without this, neither the nature of capitalism nor its history can be really understood. It is important to note, however, that this applies only to the first phase of the upswing (the compensatory phase) not to the second (inflationary) phase in which the reserve of idle capacity is already exhausted. In the latter phase, accumulation and consumption become, indeed, strictly alternative in character.
• 36F. A. von Hayek, “Capital and Industrial Fluctuations,” Econometrica, April 1934, p. 155 (reprinted in the new edition of his book Prices and Production, p. 140).
• 37Dr. von Hayek’s theory has been criticized on rather similar lines by Alvin H. Hansen and Herbert Tout, “Investment and Saving in Business Cycle Theory,” Econometrica, April 1933. The views of these authors seem to coincide particularly closely with the views of the present writer.
• 38It is interesting to observe that in his most recent publication (“Preiserwartungen, monetäre Störungen und Fehlinvestitionen,” Nationalokonomisk Tidsskrift, LXXIII, pp. 175-191) Professor von Hayek comes rather near to the view expressed in the text.
• 39The origin of the monetary theory of the cycle can be traced back to the English monetary theorists of the first half of the nineteenth century (the Currency school). More modern representatives are: R. G. Hawtrey, Currency and Credit, 2nd ed., London, 1923; L. von Mises, The Theory of Money, London, 1934 (first published in 1912 in German); F. A. von Hayek, op. cit.; L. A. Hahn, Volkswirtschaftliche Theorie des Bankkredits, 3rd ed., Tübingen, 1930; Irving Fisher, The Purchasing Power of Money, New York, 1911 (recently Professor Fisher has suggested a different explanation of cycles, the “debt-deflation” theory).
• 40F. A. v. Hayek especially has done much to refine the monetary theory of the trade cycle. See also J. Akerman, Some Lessons of the World Depression, Stockholm, 1931, and F. Machlup, Börsenkredit, Industriekredit und Kapitalbildung, Vienna, 1931.
• 41The process is now clearly explained in any text-book on economics, banking or money (especially recommendable is Hartley Withers’ Meaning of Money). A fuller treatment may be found in the following books: R. G. Hawtrey, op. cit.; J. M. Keynes, A Treatise on Money, pp. 23-49 : C. A. Philipps, Bank Credit, New York, 1920; W. F. Crick, “The Genesis, of Bank Deposits,” Economica, June 1927, and F. A. von Hayek, Monetary Theory and the Trade Cycle, London, 1933. Without an understanding of this process and of its limitations, no real insight into the working of our banking system and, consequently, of our entire economic system seems possible, to say nothing of the mechanism of business cycles. There may still be many people who can no more believe the story of the genesis of bank money than they can believe the genesis of the Bible, but on the whole it now seems to be generally accepted. A last but hopeless attempt at disproving it has recently been made by M. Bouniatian, Crédit et conjuncture, Paris, 1933.
• 42Wicksell, Geldzins und Güterpreise, Jena, 1898, and also his Lectures on Political Economy, vol. ii, London, 1935. The pioneer work done by Wicksell has given rise to an extensive literature refining and modifying his propositions (L. Mises, op. cit.; Hayek, Monetary Theory and the Trade Cycle; F. A. Fetter, “Interest Theory and Price Movements,” American Economic Review, Supplement, March 1927; J. A. Schumpeter, op. cit.; G. Halm, “Das Zinsproblem am Geld- und Kapitalmarkt,” Jahrbücher für Nationalökonomie und Statistik, 1926; W. Röpke, “Kredit und Konjunktur,” Jahrbücher für Nationalökonomie und Statistik, March-April 1926; G. Myrdal, “Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse,” in Beiträge zur Geldtheorie, edited by F. A. von Hayek, Vienna, 1933).
• 43The dislocations proceeding in the economic process are gone into in detail by Pigou, Industrial Fluctuations, loc. cit.; Hayek, Prices and Production; R. Strigl, “Die Produktion unter dem Einflusse einer Kreditexpansion,” Schriften des Vereins für Sozialpolitik, vol. 173/2, Munich, 1928, pp. 185 ff. (in this latter collection there are also other pertinent contributions).
• 44Cf. C. Reinold Noyes, “The Gold Inflation in the United States, 1921-1929,” American Economic Review, June 1930.
• 45I. Fisher, Booms and Depressions, New York, 1932.
• 46Cf. chap, iii, pp. 57-58
• 47It must be noted, moreover, that at this period the volume of cash will represent a larger percentage of the total volume of circulating media (i.e., including credit money) than formerly. In other words, the proportion between cash and credit money has now been changed in favour of cash. It follows from this that the reversal of the process of depression will lead to an increase of credit money rather than of cash, a conclusion which may go far to correct certain fanciful ideas about the process of recovery, and to strengthen the nerves of the public against the bogy of inflation so dear to many economic puritans.
• 48That the hoarding of cash means sterilization of purchasing power is evident. But it is not always understood how money held in bank deposits can also lead to sterilization of purchasing power. The important point is that the extent to which sterilization takes place will depend on how far these bank balances are idle or active, i.e., what is the rate of turnover of the accounts. Now, it is characteristic of the secondary depression that the rate of turnover of banking accounts slows down tremendously for the reasons enumerated in the text above, one of the contributing factors being the inflow into the banks of money which would otherwise have been invested on the securities market. While this “catalepsis of banking accounts,” the common disease of chronic depressions, afflicts the banking system, the latter has—except for saving accounts proper—to maintain a high degree of liquidity and, for a number of reasons, actually endeavours to increase its normal degree of liquidity. In other words, whereas banking accounts are now largely inactive, exerting no demand and moving no goods, the banks can and will dispose of this inert purchasing power only to a limited degree. For these reasons it is evident that inactive demand-deposits possess a deflationary character.
• 49Mr. Keynes has succeeded in making this process particularly clear in his picturesque example of the banana plantation where a Thrift Campaign breaks out (Treatise, i, pp. 176-178). But see Mr. Robertson’s objection in Economic Journal, 1931, p. 399.
• 50See chap, ii, pp. 24-25.
• 51See the Memorandum of the League of Nations on Commercial Banks, Geneva, 1934.
• 52The so-called “Shiftability Theory” of bank liquidity, developed especially by Waldo F. Mitchell, The Uses of Bank Funds, Chicago, 1925. Cf. Br. Suviranta, “‘The Shiftability Theory’ of Bank Liquidity,” in Economic Essays in Honour of Gustav Cassel, London, 1933, pp. 623-635.
• 53Quoted from the Monthly Review of the Midland Bank, April-May 1935.
• 54J. J. O. Lahn (N. Johannsen), Depressions-Perioden und ihre einheitliche Ursache, Brooklyn, 1903. The present writer found this obscure pamphlet while rummaging among old books in the University of Constantinople. Mr. Johannsen died in 1928 before the great depression drew attention to his early contribution to the problem of the secondary depression.
• 55N. Johannsen, A Neglected Point in Connection with Crises, New York, 1908, and later post-war pamphlets. All these publications are mainly variations of the theme contained in the pamphlet of 1903.
• 56D. H. Robertson, Banking Policy and the Price Level, London, 1926.
• 57J. M. Keynes, Treatise, II, p. 100n.
• 58See the author’s articles “Praktische Konjunkturpolitik, die Arbeit der Brauns-Kommission,” Weltwirtschaftliches Archiv, October 1931, and “Trends in German Business Cycle Policy,” Economic Journal, September 1933.
• 59Especially in his contribution to the Festschrift für Gustav Cassel, “Die sekundäre Krise und ihre Ueberwindung” (Economic Essays in Honour of Gustav Cassel, London, 1933, pp. 553-568). See also his article “Die Nationalökonomie des ‘New Deal,’” Zeitschrift für Nationalökonomie, 1934, vol. 5, No. 5.
• 60In various writings mostly published in the Economica and in the Economic Journal.
• 61Bertil Ohlin, “Ungelöste Probleme der gegenwärtigen Krisis,” Weltwirtschaftliches Archiv, July 1932; articles in the Index (Stockholm), and his book Penningpolitik, Offentliga Arbeten, Subventioner och Tullar Som Medel mot Arbetslöshet, Stockholm, 1934
• 62Jacob Viner, Balanced Deflation. Inflation or more Depression, Minneapolis, 1933.
• 63Alexander Mahr, Hauptprobleme der Arbeitslosigkeit, Vienna, 1931. Professor Haberler’s contributions are contained mostly in unpublished manuscripts.
• 64G. M. Verrijn Stuart, “Das Reflationsproblem im Lichte der Theorie des ‘neutralen’ Geldes,” Economic Essays in Honour of Gustav Cassel, pp. 605-622.
• 65The best analysis of the present depression is now to be found in Professor Robbins’ brilliant monograph The Great Depression.
• 66This belief that the present world crisis spells nothing less than the total collapse of our present economic and social system, a kind of last judgment, a “crisis to end crises,” as it were, is indeed so popular nowadays that the substance of this book would seem rather shallow if we were to pass lightly over this problem. If it were true that we must abandon the wreck of our present economic system, leaving it to break up, and seek salvation on the shores of the promised land of planned, and, necessarily, autarkic economy, then what follows in the subsequent pages would be little short of a necrologue on the Splendours and Miseries of capitalism. It would not be without value, but it would mean something different from what the author intends it to be. Let us therefore consider the problem in more detail.
• 67Exactly what has actually happened that might force us to abandon the competitive system like a sinking wreck? Various answers have been given to this question, but when we come to examine them more closely none of them is really impressive, let alone convincing. The first answer we are likely to hear is that the outlets for capitalistic expansion being greatly reduced, capitalism is condemned to stagnation and internal disintegration. Two things are usually understood by this : the slackening rate of the increase of population and the end of colonial expansion. The idea seems to be that, owing to these two facts, capitalism has to face restricted markets for the surplus product constantly increasing with the advances in productive technique. An argument along these lines sounds plausible, but it cannot stand the test of a more careful examination. Even if we suppose for a moment that the theory of capitalist expansion being hopelessly restricted is true, it seems impossible that this can have acted as a cause of the present depression since it is obvious that the spatial and demographic restrictions on expansion have existed for decades without having prevented a fully fledged boom several years ago. We must allow, however, for the remote possibility that this restriction may have acted, up to the present, only latently, and that after the world crisis had been started by other causes, it may have exerted its paralysing effect openly and to its full extent. Therefore, the fundamental question to be raised is this : Is it really true that capitalism, in order to extend its markets, is continuously in need of fresh supplies of human beings and of unexplored territories? Put this way, the question can, of course, be answered only in the negative, for it is obvious that goods are not paid for with human beings or square miles but with incomes, and these incomes owe their origin to the successful production of other goods. In other words, the fundamental fallacy, which is at the bottom of the argument in question, is simply that it confounds human beings and square miles with purchasing power, and so far it is only an interesting variety of what Whitehead aptly calls the “fallacy of misplaced concreteness.” It is a gross error of thinking which might be properly ignored in merciful silence were it not repeated monotonously every day. At the same time, it is a good example of the crude overproduction theory with which we shall have to deal later on (§ 11). It is interesting to note, moreover, that the neo-Marxian theory of economic imperialism has been based principally on the same sort of fallacies, a fact which is a good illustration of the tenacity with which survivals of Marxist thinking linger on in contemporary thought on economic, social, and political problems.
• 68Exactly what has actually happened that might force us to abandon the competitive system like a sinking wreck? Various answers have been given to this question, but when we come to examine them more closely none of them is really impressive, let alone convincing. The first answer we are likely to hear is that the outlets for capitalistic expansion being greatly reduced, capitalism is condemned to stagnation and internal disintegration. Two things are usually understood by this : the slackening rate of the increase of population and the end of colonial expansion. The idea seems to be that, owing to these two facts, capitalism has to face restricted markets for the surplus product constantly increasing with the advances in productive technique. An argument along these lines sounds plausible, but it cannot stand the test of a more careful examination. Even if we suppose for a moment that the theory of capitalist expansion being hopelessly restricted is true, it seems impossible that this can have acted as a cause of the present depression since it is obvious that the spatial and demographic restrictions on expansion have existed for decades without having prevented a fully fledged boom several years ago. We must allow, however, for the remote possibility that this restriction may have acted, up to the present, only latently, and that after the world crisis had been started by other causes, it may have exerted its paralysing effect openly and to its full extent. Therefore, the fundamental question to be raised is this : Is it really true that capitalism, in order to extend its markets, is continuously in need of fresh supplies of human beings and of unexplored territories? Put this way, the question can, of course, be answered only in the negative, for it is obvious that goods are not paid for with human beings or square miles but with incomes, and these incomes owe their origin to the successful production of other goods. In other words, the fundamental fallacy, which is at the bottom of the argument in question, is simply that it confounds human beings and square miles with purchasing power, and so far it is only an interesting variety of what Whitehead aptly calls the “fallacy of misplaced concreteness.” It is a gross error of thinking which might be properly ignored in merciful silence were it not repeated monotonously every day. At the same time, it is a good example of the crude overproduction theory with which we shall have to deal later on (§ 11). It is interesting to note, moreover, that the neo-Marxian theory of economic imperialism has been based principally on the same sort of fallacies, a fact which is a good illustration of the tenacity with which survivals of Marxist thinking linger on in contemporary thought on economic, social, and political problems.
• 69We may conclude that the spatial and the demographic restrictions on expansion as far as they are real facts, are a long way from making the decay of capitalism an inevitable necessity. The wants of men remain just as unlimited as before. This is not to say, of course, that, owing to the trend of development depicted above, the composition of wants might not be altered. In fact, there are wants which, being easily satisfied for each individual, can, on the whole, only be extended by the increase of men. That is especially true in the case of grain. Consequently it does not seem unlikely that the present agricultural crisis—as far at least as it is a world-wide crisis of grain production—may be closely connected with the falling off in the rate of increase of the population of the bread-eating nations, a causal relationship intensified on the supply side by the improved technique of grain production (the combine, the tractor, and “dry farming” being well-known examples). This unfortunate development has, in turn, contributed tremendously to an intensification of the universal economic depression since the grain-importing countries of Europe, impelled by certain ideologies, did not resist the temptation to avert, by all possible means, from their own grain producers the consequences of the relative over-expansion of the world production of grain. As is invariably the case in State intervention of this kind, the ultimate price to be paid for it was not duly reckoned with. As in so many other instances, these nations thought they could protect themselves against some unpleasant draught coming from the world markets by just shutting the door and living happily ever after. It was quite otherwise. Not only were these drastic measures apt to imperil the other branches of agriculture and to infect them also with the bacillus of depression, but they turned out to be deadly blows for the world economy as a whole and, consequently, also for the industries of the grain-importing countries. Undoubtedly, this has been one of the biggest charges of dynamite to be exploded beneath the foundations of the world economy. There is consequently a subtle causal connexion between the changed dynamics of world population and the present universal crisis of our economic system. But it must be emphasized that the nature of this causal connexion is quite different from what the prophets of doom have in their minds, and that the causal sequence lacks the inevitableness which is generally supposed.
• 70We may conclude that the spatial and the demographic restrictions on expansion as far as they are real facts, are a long way from making the decay of capitalism an inevitable necessity. The wants of men remain just as unlimited as before. This is not to say, of course, that, owing to the trend of development depicted above, the composition of wants might not be altered. In fact, there are wants which, being easily satisfied for each individual, can, on the whole, only be extended by the increase of men. That is especially true in the case of grain. Consequently it does not seem unlikely that the present agricultural crisis—as far at least as it is a world-wide crisis of grain production—may be closely connected with the falling off in the rate of increase of the population of the bread-eating nations, a causal relationship intensified on the supply side by the improved technique of grain production (the combine, the tractor, and “dry farming” being well-known examples). This unfortunate development has, in turn, contributed tremendously to an intensification of the universal economic depression since the grain-importing countries of Europe, impelled by certain ideologies, did not resist the temptation to avert, by all possible means, from their own grain producers the consequences of the relative over-expansion of the world production of grain. As is invariably the case in State intervention of this kind, the ultimate price to be paid for it was not duly reckoned with. As in so many other instances, these nations thought they could protect themselves against some unpleasant draught coming from the world markets by just shutting the door and living happily ever after. It was quite otherwise. Not only were these drastic measures apt to imperil the other branches of agriculture and to infect them also with the bacillus of depression, but they turned out to be deadly blows for the world economy as a whole and, consequently, also for the industries of the grain-importing countries. Undoubtedly, this has been one of the biggest charges of dynamite to be exploded beneath the foundations of the world economy. There is consequently a subtle causal connexion between the changed dynamics of world population and the present universal crisis of our economic system. But it must be emphasized that the nature of this causal connexion is quite different from what the prophets of doom have in their minds, and that the causal sequence lacks the inevitableness which is generally supposed.
• 71Almost everywhere it becomes a fact beyond dispute that dimensions have outgrown the optimum size and must now be reduced, by a very painful process, to more reasonable proportions. It would be very interesting to have the testimony of engineers as to how far enterprises have been inflated beyond the technical optimum scale by a pathological predilection for mere size, by considerations of prestige and other irrational motives, and how far the recent development in the technique of machinery—especially the spread of the electromotor and the gasoline engine—has, in many directions, exerted even a lowering influence on the optimum size. In this connexion it should not be forgotten that, for example, the automobile signifies after all the triumph of the small unit over the larger one, so far as the business of locomotion is concerned. Thus it seems by no means true that natural forces are driving the world in the not too cheerful direction of the “skyscraper principle,” and so it is equally untrue that we have helplessly to submit to structural changes in our economic system which an inevitable development of this kind might bring about. The breakdown of the “skyscraper principle” would have been still more complete to-day if so many governments had not obstructed the process of readjustment by all kinds of subsidies and interventions. It is beside the point to declare that many firms have become so large that they represent, as the phrase often goes, “national institutions” which the government can no longer to their own fate. The recent example of the Citroen Works in Paris, in vain imploring the French Government to socialize its heavy losses, plainly shows that the governments can perfectly well leave these giants alone, without the community as a whole being any the worse off by it. The question as to whether the State should, in these cases, support the cracking pillars or let them fall is a question of expediency, without any cogent necessity in favour of the former policy, and still less convincing is the alleged necessity for the following up of the socialization of losses by the entire socialization of the whole firm. State subsidies of any kind must remain a very rare exception if the mechanism of capitalism is to work according to its well-tested rules, but it cannot be said that they mark the downfall of capitalism, and still less that, once this policy has been started, there is no way back. Again, we find no sign of any fate from which there is no escape.
• 72It is obvious that a planned world economy is equivalent to a dense network of commercial treaties dealing with the minutiae of international economic relations. It is, therefore, absolutely dependent for its functioning on an atmosphere of honesty, fairness, and continuity which has been a concomitant of the Liberal epoch and which is now slowly dying with it. In a world in which the fundamental principle of a civilized society pacta sunt servanda is more and more regarded as a Liberal prejudice a planned world economy is a fortiori an absolute impossibility. In other words, the same forces which are undermining the old Liberal world economy are also destroying the moral and legal foundations on which a planned world economy must be based, and the irony of it is that most of the planners are the same persons who are doing their utmost to lend their support to these sinister forces, apparently impelled by the curious idea that you can eat the cake and have it. The world is to-day living from a moral (and intellectual) capital accumulated during the Liberal epoch, and is consuming it rapidly, but the increasing difficulties of the new methods in international economic policies give a foretaste of that to which the world is rapidly coming. So a planned world economy is no real alternative at all, the only alternatives being the return to a Liberal world economy or complete chaos. In either case, the present attempts at planning in international relations have no future at all, the numerous assertions to the contrary notwithstanding. With these attempts the world resembles to-day a man who, having fallen down a precipice, is holding himself above the abyss by aid of a shrub which he happened to grasp : despite his boastful assertions that this is “the real thing,” his only choice is to be rescued from above or sooner or later to fall down into the abyss below. Let us add that the rope for rescuing him must not be of paper but must have a strong golden thread in it. Here, as everywhere else, the essential thing is to make the choice clear.
• 73The form of the cyclical fluctuation is furthermore distinguished by the fact that (as its name implies) it is cyclical and is subject to a characteristic rhythm. That is to say that each phase of the trade cycle is to be regarded as a definite though not always strictly diagnosable phase, which along with other phases goes to form an economic cycle. Each phase develops from the one before—in a way which the theory of economic cycles has to explain—until the initial phase is again reached and a new cycle begins. The phase of the depression (the fall) is followed by the phase of the boom (the rise), which sooner or later, with or without the acute change which we call a crisis, passes into the phase of a new depression which then makes way for a new economic cycle. This rough picture of the sequence of phases can be analysed in greater detail. Thus, according to Spiethoff, who further subdivides the “cyclical phases” into “alternating stages,” the typical course followed by the trade cycle may be analysed as follows: (1) recession, (2) primary rise, (3) secondary rise, (4) boom, (5) shortage of capital, (6) crisis,—recession and primary rise together forming the “slump,” and the secondary rise, boom and shortage of capital together forming the “up-swing.” The Harvard Committee of Business Research divides the business cycle into five phases: depression, recovery, business prosperity, financial strain, and industrial crisis. The German Institut für Konjunkturforschung has decided in favour of a four-part schema: depression, business prosperity, acute strain, and crisis. These are all refinements of the basic type of the cyclical economic fluctuation, which continually repeats itself in expansion and contraction.
• 74This brings us to the question of the duration of the trade cycle, on which we have already touched. Speaking generally, we may say that the trade cycle lies between the short waves of seasonal variations and the long-period waves of prosperity and depression. Basing our calculations on the more or less reliable economic history of the last eighty years, we may assume that the average duration of the trade cycle—from one peak of the cycle to the other or from one crisis to the other—is a period of five to eleven years at the most, although here, too, there is no unanimity among students of the trade cycle and some assert that the irregularity is still greater. According to Spiethoff’s table German economic history from 1843-1913 shows the following turning points (from upward swing to recession, sometimes taking the acute form of a crisis)—
• 75The inner connexions and inter-actions between agrarian and industrial cycles have as yet, comparatively speaking, been little explored, as they are in fact very intricate and by no means easy to define. While it cannot be disputed that prosperity or depression in the non-agricultural branches of the economy decides to a great extent whether there shall be prosperity or depression in agriculture (especially for the products the demand for which is more elastic, e.g., dairy products), the question as to how the state of agriculture, inversely, influences the state of business, cannot be answered so simply. A depression in agriculture may accompany an industrial-commercial prosperity—more, it may perhaps stimulate this prosperity by bringing down the price of food and raw material, and by driving workers into industry. The proximity of industrial-commercial prosperity and agrarian depression in the United States from 1925 to 1929 is a good example of this. The question must therefore be handled with the greatest caution.
• 76As we have shown, the earliest symptoms of the revival of business begin to appear in the money market. In the course of the depression an easing of the market, reflecting the increased readiness of the banks to give credit, has taken place, which has an extremely important bearing upon the course of the whole economic process. This easing of the credit market is, as we have already seen, connected with a fall in the rate of interest, which reflects the unwillingness of the entrepreneurs to undertake new investments. The money therefore accumulates in the banks, this being a marked characteristic of the depression and, as we shall see later, one of its chief sources. The further the rate of interest falls, however, and the more distant business is removed in time, spirit, and substance from the convulsions of the crisis, the nearer comes the moment when the savings deposits, the interest on which has been falling lower and lower, will again be invested in securities, and at the same time the increased readiness of the banks to expand credit will be applied to new investments which seem profitable as compared with the low rate of interest. The first step towards a rise in investments in the economic system is the investment of capital in fixed-interest-bearing securities; this in turn frees the banks from many uncomfortable debtors and thus increases their readiness to give credit. At a later stage of the development there is a rise in share values, while the rise in the price of fixed-interest-bearing securities, as a result of the gradual levelling up in the rate of interest, which is characteristic of the recovery period, gives way to a gradual fall. Not only the Stock Exchange figures but also the issue statistics reflect this characteristic development, behind which, as the ultimate great source of strength for the upward swing, stands the expansion of the volume of credit. This expansion of the volume of credit, again, depends upon two essential conditions: the greater readiness of the banks to lend, and the greater readiness of the business man to borrow, or what is almost the same, to invest. The question as to how this double readiness comes about at the beginning of the recovery period does not concern us here, as it would take us deep into the analysis of the causes of the trade cycle. It is important, however, to recognize at this point that the low rate of interest prevailing at the beginning of the upward swing increases the readiness to invest. Projects which were not profitable at a rate of interest of 5% become profitable when the rate of interest falls to 4%, and the further the rate of interest falls, the wider becomes the range of profitable investments for capital. And this brings us to a problem which has become specially important during the present depression: the problem whether the low rate of interest exercises always and under all conceivable circumstances the instigating influence attributed to it. The present experiences show clearly that it does not, for even a rate for short-term money of 1% or less fails to lead to a corresponding increase of investments. It has to be noted, however, that it is hardly conceivable that an unusually low rate for long-term credits, i.e., on the capital market, would not be a strong stimulus for an increase of investments. This is especially to be expected in the building industry. There is nobody who would not take advantage of a long-term rate of 1% for building a neat little villa. The building industry is, indeed, playing an important role in turning the tide of the depression. It is obvious, however, that the transference of the abundance of the money market to the capital market is an essential prerequisite for economic recovery, a fact which has a special bearing on the recovery programmes of the present day.
• 77export trade,
• 78This is not, however, to dismiss the question as to whether every crisis is necessarily a cyclical crisis, or whether there may not also be crises which are essentially independent of the cycle. As far as agrarian crises are concerned, this question has already been answered in the affirmative. But it is also possible to imagine crises of the whole economic structure, which come in from outside, and cannot be construed as a reaction to a preceding boom. The causes may be political or natural catastrophes. The probability of such “exogenous” crises is not, however, very great. We are brought face to face with the intricate relationships of the innermost heart of our economic system when we remember that a political catastrophe like the Great War or a natural catastrophe like the Japanese earthquake of 1923, instead of retarding economic life, generally enlivens it, and thus tends to bring about not a crisis but a boom. Certainly catastrophes lead to an impoverishment of the economic system, but we must guard against confusing impoverishment with a crisis, all the more so as this confusion is an extraordinarily common one. If we agree to understand by an economic crisis a temporary paralysis of the economic process which leads to a disturbance of the exchange apparatus with its consequences of over-production, surplus stocks, and insolvencies, we realize that it is characterized not by a scarcity but by a superfluity of goods, while the hall-mark of impoverishment is a deficiency of goods. This deficiency of goods generally spurs on the economic machine to make the highest number of revolutions of which it is capable, as was very markedly the case during the war. An economic crisis is therefore not an expression of shortage but of abundance or—to put it better—of what seems to us “abundance” because of the temporary paralysis of the process of exchange and of the economic process in general. That it leads in the long run to an impoverishment of the economic system is self-evident, but this does not affect the question of the origin of crises, which is the question we are discussing here. Nevertheless the possibility of non-cyclical crises cannot be flatly denied, for it is precisely these that are meant when it is asserted that the present world-economic crisis is not merely a cyclical but a structural crisis, which, it is alleged, reflects the inner rottenness or instability of the economic structure and is accordingly to be described as a permanent crisis. To prove this people refer loosely to the presumed inevitable collapse of the world-economic system, the emergence of anti-capitalistic tendencies, the ossification of capitalism, the political and economic chaos of the world, the technical revolutions of the last ten years, and much more of the same kind. The question as to whether we are justified in interpreting the present world crisis as a structural and permanent crisis has already been discussed in the introductory chapter and something more will be said about it later. In any case it cannot be denied that it started from a cyclical crisis.
• 79To revert to the “normal” cyclical crisis, we shall now seek to answer the question whether the reaction which follows the boom need necessarily always take the form of a crisis. The answer to this question depends on the definition which we give to the term crisis. If we reserve this expression for that form of the reaction which is marked by the suddenness and the stormy nature of the collapse, we shall find many examples, in the very recent history of business cycles, of reactions which were no crises in this dramatic sense of the word. Real crises happened in Germany in the years 1857 and 1873 and in the United States in the year 1907, whilst the cyclical reaction in Germany in the year 1907 showed just as few marks of a crisis as in the years 1913-1914. There can of course be no doubt as to the real crisis character of the present world-economic crisis. As we base the meaning of crisis on the characteristic signs of the “suddenness “and the “stormy nature of the collapse,” we cannot of course possibly claim that this definition has any precision. How fast and how far must security prices fall before we can speak of a crisis? How great must the number of bankruptcies be? In many cases, therefore, the decisive factor must be the feeling whether the reaction is accompanied by a definite credit crisis or not. It is therefore understandable that some economists should call every transition from boom to depression a crisis, and that, on the other hand, an authority like Mitchell is emphatic in refusing to apply the term “crisis” to any definite cyclical phase.
• 80To revert to the “normal” cyclical crisis, we shall now seek to answer the question whether the reaction which follows the boom need necessarily always take the form of a crisis. The answer to this question depends on the definition which we give to the term crisis. If we reserve this expression for that form of the reaction which is marked by the suddenness and the stormy nature of the collapse, we shall find many examples, in the very recent history of business cycles, of reactions which were no crises in this dramatic sense of the word. Real crises happened in Germany in the years 1857 and 1873 and in the United States in the year 1907, whilst the cyclical reaction in Germany in the year 1907 showed just as few marks of a crisis as in the years 1913-1914. There can of course be no doubt as to the real crisis character of the present world-economic crisis. As we base the meaning of crisis on the characteristic signs of the “suddenness “and the “stormy nature of the collapse,” we cannot of course possibly claim that this definition has any precision. How fast and how far must security prices fall before we can speak of a crisis? How great must the number of bankruptcies be? In many cases, therefore, the decisive factor must be the feeling whether the reaction is accompanied by a definite credit crisis or not. It is therefore understandable that some economists should call every transition from boom to depression a crisis, and that, on the other hand, an authority like Mitchell is emphatic in refusing to apply the term “crisis” to any definite cyclical phase.
• 81The cyclical crisis, like the entire trade cycle, must of necessity be conceived as a “total” crisis, which differentiates it from the crises of isolated branches of the economic system (partial crises), which can be traced to the most varied causes and are of no interest in this connexion. Partial crises (a crisis in shipbuilding, in the English coal industry, in vine-growing, &c.), may naturally crop up in any phase, though they are apt to be modified in the boom phase and made more acute in the depression phase. The grave crisis of the American bituminous coal-mining industry (in Kentucky and West Virginia) during the recent unprecedented boom in the United States is a significant example of the lack of connexion between the trade cycle and the emergence of partial crises.
• 82The fact that the cyclical crisis is “total” in character does not prevent it from appearing at times in different forms and coming to a head in this or that sector of economic life. In so doing it would of course lose its character of a “total” cyclical crisis and become a mere partial crisis, if it remained confined to that particular sector. This must be kept in mind when considering the numerous attempts to find a classification of types of crisis. For it is either a case of partial crises, when any attempt at classification would be meaningless since it would amount to nothing more than a catalogue of all the branches of economic activity; or it is a question of “total” crises, in which case the only purpose a classification can have is to show the possible variations of the crises with respect to their starting-point and climax, the danger here being that the character of “totality” may be obscured. With, this reservation in mind, we reproduce Spiethoff’s classification, which distinguishes the following types of crises:—
• 83The British credit crisis differed from the German credit crisis substantially in that in the British case there was absolutely no run of the home creditors on the banks, and thus no crippling of the internal financial machinery. The run remained confined to the foreign creditors. While Germany succeeded in a short time in re-establishing to some extent the value of the mark by a number of artificial means (compulsory exchange control, legislation to prevent the flight of capital, standstill agreements), in Britain the external stability of the currency was abandoned. Other countries also were drawn into the international credit crisis and a number of them let their currencies follow the fall in the pound, particularly the Scandinavian countries and the British dominions. Later Japan also entered this group of countries abandoning the gold standard. At the end of the year the credit crisis flared up in the United States, where the public were getting more and more nervous, and very many of the smaller banks fell victims to the creditors’ panic. The full explosion came here more than a year later in the spring of 1933, just when the new Roosevelt administration took office. As is invariably the case, the avalanche was started by a minor accident (the difficulties of the Union Guardian Trust Company of Detroit), but out of this there grew a panic which forced every bank in the country, including the twelve reserve banks themselves, to close their doors. The essential difference between the credit crisis in the United States and in Europe was that the American crisis had all the characteristics of a real panic and that it was absolutely confined to an internal drain, the flight of capital, and sudden withdrawals of foreign funds being almost totally absent. Even in France the nervousness was noticeable in anxious withdrawals, hoarding of cash, and a few bank failures (particularly that of the Banque Nationale de Crédit).
• 84The closest great historical predecessors of the credit crisis of 1931 were the American credit crisis of 1907 and the Japanese one of 1927. The first-named in particular won a certain measure of fame as the events of the year 1907 were mainly responsible for the reform of the American system of banks of issue by the Federal Reserve Law of 1913. The American credit crisis of 1907—christened the “Knickerbocker Crisis” after the Knickerbocker Trust Company, the institution which was principally concerned—led to the wholesale suspension of payments by the American banks, to the shooting up of the rate of interest for call money to fantastic heights (as high as 125%) and, lastly, to the utilization of various substitutes for cash payments (particularly the Clearing-house Certificate).
• 85The more quickly this “bold generosity” is declared, the less—as Anglo-American banking literature is never tired of recommending from first-hand experience—it will require to be used, the more quickly will the credit crisis be overcome and the less marked will its repercussions be on the circulation and production of goods. Again and again experience teaches that at such times of panic the public only wants the money it cannot get, while it does not want the money which it can get. The longer one hesitates, however, the more fatal will these repercussions be, the more difficult it will be to overcome the crisis, and the greater sacrifices it will cost when one is eventually forced to do what one should have done in the very beginning, viz., keep the banks open to satisfy the claims of everyone desiring payment. This old truth was forgotten in Germany in the summer of 1931.
• 86A particularly disastrous feature of the present depression have been the international financial troubles and the crises of the balance of payments of numerous countries. Several factors concurred to bring this about. In the first instance, a huge amount of international short-term funds had been piled up which was estimated by the Bank for International Settlements for the beginning of 1931 as at least $10,000 million, and this avalanche came down in the summer of 1931 with most fatal consequences, though it is again to the credit of our economic system that it proved possible to mobilize and transfer about one-half of this enormous amount of indebtedness within one year. Another strain, increasing year by year, was the international long-term indebtedness which had also reached sky-high dimensions, especially on account of the political indebtedness (reparations and inter-allied debts) and its implications. With the declining volume of world trade and the complete collapse of the prices of raw materials, the burden of this foreign indebtedness became increasingly unbearable for the greater part of debtor countries, especially for the countries producing raw materials. This, in turn, had disastrous effects on the banking systems of the creditor countries. So it was that numerous bank failures in the United States were closely connected up with the South-American failures. In addition to all this, irregular movements of capital, directed by the motive of security rather than by the motive of economic yield, gained an importance unheard of hitherto. The most fatal case, in this respect, was perhaps the flight of capital from Germany after the rise of political radicalism had become appallingly manifest by the sweeping victory of the National-Socialist Party at the end of 1930. Considering the ultimate effects of the breakdown of the German financial system, it is not too much to say that the triumph of the Nazi movement has been one of the heaviest blows to economic conditions not only in Germany but also in the world at large. Later on, with the waning number of stable currencies, political insecurity as a factor making for irregular capital movements was supplemented by the instability of currencies. In view of all these extraordinary circumstances, it is not to be wondered at that the monetary and financial system of the world went thoroughly out of order. One of the most conspicuous effects of this development—not its cause, as it is sometimes believed—has been the grossly unequal distribution of the world’s gold reserves among the different countries, a factor which, in turn, has gone far to intensify the economic crisis. At the end of 1934, the central banks and treasuries of all countries held nearly 700 million fine ounces of gold, but of this total nearly 400 millions was held by the United States and France alone while the United Kingdom, in spite of her pre-eminence in world trade and finance and the position of sterling as a basis for other currencies, held less than one-fourteenth of the total, and no other country held more than about one-eighth of the quantity held by France alone. It goes without saying that this distribution is absolutely out of harmony with the share of the different countries in the world’s trade and finance and that it is a sure symptom of the world’s financial mechanism being thoroughly out of gear.
• 87In an economic system which is based on the free decisions and economic conduct of millions of individuals the fluctuations of mind underlying these decisions must be of decisive importance for the equilibrium of the economic system, and the question arises whether the phenomena of economic oscillations do not depend in the last analysis on such fluctuations in mass feelings and opinions. An affirmative answer to this question is given by the theory of the trade cycle of the psychological school. There is much that this theory can count in its favour, especially the important circumstance that the upward swing of the cycle is characterized by a feeling of general optimism and the downward swing by one of general pessimism, and that the one is carried just as far in the upward direction as the other is in the downward direction. In every cycle the experience repeats itself with wearisome regularity, that in the boom people seem to trust to the eternal duration of prosperity, while in the depression they are seized with a dismal melancholy bordering almost on a feeling that the end of the world is approaching. They speak of the “end of capitalism” and forget that up till now every depression has none the less come to an end. It is a case of a mass mental epidemic which only very few are able to withstand, while the vast majority are carried away by the power of suggestion of popular feeling. This is what is in the main at the back of speculative extravagances on the stock markets in which people eventually lose touch with every real foundation of fact. In describing this frenzy, Lavington has compared people to boys who tread on a surface of ice on which there are already many people skating and are given courage by the very fact that there are already so many others on the ice, although the danger that the ice may break increases with the increasing number of the skaters. If a speculative price movement sets in on a market, it tends to be accentuated in a vicious circle and driven to excess. This is as true of the upward movement as of the downward one, so that the French saying: “La hausse amène la hausse” can be equally well applied to the “baisse.” If, for example, the public, frightened off and disheartened by security losses in the crisis, has turned away from the security market, then the desertion of the stock exchange is likely to intensify the lack of disposition towards investing savings in securities. This in turn presses on the whole economic situation and thereby strengthens the real grounds for the depressed state of security prices.
• 88The origins of this proposition can be traced back to the early under-consumptionists (Lauderdale, Malthus, Sismondi and others). It was developed very much further by Marx. The same trend of thought has been followed up by the Russian Tugan-Baranowski who is, not quite correctly, usually regarded as the real founder of this modern over-capitalization theory. His work has been developed further with some substantial modifications by Spiethoff and from there onwards the concept has become common property through the writings of Cassel, Schumpeter, Aftalion, Bouniatian, D. H. Robertson and others.
• 89The origins of this proposition can be traced back to the early under-consumptionists (Lauderdale, Malthus, Sismondi and others). It was developed very much further by Marx. The same trend of thought has been followed up by the Russian Tugan-Baranowski who is, not quite correctly, usually regarded as the real founder of this modern over-capitalization theory. His work has been developed further with some substantial modifications by Spiethoff and from there onwards the concept has become common property through the writings of Cassel, Schumpeter, Aftalion, Bouniatian, D. H. Robertson and others.
• 90This self-inflammatory character of any rise of the rate of investment due to the mechanism of intensification described above (“principle of acceleration”) has been stressed by many trade-cycle theorists (Aftalion, Bouniatian, Bickerdike, Carver, Marco Fanno and especially by J. M. Clark). As it is of the greatest importance for a better understanding of the whole process of the business cycle, something more must be said in order to make its meaning quite clear. From the examples given above, it will be easily grasped that any increase in general economic activity will have the tendency to produce a disproportionate expansion in the higher stages of production, the rate of expansion being the greater the higher is the stage of production, i.e., the further it is removed from the sphere of consumption. The opposite is true for any decrease of general economic activity.
• 91This proposition is, however, subject to a number of qualifications: (1) If capital equipment is being continuously increased, a secondary demand is thereby created which is not dependent on a continuous and progressive increase of ultimate demand but only on its steady level. This secondary demand is the demand for the replacement of durable means of production which is bound to develop as time goes on and so partly to take care of the problem of how the top-heavy superstructure can be permanently maintained. It is conceivable that, under certain circumstances, this factor may serve as a parachute for the blown-up structure of production, the decrease in new construction being compensated to a considerable extent by the increase in replacement demand. But the peculiarities of the business cycle do not make it very likely that this will happen. Apart from the fact that the top-heaviness of the structure of production is usually much too great at the end of the boom to be relieved in this manner, the replacement demand is itself highly elastic and subject to the mass psychology of the different phases of the cycle. As it is, this factor is apt to work in a direction inverse to what is desirable for the purpose of compensation. For it is precisely during the boom period that replacements are speeded up, and it is precisely during the depression that replacements are postponed as long as possible. In both cases, this factor acts to intensify rather than to attenuate the violence of the movements. It is a well-known fact that the intensity of the present depression owes much to the circumstance that the replacement demand has been reduced to the utmost minimum. (2) Account has to be taken of the possibility that, on the average, stocks may not rise in proportion to the growing volume of sales and of goods produced during the boom, nor decrease in proportion to the decreasing volume during the depression. If that is the case, they will also serve as a compensating element. But it is again very unfortunate that just the opposite is probable, in view of the fact that rising prices (boom period) may induce the carrying of larger stocks and vice versa. Though we cannot be so sure in this case as in the case of replacement demand, it will not be an error to assume that the varying volume of stocks is an intensifying rather than a compensating factor. How both factors can work together, bringing about disastrous results, may be gathered from the fact that in the United States the production of automobiles (a durable consumption good to which the same principles must be applied) decreased from 5,621,715 in 1929 to 1,431,494 in 1932, while the number of registrations declined only from 26,545,281 to 24,136,879. Thus a decline of nearly 75 per cent. in annual production corresponded to a decline of only a little over 9 per cent, in the total number in use. (3) A very important qualification must be made with regard to the possible existence of excess capacity and of surplus stocks during the upward-swing of the cycle. As long as the increase of general economic activity can be based on excess capacity and surplus stocks, the mechanism of intensification will not begin to work and so the otherwise unavoidable reaction may be avoided. Now, this is not a mere hypothetical assumption. It is usually the actual situation during the first stage of the upward-swing, though not so much for surplus stocks as for excess capacity. This is one of the main reasons why the upward-swing of the business cycle must be sharply divided into two phases, the first being of a compensatory and balancing character, the second of a self-inflammatory and unbalancing character.
• 92Over-investment, conducive of general economic disequilibrium, may develop in any economic system, provided that the volume of “saving” (in the broadest sense of a relative curtailment of current consumption, i.e., “lacking” in Mr. Robertson’s terminology) is allowed to expand, in quantity and in speed, at a rate which is no longer compatible with economic equilibrium. There is no maximum rate of saving as such which must not be exceeded if disequilibrium is to be avoided. In this long-run sense a problem of “over-saving” certainly does not exist. But a problem of “over-saving” does appear if the rate of saving rises so suddenly and in such a degree that it leads to over-investment. The balancing forces of the economic system can take care of a rise of the rate of saving if it does not exceed a certain maximum of speed and quantity; beyond that point the equilibrium will give way. The question then raised is this: how is such a sudden and substantial rise in the rate of saving conceivable in our economic system?
• 93Over-investment, conducive of general economic disequilibrium, may develop in any economic system, provided that the volume of “saving” (in the broadest sense of a relative curtailment of current consumption, i.e., “lacking” in Mr. Robertson’s terminology) is allowed to expand, in quantity and in speed, at a rate which is no longer compatible with economic equilibrium. There is no maximum rate of saving as such which must not be exceeded if disequilibrium is to be avoided. In this long-run sense a problem of “over-saving” certainly does not exist. But a problem of “over-saving” does appear if the rate of saving rises so suddenly and in such a degree that it leads to over-investment. The balancing forces of the economic system can take care of a rise of the rate of saving if it does not exceed a certain maximum of speed and quantity; beyond that point the equilibrium will give way. The question then raised is this: how is such a sudden and substantial rise in the rate of saving conceivable in our economic system?
• 94In answering this question, the crucial point is that the normal source for the formation of capital in our economic system, viz., voluntary savings by individuals laying aside a part of their incomes, is unlikely to give rise to a sudden and substantial increase in savings. It has to be observed, however, that once the up-swing of the cycle has been started certain forces are set in motion which stimulate a substantial increase of voluntary savings. Apart from the favourable effect of the increase in the national income on the volume of savings during the up-swing, we have to recall what has been said in § 12 about the change in the social structure of incomes during the up-swing, a change characterized by an expansion of profit incomes and variable incomes relatively to fixed incomes. This change is equivalent to a rise of those incomes which are more liable to be saved rather than spent. In addition to this, account has to be taken of the large corporate surpluses (entrepreneurial formation of capital or “self-financing”) which are apt to develop during the boom, adding enormously to the aggregate of savings. This source of saving has risen to prime importance during the last decades along with the development of industrial monopolies and large corporations, with the policy of stabilizing dividends, and with certain degenerate tendencies in the financial structure of industry and banking. The importance of this factor is enhanced by two further circumstances: (1) corporate surpluses are usually larger in the industries producing capital goods than in those producing consumption goods so that the tendencies towards over-investment are accordingly reinforced; (2) corporations have a well-known inclination to reinvest their surpluses in their own plants instead of investing them on the general capital market so that the rate of interest has to this extent lost its regulating influence. This tendency, since it leads to over-expansion in special trades (for instance, the copper industry in the United States or the cement industry in Germany after the war) reveals an additional source of trouble. So we see that the entrepreneurial formation of capital (corporate surplus) may become an important means of enlarging the aggregate of savings and contributing to a tendency towards over-investment.
• 95In answering this question, the crucial point is that the normal source for the formation of capital in our economic system, viz., voluntary savings by individuals laying aside a part of their incomes, is unlikely to give rise to a sudden and substantial increase in savings. It has to be observed, however, that once the up-swing of the cycle has been started certain forces are set in motion which stimulate a substantial increase of voluntary savings. Apart from the favourable effect of the increase in the national income on the volume of savings during the up-swing, we have to recall what has been said in § 12 about the change in the social structure of incomes during the up-swing, a change characterized by an expansion of profit incomes and variable incomes relatively to fixed incomes. This change is equivalent to a rise of those incomes which are more liable to be saved rather than spent. In addition to this, account has to be taken of the large corporate surpluses (entrepreneurial formation of capital or “self-financing”) which are apt to develop during the boom, adding enormously to the aggregate of savings. This source of saving has risen to prime importance during the last decades along with the development of industrial monopolies and large corporations, with the policy of stabilizing dividends, and with certain degenerate tendencies in the financial structure of industry and banking. The importance of this factor is enhanced by two further circumstances: (1) corporate surpluses are usually larger in the industries producing capital goods than in those producing consumption goods so that the tendencies towards over-investment are accordingly reinforced; (2) corporations have a well-known inclination to reinvest their surpluses in their own plants instead of investing them on the general capital market so that the rate of interest has to this extent lost its regulating influence. This tendency, since it leads to over-expansion in special trades (for instance, the copper industry in the United States or the cement industry in Germany after the war) reveals an additional source of trouble. So we see that the entrepreneurial formation of capital (corporate surplus) may become an important means of enlarging the aggregate of savings and contributing to a tendency towards over-investment.
• 96In answering this question, the crucial point is that the normal source for the formation of capital in our economic system, viz., voluntary savings by individuals laying aside a part of their incomes, is unlikely to give rise to a sudden and substantial increase in savings. It has to be observed, however, that once the up-swing of the cycle has been started certain forces are set in motion which stimulate a substantial increase of voluntary savings. Apart from the favourable effect of the increase in the national income on the volume of savings during the up-swing, we have to recall what has been said in § 12 about the change in the social structure of incomes during the up-swing, a change characterized by an expansion of profit incomes and variable incomes relatively to fixed incomes. This change is equivalent to a rise of those incomes which are more liable to be saved rather than spent. In addition to this, account has to be taken of the large corporate surpluses (entrepreneurial formation of capital or “self-financing”) which are apt to develop during the boom, adding enormously to the aggregate of savings. This source of saving has risen to prime importance during the last decades along with the development of industrial monopolies and large corporations, with the policy of stabilizing dividends, and with certain degenerate tendencies in the financial structure of industry and banking. The importance of this factor is enhanced by two further circumstances: (1) corporate surpluses are usually larger in the industries producing capital goods than in those producing consumption goods so that the tendencies towards over-investment are accordingly reinforced; (2) corporations have a well-known inclination to reinvest their surpluses in their own plants instead of investing them on the general capital market so that the rate of interest has to this extent lost its regulating influence. This tendency, since it leads to over-expansion in special trades (for instance, the copper industry in the United States or the cement industry in Germany after the war) reveals an additional source of trouble. So we see that the entrepreneurial formation of capital (corporate surplus) may become an important means of enlarging the aggregate of savings and contributing to a tendency towards over-investment.
• 97The central theses of Mr. Keynes, which he develops by the aid of a number of ingenious though debatable equations, runs as follows: The real sources of rhythmic disturbances are not changes of the rate of saving or of the rate of investment but recurrent discrepancies between the two rates, in such a way that a rate of investment greater than the rate of saving engenders the boom, and a rate of saving greater than the rate of investment engenders the depression. Equilibrium can be maintained only by the equality of the rates of saving and of investment, but this is also a sufficient condition. Of these two rates the rate of saving is more steady in character, while the rate of investment, is subject to jerky fluctuations. The essence of his theory is given by Keynes in this classical passage : “It is enterprise which builds and improves the world’s possessions. Now, just as the fruits of thrift may go to provide either capital accumulation (if savings are invested—R) or an enhanced value of money-income for the consumer (if savings are not invested—R), so the outgoings of enterprise may be found either out of thrift or at the expense of the consumption of the average consumer. Worse still;—not only may thrift exist without enterprise, but as soon as thrift gets ahead of enterprise, it positively discourages the recovery of enterprise and sets up a vicious circle by its adverse effects on profits. If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. . . . Now, for enterprise to be active, two conditions must be fulfilled. There must be an expectation of profit; and it must be possible for enterprisers to obtain command of sufficient resources to put their projects into execution. Their expectations partly depend on non-monetary influences—on peace and war, inventions, laws, race, education, population and so forth. But . . . their power to put their projects into execution on terms which they deem attractive, almost entirely depends on the behaviour of the banking and monetary system.” To this the present author would whole-heartedly subscribe, adding that it contains a truth which could hardly be put more eloquently. When Keynes makes the rise of the rate of investment above the rate of saving (which, in his definition, excludes “forced saving”) responsible for the boom, he says essentially the same thing as was said in the course of our preceding analysis where it was stated that it is usually the adding of “forced savings” to normal saving which raises investments to a dangerous height. Though the practical result is the same, the approach is different, since in our analysis it is not the rise of the rate of investment relative to the rate of saving which is the real cause of instability but the absolute rise of investments no matter whether financed by voluntary or forced savings. For all practical purposes this amounts to the same thing, so far as the explanation of the capitalistic boom is concerned.
• 98The central theses of Mr. Keynes, which he develops by the aid of a number of ingenious though debatable equations, runs as follows: The real sources of rhythmic disturbances are not changes of the rate of saving or of the rate of investment but recurrent discrepancies between the two rates, in such a way that a rate of investment greater than the rate of saving engenders the boom, and a rate of saving greater than the rate of investment engenders the depression. Equilibrium can be maintained only by the equality of the rates of saving and of investment, but this is also a sufficient condition. Of these two rates the rate of saving is more steady in character, while the rate of investment, is subject to jerky fluctuations. The essence of his theory is given by Keynes in this classical passage : “It is enterprise which builds and improves the world’s possessions. Now, just as the fruits of thrift may go to provide either capital accumulation (if savings are invested—R) or an enhanced value of money-income for the consumer (if savings are not invested—R), so the outgoings of enterprise may be found either out of thrift or at the expense of the consumption of the average consumer. Worse still;—not only may thrift exist without enterprise, but as soon as thrift gets ahead of enterprise, it positively discourages the recovery of enterprise and sets up a vicious circle by its adverse effects on profits. If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. . . . Now, for enterprise to be active, two conditions must be fulfilled. There must be an expectation of profit; and it must be possible for enterprisers to obtain command of sufficient resources to put their projects into execution. Their expectations partly depend on non-monetary influences—on peace and war, inventions, laws, race, education, population and so forth. But . . . their power to put their projects into execution on terms which they deem attractive, almost entirely depends on the behaviour of the banking and monetary system.” To this the present author would whole-heartedly subscribe, adding that it contains a truth which could hardly be put more eloquently. When Keynes makes the rise of the rate of investment above the rate of saving (which, in his definition, excludes “forced saving”) responsible for the boom, he says essentially the same thing as was said in the course of our preceding analysis where it was stated that it is usually the adding of “forced savings” to normal saving which raises investments to a dangerous height. Though the practical result is the same, the approach is different, since in our analysis it is not the rise of the rate of investment relative to the rate of saving which is the real cause of instability but the absolute rise of investments no matter whether financed by voluntary or forced savings. For all practical purposes this amounts to the same thing, so far as the explanation of the capitalistic boom is concerned.
• 99Just the opposite is true in the case of the equally important contributions to the problem of crises and cycles of Dr. v. Hayek. As far as the explanation of the depression is concerned, Dr. v. Hayek’s endeavours seem to be unsuccessful to the point of being positively misleading, but his analysis of the boom period on the other hand contains elements which represent a real advance. The gist of his theory is that, while any amount of investments financed out of voluntary savings tends to leave the structure of production intact, it is a rise of investments financed out of forced savings which puts the structure of production out of balance so that a subsequent readjustment becomes inevitable. We cannot enter here into the very intricate details of his reasoning which are connected up with some rather controversial propositions of the theory of capital of the Viennese school (Böhm-Bawerk, Mises, Strigl and others). Let it suffice to remark that, by emphasizing the rôle of forced savings (credit expansion) as the driving force of overinvestment, Dr. v. Hayek’s theory amounts, in the last analysis, to the game thing as Mr. Keynes’ theory and our own analysis, at least for all practical purposes. But below the surface there are substantial differences. In our analysis, over-investment by forced savings appears as the special form in which, in our present economic system, the general source of instability, i.e., over-investment no matter how financed, becomes a practical possibility. In Dr. v. Hayek’s analysis, over-investment by forced savings appears as the sole case in which over-investment as a factor of instability is conceivable. To be more explicit, we must say that, in Dr. v. Hayek’s view, the real source of trouble is not too much investment, but too little voluntary saving.
• 100Just the opposite is true in the case of the equally important contributions to the problem of crises and cycles of Dr. v. Hayek. As far as the explanation of the depression is concerned, Dr. v. Hayek’s endeavours seem to be unsuccessful to the point of being positively misleading, but his analysis of the boom period on the other hand contains elements which represent a real advance. The gist of his theory is that, while any amount of investments financed out of voluntary savings tends to leave the structure of production intact, it is a rise of investments financed out of forced savings which puts the structure of production out of balance so that a subsequent readjustment becomes inevitable. We cannot enter here into the very intricate details of his reasoning which are connected up with some rather controversial propositions of the theory of capital of the Viennese school (Böhm-Bawerk, Mises, Strigl and others). Let it suffice to remark that, by emphasizing the rôle of forced savings (credit expansion) as the driving force of overinvestment, Dr. v. Hayek’s theory amounts, in the last analysis, to the game thing as Mr. Keynes’ theory and our own analysis, at least for all practical purposes. But below the surface there are substantial differences. In our analysis, over-investment by forced savings appears as the special form in which, in our present economic system, the general source of instability, i.e., over-investment no matter how financed, becomes a practical possibility. In Dr. v. Hayek’s analysis, over-investment by forced savings appears as the sole case in which over-investment as a factor of instability is conceivable. To be more explicit, we must say that, in Dr. v. Hayek’s view, the real source of trouble is not too much investment, but too little voluntary saving.
• 101Dr. v. Hayek’s theory is, indeed, the most uncompromising example of an under-saving theory of business cycles. The same amount of investments which, if financed by forced savings, spells disaster would, according to this theory, be harmless if it were financed by voluntary savings or even if the forced savings were replaced later by voluntary savings. In our view, it is the steep rise of the absolute amount of investments which matters, not the fact that our economic system must rely on credit expansion to make this rise possible. In our view, therefore, even a socialist state has to face the same problem if investments are sped up by authoritarian forced savings, a statement which is contrary to Dr. v. Hayek’s analysis. He must, consequently, hold the belief that a socialist system is not exposed to this kind of disturbance. But there are other consequences too. While in our analysis the ultimate breakdown of the boom is explained by the acceleration principle, in Dr. v. Hayek’s theory it is the shortage of capital which puts an end to the boom, and this shortage of capital must come sooner or later if investments are being financed by credit expansion. He makes no use of the acceleration principle, and even rejects it, explicitly, by saying that the top-heavy structure of production could be maintained if so much more were saved as to increase the capital equipment in the higher stages to such a magnitude that its replacement demand would use fully the capacity of the lower stages. But since it is indisputable that the top-heavy structure has been brought about by a general rise of investments no matter how financed, it is difficult to understand how more savings and more investments could restore the balance instead of postponing the ultimate breakdown at the cost of intensifying it. In this sense, the shortage of capital at the end of the boom is an indubitable calamity, but, as was said earlier in this section, it is no real explanation, since it is the inevitable result of the whole process of the boom. All this is, it must be repeated, a philosophy slightly reminiscent of the legendary “victory at arm’s reach” and “dagger-stab in the back” in Germany after the war.
• 102Dr. v. Hayek’s theory is, indeed, the most uncompromising example of an under-saving theory of business cycles. The same amount of investments which, if financed by forced savings, spells disaster would, according to this theory, be harmless if it were financed by voluntary savings or even if the forced savings were replaced later by voluntary savings. In our view, it is the steep rise of the absolute amount of investments which matters, not the fact that our economic system must rely on credit expansion to make this rise possible. In our view, therefore, even a socialist state has to face the same problem if investments are sped up by authoritarian forced savings, a statement which is contrary to Dr. v. Hayek’s analysis. He must, consequently, hold the belief that a socialist system is not exposed to this kind of disturbance. But there are other consequences too. While in our analysis the ultimate breakdown of the boom is explained by the acceleration principle, in Dr. v. Hayek’s theory it is the shortage of capital which puts an end to the boom, and this shortage of capital must come sooner or later if investments are being financed by credit expansion. He makes no use of the acceleration principle, and even rejects it, explicitly, by saying that the top-heavy structure of production could be maintained if so much more were saved as to increase the capital equipment in the higher stages to such a magnitude that its replacement demand would use fully the capacity of the lower stages. But since it is indisputable that the top-heavy structure has been brought about by a general rise of investments no matter how financed, it is difficult to understand how more savings and more investments could restore the balance instead of postponing the ultimate breakdown at the cost of intensifying it. In this sense, the shortage of capital at the end of the boom is an indubitable calamity, but, as was said earlier in this section, it is no real explanation, since it is the inevitable result of the whole process of the boom. All this is, it must be repeated, a philosophy slightly reminiscent of the legendary “victory at arm’s reach” and “dagger-stab in the back” in Germany after the war.
• 103Though this and a number of other propositions are highly debatable the merits of Dr. v. Hayek’s work can hardly be overrated. He has given a new stimulus to economic thinking on all these problems by diverting attention to questions hitherto unseen and by the brilliance and profoundness of his attack, even in those points where his analysis is the most provocative of contradiction.
• 104The part played by changes on the money and credit side of the economic system has already come into prominence many times, and especially in the last section. It is in fact such an outstanding feature that a group of trade-cycle theorists who have recently become increasingly influential—the representatives of the monetary or credit theory of the trade cycle—see the ultimate causes of cyclical movements in the changes taking place during the cycle on the money and credit side, and they emphatically declare that cycles and crises are a mere monetary and credit phenomenon.
• 105This contention seems to contradict the well-known fact that the most recent American boom which sowed the seeds of the heaviest of all economic depressions was not characterized by a rise in the general price level. This was presumed to be a sign that no reaction was to be feared and that we could count on “eternal prosperity.” That this reaction has nevertheless followed, and in the most severe form, leads to the conclusion that the American boom of the years 1926-1929 was not very different in its essentials from an ordinary boom and that the inflationary expansion of the economic system can scarcely have been absent from it. In fact, although the volume of cash rose only slightly in that period, the volume of credit rose to an enormous extent. A rise in the general price level did not occur in spite of this enormous credit expansion for the reason that at the same time the prices of commodities were being pressed downwards by the fall in costs due to the progress of technique and organization. In other words: if at that time enormous quantities of additional credit had not been pumped into the American economic system, prices would have fallen considerably. The fall of average production costs in industry and agriculture realized in that period was so large that a rise in the price level was all the time prevented in spite of the fact that additional credits were always being pumped into circulation. The opinion that the credit inflation would thereby be rendered harm-less turned out to be fatal. To maintain stable a price level which in ordinary circumstances would have had to fall on account of a general lowering of production costs, amounts to the same thing as pushing prices up by an unconcealed credit inflation when production costs have remained unchanged. The important point is then not that the general price level rises, but simply the circumstance that additional quantities of money and credit are supplied to the economic system, calling forth dangerous disturbances in the structure of production. The monetary theory thus formulated is capable of explaining even the otherwise incomprehensible American boom. It is indeed the only trade-cycle theory which can really explain it satisfactorily. The conclusion then is that in order to set in motion the boom mechanism which undeniably leads to a breakdown, it is not at all necessary for there to be an absolute credit inflation (in the sense of an expansion of credit leading to a general rise in the prices of commodities) but that a relative credit inflation is quite sufficient.
• 106The increase of money, which the monetary theory of the trade cycle designates as the cause of the upswing, is essentially an increase in credit money which comes from the central note-issuing banks and banks doing current-account deposit business. An understanding of the monetary theory of the cycle presupposes above all a knowledge of how such an increase of credit money—“credit creation”—can come about. This process cannot be described here in detail, but it may be more easily intelligible if we point out what an extremely large proportion of transactions are effected without the use of cash (cheques, clearing), that is by disposing over demand deposits (current accounts), so that a superstructure of credit is built on the cash basis. The size of this superstructure is dependent on the width of the cash basis and on liquidity considerations of the banks, and it can therefore be subject to substantial fluctuations. This means that our credit system is elastic and that within certain moderately wide limits it permits of arbitrary changes in the volume of credit money. These changes are according to the monetary theory of the cycle identical with the cyclical movements. Thus the volume of credit rises to the detriment of bank liquidity in the boom period and falls accompanied by an improvement in liquidity in the depression. The leading rôle in this connexion is usually played by the central note-issuing banks.
• 107For a complete understanding of the monetary theory of the cycle it is essential to realize that the pivot of the whole mechanism is the rate of interest. In so far as the banks—led by the central note-issuing bank via its discount policy—lower or raise the rate of interest, there ensues an expansion or contraction of credit. The decisive factor is not the absolute height of the banks’ interest rate, but the discrepancy between this and that rate of interest (the real rate of interest in Wicksell’s sense or the equilibrium rate) which would establish itself if the volume of credit in the community were built up solely out of real savings and not out of additional credits besides. A credit inflation can therefore very well arise by the fact that the banks leave their interest rate unchanged or do not raise it far enough at a moment when the equilibrium rate in the economic system—which is only a fictitious figure reflecting roughly the average rate of profits anticipated from capital investment—has risen. This is, however, exactly what regularly happens in the boom period. If at the commencement of the boom the profit expectations of the economic system rise but the banks maintain their previous rate for credit advances or do not raise it sufficiently, then the automatic consequence is an increase in the demand for credit, owing to the widening of the gap between the rate of interest and profits on capital. In this case, therefore, no active intervention of the banks is necessary in order to call forth an increase in the demand for credit. It is sufficient if they do not follow or do not follow quickly enough the changes in average profit expectations (subjective real rate of interest). This is the situation that repeats itself with the beginning of every boom.
• 108The credit expansion setting the boom going proceeds by way of the interest rate being “too low.” The too low interest rate invites a general increase in investment which then leads to the mechanism of the boom drifting on towards its ultimate débâcle as was described in the preceding section. At the same time the additional credits are the source out of which the increased capital needs of the boom are in the main satisfied. The chain of reasoning is now complete: the expansion of credit in the boom expressing itself in the too low interest rate leads to an over-expansion of the economic process and by introducing a general over-investment disrupts the equilibrium of the economic system. It allows more to be invested than is saved and makes available the necessary increase in money capital from credits which do not originate from savings but are created out of nothing through the banking system. The restriction of direct consumption necessary for every increase in investment which is undertaken voluntarily in the case of real savings, is here replaced by the shrinkage of consumption imposed by the (relative) price rise, consequent on the credit inflation, on all those whose incomes are not adjusted rapidly enough to the rise in prices (monetary forced saving). Through the additional credit there is made possible a shift in the economic system in the direction of an expansion of production, the “carrying out of new productive combinations of factors of production” as Schumpeter puts it, and “room” is “squeezed out” for the production of new goods at the cost of consumption.
• 109The monetary theory of business cycles, as so far expounded, centres around the idea that it is variations in the quantity of circulating media which set the process of alternating booms and depressions in motion. The widening or the narrowing of the money stream in total is declared to be the essential thing. This very important aspect must not, however, lead us to overlook the possibility that the qualitative distribution of the money stream may also become an additional factor of instability. Thus it might not be unimportant whether the flood of additional credits goes into commercial loans, into the real estate markets, into the export or import business, into instalment selling, or into stock exchange speculation. This question gained great topical interest in connexion with the last American boom period up to 1929. It has been already remarked that this period is full of riddles, and one of these riddles is the fact that this period which has been followed by the severest crisis in history shows, on the whole, a price level which was slightly sagging rather than rising. How, then, can there have been inflation? The answer to this question has been given in the text above where it was stated that, owing to decreasing costs following on technical progress, prices would have fallen if an enormous amount of additional credit had not been pumped into the economic system. Hence there was inflation, even if only of the relative kind. But it can be perfectly well argued that the quantitative effect of this inflationary credit expansion was considerably aggravated by an abnormal qualitative distribution of credits. One case is the great expansion of instalment credits which gives the impression as if the Federal Reserve system was trying to administer the heroin not only per os but also per rectum. Indeed, hardly anything was more disquieting than the sanguine light-heartedness which prevailed at that time in the United States in the sphere of instalment selling. Another instance is the real estate market which was also grossly over-supplied with credits. The worst and most conspicuous case, however, was the stock-market speculation which was the leader on the road to disaster. For purposes of illustration, it may be mentioned that the volume of brokers’ loans rose from 1921 to 11929 by about 900 per cent. It cannot possibly be denied that to conduct a large part of the additional credits over the securities market was a particularly dangerous procedure, for a number of reasons among which the disastrous international repercussions were not the least important. We may conclude, then, that the last American boom is a striking example of how the disequilibrating effects of variations in the volume of credit may possibly be greatly aggravated by peculiarities in the qualitative composition of the stream. But it must, of course, not be overlooked that this can only be an additional factor of instability and presupposes that an inflatory credit expansion is already going on. Without this, misdirections of credit can hardly give rise to a general economic disequilibrium. The same must be said about Irving Fisher’s “debt-deflation” theory of cycles which implies that it is over-indebtedness incurred during the boom which starts the crisis. Over-indebtedness could not occur without an inflationary expansion of credit, or, to be more explicit, it is only another word for it, since expansion of credit means, on the reverse side, expansion of debits, i.e., a growing volume of indebtedness.
• 110The monetary theory of business cycles, as so far expounded, centres around the idea that it is variations in the quantity of circulating media which set the process of alternating booms and depressions in motion. The widening or the narrowing of the money stream in total is declared to be the essential thing. This very important aspect must not, however, lead us to overlook the possibility that the qualitative distribution of the money stream may also become an additional factor of instability. Thus it might not be unimportant whether the flood of additional credits goes into commercial loans, into the real estate markets, into the export or import business, into instalment selling, or into stock exchange speculation. This question gained great topical interest in connexion with the last American boom period up to 1929. It has been already remarked that this period is full of riddles, and one of these riddles is the fact that this period which has been followed by the severest crisis in history shows, on the whole, a price level which was slightly sagging rather than rising. How, then, can there have been inflation? The answer to this question has been given in the text above where it was stated that, owing to decreasing costs following on technical progress, prices would have fallen if an enormous amount of additional credit had not been pumped into the economic system. Hence there was inflation, even if only of the relative kind. But it can be perfectly well argued that the quantitative effect of this inflationary credit expansion was considerably aggravated by an abnormal qualitative distribution of credits. One case is the great expansion of instalment credits which gives the impression as if the Federal Reserve system was trying to administer the heroin not only per os but also per rectum. Indeed, hardly anything was more disquieting than the sanguine light-heartedness which prevailed at that time in the United States in the sphere of instalment selling. Another instance is the real estate market which was also grossly over-supplied with credits. The worst and most conspicuous case, however, was the stock-market speculation which was the leader on the road to disaster. For purposes of illustration, it may be mentioned that the volume of brokers’ loans rose from 1921 to 11929 by about 900 per cent. It cannot possibly be denied that to conduct a large part of the additional credits over the securities market was a particularly dangerous procedure, for a number of reasons among which the disastrous international repercussions were not the least important. We may conclude, then, that the last American boom is a striking example of how the disequilibrating effects of variations in the volume of credit may possibly be greatly aggravated by peculiarities in the qualitative composition of the stream. But it must, of course, not be overlooked that this can only be an additional factor of instability and presupposes that an inflatory credit expansion is already going on. Without this, misdirections of credit can hardly give rise to a general economic disequilibrium. The same must be said about Irving Fisher’s “debt-deflation” theory of cycles which implies that it is over-indebtedness incurred during the boom which starts the crisis. Over-indebtedness could not occur without an inflationary expansion of credit, or, to be more explicit, it is only another word for it, since expansion of credit means, on the reverse side, expansion of debits, i.e., a growing volume of indebtedness.
• 111If the fall of the price level is a very incomplete and inadequate index of the secondary deflation, what else is this mysterious and elusive thing? If we next turn to the behaviour of the volume of currency, we shall find that this also provides no real clue, and that for two reasons: firstly, because the volume of currency (cash) represents only the base of our modern money system, and secondly, because the shrinkage of the demand for cash engendered by the economic contraction is, to a large extent, compensated by the increased demand for hoarding and for the strengthening of the liquidity of the banks. Consequently, the shrinking volume of currency is also only a weak reflection of the general economic contraction. The only adequate way of characterizing the secondary deflation is to point to the contraction of the total demand, especially as it is expressed by the contraction of credit money (the main symptoms being the immobility of banking accounts, the shortening of the banks’ balance-sheets, the shrinkage of the clearing-house figures, &c.). This contraction of the total demand—which goes on behind the curtain of a more constant volume of currency—is the essential thing, the prime mover of the secondary depression. It is closely connected with the contraction of incomes and, also, though not so closely, with the contraction of costs, and ends in the general contraction of production which, in turn, reacts towards a contraction of demand and incomes. This mechanism of the secondary depression operates through a double “lag” which is self-maintaining as long as the vicious circle of the depression remains unbroken: firstly, the contraction of production tends to lag behind the fall of prices since it means a contraction of incomes and demand, and, secondly, the contraction of costs tends also to lag behind the falling prices. In the first case, it is the disproportion between supply and demand, and, in the second case, it is the disproportion between costs and prices, i.e., the lack of profitability, which tends to be continuously maintained.
• 112If the fall of the price level is a very incomplete and inadequate index of the secondary deflation, what else is this mysterious and elusive thing? If we next turn to the behaviour of the volume of currency, we shall find that this also provides no real clue, and that for two reasons: firstly, because the volume of currency (cash) represents only the base of our modern money system, and secondly, because the shrinkage of the demand for cash engendered by the economic contraction is, to a large extent, compensated by the increased demand for hoarding and for the strengthening of the liquidity of the banks. Consequently, the shrinking volume of currency is also only a weak reflection of the general economic contraction. The only adequate way of characterizing the secondary deflation is to point to the contraction of the total demand, especially as it is expressed by the contraction of credit money (the main symptoms being the immobility of banking accounts, the shortening of the banks’ balance-sheets, the shrinkage of the clearing-house figures, &c.). This contraction of the total demand—which goes on behind the curtain of a more constant volume of currency—is the essential thing, the prime mover of the secondary depression. It is closely connected with the contraction of incomes and, also, though not so closely, with the contraction of costs, and ends in the general contraction of production which, in turn, reacts towards a contraction of demand and incomes. This mechanism of the secondary depression operates through a double “lag” which is self-maintaining as long as the vicious circle of the depression remains unbroken: firstly, the contraction of production tends to lag behind the fall of prices since it means a contraction of incomes and demand, and, secondly, the contraction of costs tends also to lag behind the falling prices. In the first case, it is the disproportion between supply and demand, and, in the second case, it is the disproportion between costs and prices, i.e., the lack of profitability, which tends to be continuously maintained.
• 113But why this continuous contraction of demand? Why do not the forces which are always working for economic equilibrium reassert themselves? To put the matter briefly, the whole trouble may be ascribed to the disastrous destruction of that harmony between the process of the formation of incomes and the process of the utilization of incomes which constitutes an essential condition of general economic equilibrium. The discrepancy tends to become cumulative and leads to a continuous fall of demand on commodity markets, which in turn tends to bring about a yet further fall. The stream of money flowing to economic units—business firms and private households—and flowing out again is interrupted. Sums which flow in do not flow back to commodity markets, or else they flow back either only partially or after long delay. For purposes of illustration reference may be made to the large number of firms which are holding themselves as liquid as possible instead of using their funds for replacing old machinery let alone for making additional investments, or to those households which are actually hoarding money or leaving their banking accounts idle. A special form of this process of sterilization of purchasing power is the preference on the part of the public for accumulating funds on banking accounts rather than investing them on the securities markets, a preference which is tantamount to preferring liquidity and security to profit. This “bearishness” (Keynes) of the public towards investment in securities is a very important part of the whole machinery of the secondary depression which must be taken into account by any rational policy of initiating the recovery.
• 114In all these cases money is being saved in a form, and under circumstances, which largely prevent it from being invested, so that the rate of saving is continuously greater than the rate of investment. As long as this is the case, savings not only add nothing to the wealth of the community but are positively harmful for economic welfare. Saving in this case is not only “abortive” (Robertson) but downright destructive—always in the relative sense that the money saved finds no outlet in new investments. Or in other words: money is withheld from expenditure on consumption goods, without any compensation for this non-consumption taking place in the form of investments in capital goods. The general contraction of demand is, then, tantamount to an excess of savings over investment. By force of logic, these two things must be identical.
• 115Now the reluctance of entrepreneurs to enter upon new investment is due not only to the confidence crisis, to the recession of prices, and to the over-investment of the previous boom, but also to the fact that entrepreneurs do not dare, for the purpose of long-term investment, to have recourse to short-term credits—almost the only available method of financing new investment at this stage—unless a marked recovery of the stock exchange points to the possibility of an early funding of the preliminary advances of the banks. That is the reason (apart from the immediate psychological effects) why rising stock markets are a necessary condition for general recovery and why every measure and every event which has the effect of driving the public away from the stock markets constitutes a serious blow to recovery. And for the same reason it is the acid test for every recovery programme whether it succeeds in “priming” the securities markets, or not. Again, it must not be forgotten that a rising stock market provides a tremendous relief also to the banks by improving their liquidity and by enhancing thereby their willingness to enter upon new credit expansion. This is done in two ways: (a) by offering the banks an opportunity for turning their own securities into cash, and (b) by doing the same for their debtors, thereby thawing their frozen assets.
• 116Many factors have contributed to this, the frenzied speculation of 1929 being one of the most obvious. Among these factors, however, the fact deserves greater attention than it has so far received that after the war a larger proportion of capital to be invested than before the war has gone into time deposits (or savings accounts) instead of being invested by the public directly in securities. This may be inferred from the fact that in many countries the ratio of time deposits to demand deposits has markedly increased, most of all in the United States where, for the United States as a whole, the percentage of time deposits to total deposits has risen from 23 in 1913 to 45 in 1932 while, for the U.S. National Banks, the corresponding rise has been even from 9 to 47. In order to grasp the significance of this change-over in favour of time deposits, one has to take into account the further fact that there corresponds to this change on the liabilities side a change also, in large measure, on the assets side, viz., the equally excessive enlargement of banks’ investments in securities. In other words, the public is investing its money in securities indirectly by way of the banks, thereby combining security with a high degree of liquidity and also—if the banks are paying good interest on time deposits as they have done in the United States, in Germany and elsewhere—with a reasonable degree of profit. The banks are bearing the risk of possible depreciation of the securities held in stock, but—unfortunately even South-American bonds included!—this risk seemed so small during normal times that in the United States there even came into being a new school of Bank Liquidity which preached this sort of investment as the last word in the art of banking. In the light of later experiences we may safely say now that this development was unsound and dangerous, so much so that the name “deposits disease” does not seem altogether inapt. When during the depression the confidence in the banks began to crumble and deposits were withdrawn the American banks had to sell out their securities on a weak market, thereby causing a collapse on the stock exchange to an absolutely abnormal extent out of all proportion to the mere influence of speculation. In contrast to the United States and several other countries, France is the outstanding example of a country which has remained absolutely free from the “deposits disease,” the percentage of demand deposits having even slightly increased between 1913 and 1932. This notable fact is a very telling expression of the investment habits of the French population and of the kind of banking institutions corresponding to them. Since the great commercial banks of the type of the Crédit Lyonnais pay practically no interest on deposit accounts they offer no incentive to the public seeking investment for their disposable capital. It seems to the present writer that this accounts, to a large extent, for the fact that France has been relatively free from the kind of financial disturbances which have shaken American economic life to the core.
• 117Many factors have contributed to this, the frenzied speculation of 1929 being one of the most obvious. Among these factors, however, the fact deserves greater attention than it has so far received that after the war a larger proportion of capital to be invested than before the war has gone into time deposits (or savings accounts) instead of being invested by the public directly in securities. This may be inferred from the fact that in many countries the ratio of time deposits to demand deposits has markedly increased, most of all in the United States where, for the United States as a whole, the percentage of time deposits to total deposits has risen from 23 in 1913 to 45 in 1932 while, for the U.S. National Banks, the corresponding rise has been even from 9 to 47. In order to grasp the significance of this change-over in favour of time deposits, one has to take into account the further fact that there corresponds to this change on the liabilities side a change also, in large measure, on the assets side, viz., the equally excessive enlargement of banks’ investments in securities. In other words, the public is investing its money in securities indirectly by way of the banks, thereby combining security with a high degree of liquidity and also—if the banks are paying good interest on time deposits as they have done in the United States, in Germany and elsewhere—with a reasonable degree of profit. The banks are bearing the risk of possible depreciation of the securities held in stock, but—unfortunately even South-American bonds included!—this risk seemed so small during normal times that in the United States there even came into being a new school of Bank Liquidity which preached this sort of investment as the last word in the art of banking. In the light of later experiences we may safely say now that this development was unsound and dangerous, so much so that the name “deposits disease” does not seem altogether inapt. When during the depression the confidence in the banks began to crumble and deposits were withdrawn the American banks had to sell out their securities on a weak market, thereby causing a collapse on the stock exchange to an absolutely abnormal extent out of all proportion to the mere influence of speculation. In contrast to the United States and several other countries, France is the outstanding example of a country which has remained absolutely free from the “deposits disease,” the percentage of demand deposits having even slightly increased between 1913 and 1932. This notable fact is a very telling expression of the investment habits of the French population and of the kind of banking institutions corresponding to them. Since the great commercial banks of the type of the Crédit Lyonnais pay practically no interest on deposit accounts they offer no incentive to the public seeking investment for their disposable capital. It seems to the present writer that this accounts, to a large extent, for the fact that France has been relatively free from the kind of financial disturbances which have shaken American economic life to the core.
• 118Leaving aside the industry of manufacturing books on crises and cycles, there are two big industries likely to prosper inversely to the depression, the armaments industry and the gold-mining industry. It is a remarkable fact that throughout the present depression the shares of the great armaments firms have not only kept their level but soared continuously at a time when almost all other shares were sagging, and it is surely not a too far-fetched idea to suppose that the rising prosperity of this branch of industry owes much to the political repercussions of the general economic and social atmosphere created by the protracted depression, especially in certain countries. What has been achieved recently in the way of economic recovery is, indeed, due, to no small extent, to the boom in all kinds of war materials. Certainly the temporary German recovery after 1933 must be largely ascribed to this factor, and it is no secret that countries like Sweden have greatly profited therefrom. But while in the case of the armaments industry the influence of the depression depends on many and uncertain intermediary factors, the favourable effect on the gold-mining industry is direct and quasi-automatic and this for a simple reason. “So long as there exists at least one country on a full gold standard, an essential condition of which is freedom to buy gold from or sell gold to the central institution at a fixed price, there is literally an unlimited demand for the commodity at that price. In other words, not only is a minimum price for the product of the industry guaranteed, but there is, besides, no limit to the amount the market will take. Added to this, the effective minimum price, translated into terms of the producing countries’ currencies, has risen substantially in recent years, without a corresponding rise in costs, in consequence of widespread departure from the gold standard. Happily, prosperity in any one industry cannot fail to contribute to recovery in others, and in this respect gold producing is not exceptional.” The world’s gold production has, in fact, increased from 1930 to 1934 by about one-third.
• 119Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 120Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 121Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 122Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 123Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 124Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 125Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 126Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 127Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 128Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 129Although even in earlier periods of long-lasting depression tendencies to treat it as a special phenomenon have not been absent, the theory of the secondary depression is the result of a rather recent development which only attained the dignity of a piece of analysis recognized in academic circles under the pressure of the present world depression. The very first treatment on the lines of the savings-investments approach, made famous later by Mr. Keynes, is perhaps to be found in an obscure little pamphlet in German published in 1903 in Brooklyn by an American business-man writing under the pseudonym of J. J. O. Lahn. His real name was N. Johannsen under which his later publications are known. He clearly recognizes that long depressions must be explained by the deflationary effect of savings which are not adequately absorbed by investments, a process likely to be made cumulative by the entrepreneurs’ losses and their repercussions. He calls the savings thus made inactive and harmful “impaired savings,” reminding us of the term “abortive savings” introduced more than twenty years later by Mr. Robertson. Mr. Johannsen’s pamphlet is full of shrewd observations and bold analysis, and his whole treatment is such that Mr. Keynes is right in giving him the credit of having “come very near to the truth,” though Mr. Keynes does not seem to know his first pamphlet of 1903. But, as Mr. Keynes justly observes, the weak point in his argument is that he “regarded the failure of current savings to be embodied in capital expenditure as a more or less permanent condition in the modern world due to a saturation of the capital market, instead of as a result of a temporary but recurrent failure of the banking system to pass on the full amount of the savings to entrepreneurs, and overlooked the fact that a fall in the rate of interest would be the cure for the malady if it were what he diagnoses it to be.” In this Mr. Johannsen has, indeed, come very near to the view rejected above. The main fact accounting for this is that, at that time, the nature of credit expansion and its role in financing the boom was, if at all, only dimly perceived. The real development of the theory of the secondary depression on defensible lines has been the result of a stream of thought which has become more and more prominent during the course of the present depression among various writers of different countries. Most outstanding in this respect has been Mr. Keynes’ Treatise on Money which appeared in 1930. The treatment given in this paragraph owes much to this great work, notwithstanding the substantial reservations and differences which need not be repeated here. The present author must resist the temptation to follow up in detail the various phases of increasing heresy and to compare the developments in the different countries, emanating from the growing dissatisfaction with the orthodox view and the restrictionist policies connected therewith. As for his personal share in this development he may be permitted to say that he first became convinced of the defectiveness of the orthodox view and of the need for a special theory of the secondary depression while acting as a member of the German Reich Committee on Unemployment in the spring of 1931. The report of this committee clearly reflects its conviction that something could be done to shorten the road to recovery by arousing the national economy from the torpor into which it seemed to have fallen through the degeneration of the crisis. But in this the committee was much ahead of the development of common and even academic opinion so that its recommendations unfortunately went unheard at that time. In subsequent years the present writer tried on several occasions to elaborate his point of view. It coincides largely with the views of a number of writers in other countries, notably with those of Mr. Robertson in England, of Professor Ohlin in Sweden, of Professor Viner in the United States, of Professor Haberler and Dr. Mahr in Austria, and of Professor Verrijn Stuart in Holland. It is to be hoped that by the joint effort of these much may be achieved in giving to the theory of the secondary depression that degree of refinement and qualification which it still badly needs.
• 130If we wish to make use of the knowledge we have acquired about the causes of cycles and crises to explain the present world economic depression, then the first thing that we must realize is that the present depression is the result of a combination of the most varied factors and only this combination explains the unexampled acuteness and stubbornness of this the most severe of all depressions yet experienced. The origin of the depression is to be sought, like that of every former depression, in the over-investment of the preceding boom caused by credit expansion, so that to this extent it can be fitted into the historical rhythm of cyclical movements. The main seat of this unhealthy economic expansion was the United States whose credit expansion has already been described. From here the credit expansion spread over the whole world supported substantially by the monetary policy of the Bank of France and the Bank of England. Germany took part in the international credit expansion mainly via enormous imports of capital. These gave the incentive there also to an investment boom in which there lay a special danger, enhanced by the loan policy of the then Reichsbank President Schacht, by the fact that the foreign credits had the increasing tendency to take short-term form. If we want to go still further back, it is the World War and the destruction that it left behind it which must be designated as the ultimate great driving force behind this strenuous exertion of the nations as this enormous wave of the last investment boom may be described.