Crises & Cycles

CHAPTER V. TRADE-CYCLE POLICY.

§ 18. THE EFFECTS OF CRISES AND CYCLES.

Under trade-cycle policy we understand the totality of all measures by means of which it is sought to remove, or at least to mitigate, crises and cycles. There are here two questions involved. The first is, should we combat crises and cycles? and the second, can we combat them? It is evident that the first question must be answered before the second, and the answer to this question depends on how we judge the effects exerted by crises and cycles in the economic, social, and financial sphere.

It will seem to many strange, and will be considered sheer academic pedantry, that we should even raise the question whether we ought to counteract the phenomena of economic fluctuations by suitable means, at a time when not so long ago the recovery from the depression with its ever-growing destruction stood unchallenged on the peak of all desires and endeavours. In fact, it is very widely held to be a proposition needing no further proof that economic fluctuations are to be regarded as an evil which should in all circumstances be combated. But this attitude tends to overlook the fact that the boom belongs to the cycle just as much as the crisis and depression, and it ignores, moreover, the fact that the boom constitutes the fertile soil on which the crisis and depression are raised. If we think that the crisis and depression should be combated, then we must be prepared to sacrifice the boom in the same measure as we want to modify the later reaction. Thus, instead of its being a matter of course, we are obviously faced with a serious problem of weighing up against each other the assets and liabilities of the whole cyclical process.

The discussion finally reduces itself to the philosophical resignation that a price must be paid for everything in this world. If we want to have the acceleration of economic development which takes place during the boom, we must be ready to pay the price of the later reaction with its losses and social misery, and if, conversely, we want to avoid this reaction (crisis and depression), then we must renounce the period of accelerated economic advance. The ultimate dilemma is this: Do we prefer calm and steadiness or a quick tempo of economic progress? Comfortable stability or discontinuous outbursts of energy? It is just the same as with our own mortality and other things which we cannot change: we must face the fact that we have to decide between stability and expansion and that we cannot attain both at once. The final decision is a political one, that is, it is dependent on valuations which are subjective and have no universal validity. The task of science is to bring together all the considerations which are indispensable in making a final judgment.

In commencing with the positive functions of the cyclical movement, we may recall that we have already described it in a previous section as the form in which, in the capitalist economy, the economic development towards the perfection of the technique and organization of the apparatus of production and exchange typically takes place (see § 14). If—to vary slightly the celebrated words of the “Communist Manifesto” of Marx and Engels—“capitalism has first shown what human activity can accomplish,” if “it has achieved miracles altogether different from Egyptian pyramids, Roman aqueducts, and Gothic cathedrals, and has carried out other expeditions than migrations and crusades,” then it is the spasmodic outburst of the ardent spirit of entrepreneurship and its financing by a periodic credit expansion which has made capitalism capable of this incomparable historical feat. If, for example, we had waited for the construction of the modern railway network until the necessary means had been scraped together without a temporary speeding up of the economic process by inflation, then a railway journey would undoubtedly still be for us just as much a sensation as it was for our grandfathers fifty years ago. And what is true of railways is true also of all the other advances in technique and organization of the last hundred years: their swift diffusion always takes place in the framework of a boom on which a reaction invariably follows. The boom may be described as a period in which all the reserves of power of the economic system are mobilized for the purpose of accelerated economic progress. It is, so to speak, a periodic “Five Year Plan,” and for a hundred years past it has anticipated the fundamental ideas of the concentration of investment underlying the Russian Five Year Plan.1 The cyclical movement is, therefore, not the senseless consequence of capitalist libertinism, but a process with a quite definite positive function.

This positive function is somewhat concealed by negative effects which are representative in their totality of the price we have to pay for the speeding up of economic development. These negative effects cumulate in the crisis, or at any rate the depression, which actually takes its origin from the positive function of the boom. The latter thus brings in its train a period of economic losses all round, a shrinkage of the volume of production and trade inflicting on the majority of the population a grievous diminution of their general welfare. The diminution of wealth can, as the present depression very forcibly shows, reach such proportions that the impoverishment of large classes of the population shakes the foundations of the economic and political structure.

In the forefront of these unfavourable effects of cyclical fluctuations comes the effect on unemployment. Even the most zealous eulogist of the positive functions of the cyclical movement must admit that the alternation from over-work in the boom period to unemployment in the depression is a social evil of the worst kind. The trade cycle is, if not the sole, at least the main source of unemployment, that scourge of modern industrial countries.2 How pernicious this is is only recognized to the full when we realize that it is not so much the average level of wages as the danger of unemployment and the uncertainty that it introduces into the economic future of the wage-earner, which is the real social problem of our time. In so far as a dampening down of cyclical fluctuations promises the diminution of unemployment, trade-cycle policy becomes one of the most important measures of social policy. This includes such measures as are intended, without influencing the cycle itself, to alleviate the economic, social, and moral effects of unemployment. These will be dealt with separately in a later section.

Unemployment is a reflection of the monetary and material losses and the general contraction of economic activity which characterize the crisis and depression. Corresponding to the dismissed workmen, there are the closed workshops, the rusting machines, a mass of failures and bankruptcies with all the human tragedies bound up with them, the redistributions of incomes and wealth (in proportion to the dimensions of the boom) which take place irrespective of guilt or merit. Finally, there is a series of more remote effects among which special attention may be drawn to the decline in the figures of marriages and births, the rise in the death-rate, the fall in the standard of living, the increase in criminality, and, lastly, the intensification of social and political unrest. The net result of all these phenomena of the crisis and depression is that a large part of the economic ground gained in the boom has to be given up in the depression. Indeed, it may even happen, as the present depression bears witness, that through the convergence of all the most unfavourable circumstances the general economic level falls far below the position that had been reached before the commencement of the last boom.

The cycle has especially important effects on national budgets.3 It will be obvious that the boom must tend to increase exchequer receipts (particularly the yield of taxes that are especially sensitive to the cyclical movement) corresponding to the increase in the volume of production, trade, and income, while in the crisis and depression they fall. The expenditure side also is not unaffected by cyclical fluctuations. During the boom there is a steady fall in certain classes of expenditure, especially social expenditure, but this is counterbalanced by other expenditure and by the fact that in this period of increasing national income, increasing exchequer receipts and optimistic public feeling, the Government and Parliament usually manifest a very liberal spending mood which leads not only to the using up of the original surpluses but often even to State borrowing. We shall later show that this inflation of expenditure by State borrowing during the boom is just the opposite of a rational cycle policy.

In the depression the reverse takes place: on the expenditure side the slight tendency to an automatic fall through the reduction in the prices of materials bought by the Government is very much more than surpassed by such increases in expenditure as arise from the tasks falling to the lot of the State in the depression (unemployment relief, assistance to the banks, &c.). But since exchequer receipts fall off in the depression, the Government now seeks to maintain budgetary equilibrium by reducing any expenditure that can possibly be dispensed with, and so far as the reduction in expenditure is insufficient, it tries to tighten up the tax screw. The reduction of expenditure and increase in the burden of taxation are, however, elements which accentuate the depression so that the budgetary policy during the depression sets up a vicious circle in which the budgetary crisis and the economic crisis become increasingly intermingled especially as the budgetary crisis is a new source of pessimism and lack of confidence. Eventually a point is reached when even the severest retrenchment and the most vigorous screwing up of taxation can no longer ward off a deficit and, despite the canons of budgetary equilibrium, recourse must be had even for ordinary regular items of expenditure, to State loans, or, where even this is no longer possible, to the printing press. This point approaches nearer with the progressive growth in the difficulties of maintaining exchequer receipts in face of the general economic contraction. The development in most countries during the present depression gives abundant proof of this, the most conspicuous example at the present moment being the case of France, Holland, and Switzerland.

The fatal interaction between financial crisis and economic crisis has been particularly noticeable in Germany. It is to-day generally acknowledged that it was an unpardonable mistake to allow the expenditure of the Reich as well as the States and municipalities to rise so high in the boom years (1927-1929) that the budgetary surplus after the stabilization of the mark was almost immediately transformed into a deficit, of which the chief danger lay in the increase in the floating debt. The way in which, from the point of view of financial technique, this to-day simply incomprehensible budget deficit in the main came about was that the expenditure in the extraordinary budget (public works programme) was enormously increased and it was not found possible to cover this expenditure out of the proceeds of loans. Thus Germany entered the depression with a budgetary position that was already undermined and from which the necessary consequences of a vigorous reduction of expenditure and an increase in taxation had not been drawn in time.

The continued difficulties of the Treasury put an excessively heavy burden on the money market while the political and psychological reactions of the financial crisis, which in spite of the ever-optimistic declarations of the Government could no longer be concealed, contributed their part also to the aggravation of the economic crisis. It should not be forgotten that it was the German financial confusion that determined the fatal political development of 1930, ending in the election of the 14th September 1930, which was so destructive of business confidence. In the later phase of the depression the Brüning Government made repeated and temporarily successful attempts—by emergency decrees of increasing drasticness—to maintain the budget equilibrium by retrenchment and the tightening up of the tax screw. But here also the fatal interaction between financial contraction and economic contraction manifested itself. And since under the German system of unemployment relief the increasing length of the period of unemployment threw a constantly growing section of the unemployed on to the local authorities for poor relief, the financial needs of the local authorities also rose to an ever more threatening scale. Despite positively heroic efforts to preserve budgetary equilibrium, it proved an altogether impossible task to avoid a total budget deficit (of the Reich, the States, and the municipalities) running into billions.

It is difficult to see what more could have been done in Germany by way of retrenchments and tax-raising, and yet the result was that after a while a new budget deficit presented itself. It may be likened to the battle with the Hydra, two ghastly heads always growing in the place of the one cut off. It is a well-known fact that the drastic financial policy of the Brüning era—honest to be sure, and passively courageous but none too ingenious—paved the way for Hitler. Thus the ultimate outcome was that what—namely, an expansionist economic policy—should have been done wisely and with a skilled hand, was now done under political and economic conditions which were liable to exclude any chance of lasting success. This should be a lesson to all other countries, which, like France, Switzerland, and Holland, are at the present moment following more or less the same policy as Brüning, though it is to be conceded that the general economic and political conditions in these countries are different.

This high degree of cyclical sensitiveness of State budgets observed during the present depression, is the result of a rather recent development. If we look back at earlier depressions, it is remarkable how little the public finances have been affected. In England good examples are provided by the severe crisis of 1857, which left almost no trace on the budget, and the long depression of the ’seventies, which was even accompanied by budget surpluses which were so considerable that it was possible steadily to lower the income tax (from 6d. in the £ in 1872 down to 2d. in 1875). The reason for the change from those happier days to the present time is, of course, to be found in the fact that the percentage of the national income claimed by the State has tremendously increased, especially since the Great War, and this, in turn, is an expression of the strikingly increased importance of the State in all its activities and of the growth of interventionism in economic policy. As rough approximations, it may be said that the percentage of the national income claimed by the public authorities rose, from 1913 to 1928, in Great Britain from 12 to 25, in Germany from 16 to 28, in France from 18 to 24, in the United States from 8 to 15, and in Italy from 16 to 31.4 It is obvious that the higher the percentage the more the State budget is bound to follow the fluctuations of the national income. The reasons for this are primarily two: firstly, with the growth in the size of the budget, recourse has more and more to be had to taxes with a high degree of cyclical sensitivity (e.g., turnover taxes, income taxes, business taxes, taxes on stock exchange transactions, taxes on luxuries, &c.), and, secondly, with the growth of the economic and social responsibilities of the State an increasing percentage of State expenditure is characterized by a high degree of (inverse) cyclical sensitivity, especially the expenditure on social relief and the like. Summing up, we may say that the growth of Etatism and Inventionism has given to the State budget an increasing degree of cyclical sensitivity, rendering it more and more dependent on the fluctuations of the national income and raising its importance as an integral part of the national economic structure. The gravest consequence of this at present is the fact that the course which the public finances, owing to their high degree of cyclical sensitivity, follow during the depression react in turn very ominously on the shrinkage of the national income on which for good or ill they also depend. Consequently the growth of the State, its power, and its continual interference has added tremendously to the top-heavy sensitivity of our entire economic system. To put it bluntly, capitalism has been made more unstable and more sensitive precisely by something very dear to the hearts of those who never tire of blaming capitalism for this.

We have still not completed the debit side of the account of cycles and crises. There has, finally, to be added the circumstance which was earlier rather neglected, but which has come into the limelight at the present time, that the phenomena of economic contraction of the depression give rise to State intervention which obstructs the economic system for a long time after the recovery from the depression. Thus modern protectionism in particular has resulted in large part out of protective tariff measures seized on in time of depression. It is always in bad times that the cry for separation from abroad and protective tariffs is loudest, and that this cry finds the most willing listeners among the Government, Parliament, and the public. If it is doubtful whether protective duties are the right way for any individual country to alleviate the crisis or at any rate its consequences, there is no doubt at all that if all countries follow this policy it only aggravates the situation. But this is invariably just what actually happens, giving rise to a new vicious circle which is the more thoroughly to be condemned since protective duties, once introduced, tend to have an extraordinarily tenacious existence. For this reason the present splitting up of the world economic system by tariff walls and import regulations which tower sky-high and a barbed-wire entanglement of foreign exchange regulations is perhaps the most dangerous and most serious of all the effects of the depression.

The present economic depression shows in other spheres also, how, under the pressure of necessity, Government intervention is undertaken which changes the structure of the economic system so radically that the traces will still be visible long after the depression itself has been overcome. We need only to think of the important changes which the banking system has experienced under the measures of State support in Germany, Italy, and Austria, and we are still far from certain that the present depression will not call forth still further structural changes which will shake the capitalist system to its foundations. Without doubt the present depression is unique in every respect, but it shows in particularly striking fashion to what cataracts one may be driven if one leaves the cyclical stream to run its course.

If we sum up the result of all these considerations, it might turn out, in spite of due account being taken of the positive function of the cyclical movement as the great motive force of economic development, that so soon as the cyclical fluctuations overstep a certain level the evil far outweighs the good. Since, as things are, we should not raise our hopes of a dampening down of cyclical fluctuations too high, there is no reason why the apprehension that we may possibly destroy the machinery of economic progress should hinder us at the outset from weighing up and recommending measures of trade-cycle policy. The much greater and more pressing care is the opposite: that we may not succeed in finding the correct and effective means of freeing the capitalist system from those disturbances which constantly threaten its existence and hinder the full development of economic welfare of which it is capable. This is the biggest and most difficult task facing economists. We cannot give its solution here, but can only indicate the direction in which with our present-day knowledge this solution is probably to be sought.

§ 19. THE BASES OF TRADE-CYCLE POLICY.

In the preceding section we described as trade-cycle policy all those measures with which it is sought to remove, or at least to smooth out, cycles and crises, and there was included under this general formula the discussion of the effects of crises and cycles. As a starting point for this discussion, such a general formula was both suitable and necessary. It remains now to determine more precisely what the concept of trade-cycle policy signifies.

The aim of trade-cycle policy, as we have up till now conceived it, was the elimination or the damping down of the trade cycle as a whole so as to remove the conditions under which new economic depressions and their losses continually arise. This is, indeed, the main and most comprehensive objective of trade-cycle policy, but it is not its only aim. In addition there are two narrower aims which in times of depression like the present push the former more comprehensive one into the background. The question of how we can control the cycle as a whole habitually occupies only a small circle of people, because still few are aware that the crisis and depression must be explained as part of the cycle as a whole and that their real cause is to be sought in the preceding boom. The majority want to sip the “sweet nectar” of the boom without also swallowing the inevitable “bitter medicine” of the depression, and believe that we can allow ourselves all the extravagances of the boom only to declaim later in the depression against the economists because they can give no recipe which can be applied to render the consequences of the extravagances ineffective. As against this it cannot be too often emphasized that the combating of the depression must take place in the preceding boom and that once an over-investment has been allowed to develop in the boom we cannot evade the depression and must accept it as a necessary reaction to restore equilibrium. It would be radically wrong to combat this reaction by means of new injections of credit inflation : this would only postpone and make more difficult the final recovery of the destroyed economic equilibrium. In spite of all this, trade-cycle policy is never so popular as in the actual time of the crisis and depression.

The tragedy of this situation is that, just when the disturbing consequences of the cycle descend upon us, all that the economist can in general recommend is patience and confident waiting for the ultimate recovery from the depression, and he must give emphatic warnings against the thousand and one projects for escape which are wont to be conceived in this time in the brains of more or less fanatical reformers. The rôle into which the economist is thrust is an extremely thankless one. For a generation which has become accustomed to the State’s intervening in all cases of economic difficulty or distress does not like to be told that, in face of an economic crisis, we are in no better position than a doctor who, if he does not wish to be a quack, can, in the case of an internal malady, do nothing else than rely on the powers of self-healing of the body, strengthen them, and make their way easier.

This is sufficient, however, to imply that, even in times of depression, it is possible to adopt prudent measures aimed at accelerating the recovery from the depression by seeking to strengthen all those forces which eventually bring the economic process back to its normal course. Generally speaking, the measures suited to this will be of a negative kind and will be directed towards ridding the economic process of obstacles and frictions and towards reducing the amount of State intervention instead of increasing it. The present depression shows, however, that there are cases where positive measures as well may be apt. Such is the case when the depression has entered the phase of the secondary depression. The nature of the problem here involved has already been explained in the preceding chapter. It is around this question that the current discussion on trade-cycle policy is centred, while trade-cycle policy in its stricter and more comprehensive sense of the control of the cyclical movement has at the same time assumed on the whole a more academic character. For some countries, however, the recovery has now already progressed so far that trade-cycle policy in the latter sense is gradually gaining in immediate practical importance.

Lastly, a trade-cycle policy in times of depression may set itself a final, still more modest aim and may content itself, so long as the way out of the depression cannot be found, with making the social and financial consequences of the economic recession as little felt and therefore as bearable as possible. In particular the giving of relief to the masses of unemployed is a task which must be carried out somehow even if no direct remedy for the depression is discoverable, and the same applies in certain situations to the supporting of large banks on the verge of failure. These are merely symptomatic measures or palliatives, and considering their modest aim it is doubtful whether we should include them under trade-cycle policy. The real problem of these symptomatic measures lies in the fact that, while the necessity of mitigating measures is undeniable, it is equally undeniable that there is a danger that they may create new frictions and obstructions, making more difficult and delaying the automatic healing process. It has, for instance, to be carefully considered whether the shortening of working hours, which is demanded in many quarters and by which the unemployed would be transformed into short-time workers, does not mean a new economic obstruction making the recovery more difficult. The system of unemployment relief also gives rise to a similar dilemma. The proposal for the shortening of working hours is, moreover, an example of the widespread lack of understanding of the merely symptomatic character of a measure and the tendency often to mistake what is only an attack on symptoms for an attack on causes. On the other hand, it must be acknowledged that a mitigation of the consequences of the depression lends support at the same time to measures that are directed towards the real overcoming of the depression by keeping the unemployed from disturbing outbursts of despair or protecting the economic system from the incalculable consequences of the breakdown of a large bank.

Three kinds of measures of trade-cycle policy can thus be distinguished:

1. Measures for controlling the cycle as a whole.

2. Measures for overcoming the depression.

3. Symptomatic measures.

This is the division which we shall follow in our more detailed analysis.

References : M. B. Hexter, Social Consequences of Business Cycles, Boston, 1925; D. Thomas, Social Aspects of the Business Cycle, London, 1925; J. Soudek, Die sozialen Auswirkungen der Konjunkturschwankungen, Bonn, 1929; A. C. Pigou, Industrial Fluctuations, London, 1927, part II; A. Müller, Oekonomische Theorie der Konjunkturpolitik, Leipzig, 1926; J. R. Bellerby, Control of Credit, London, 1924; A. B. Adams, Economics of Business Cycles, New York, 1925, chap 11; R. G. Hawtrey, Trade Depression and the Way Out, London, 1933; E. Wagemann, Economic Rhythm, New York, 1930; L. Mises, Geldwertstabilisierung und Konjunkturpolitik, Jena, 1928; A. H. Hansen, Economic Stabilisation in an Unbalanced World, New York, 1932; R. Bachi, La politica della congiuntura, prevenzione e attenuazione degli effetti delle crisi economiche, Rome, 1929; Paul H. Douglas, Controlling Depressions, London, 1935.

1. MEASURES FOR CONTROLLING THE CYCLICAL MOVEMENT AS A WHOLE.

§ 20. CREDIT CONTROL.

The exposition in the previous chapter of the causes of crises and cycles should have made it clear why in the course of the discussions of the last decade on the possibility of trade-cycle stabilization the means of credit control has increasingly pushed its way into the foreground and has found a steadily growing number of adherents. If it should prove possible so to regulate the volume of credit as to nip in the bud any tendency to over-investment, then we should, indeed, have got hold of the cyclical movement by the roots. So the utmost of what is possible in the field of trade-cycle stabilization would be reached if the banks were to place sharp checks at the right time on the credit expansion of the boom. This would mean first and foremost an early and vigorous raising of the rate of interest. Once this comparatively simple idea of credit control had been expressed, it very soon awoke in many countries, and especially in England and the United States, extravagant hopes of a millennium of the “cycleless economy” and it also gave a new importance to the credit policy of central banks. It was believed that at last we had the key of the door to “eternal prosperity” in our hands. The circumstance that this enthusiasm was followed by the most severe of all economic depressions has displaced the enthusiasm by extreme scepticism and has seriously discredited the idea of credit control. Nevertheless, the bitter experiences of the depression should not lead to the conclusion that the idea of credit control has in the least lost in importance. The American crash was in reality due, as we have already shown, not to an excessive but to an insufficient and wrongly directed control of credit. The experiences only go to prove that there is no more urgent task for the economists of all countries than to show how the repetition of such a disastrous credit and economic expansion as the most recent may be prevented in the future by a more rigid and more carefully thought-out credit control. They prove also, however, that this task is much more difficult than had previously been assumed—indeed, that the difficulty seems almost insurmountable.5 All problems relating to a trade-cycle policy based on credit control can be seen from two main points of view: from the point of view of the aim, and from the point of view of the means, of such a policy.

So far as concerns the aim, the question is one of determining the criterion to be followed in regulating the volume of credit. It was thought formerly that this question could be answered simply by the requirement that the control of credit should stabilize the general price level so that trade-cycle stabilization would be synonymous with price-level stabilization. This supposition must, however, be rejected on two grounds. The first is that the concept of the general price level is extremely vague and we cannot even speak of a very approximate determination of the average price level. Every index number is to a certain extent arbitrary: the selection of the commodities that are to be included, the choice of the weighting, the base from which the index starts, and, lastly, the mathematical processes applied, are all arbitrary, and it is consequently to be feared that the calculation of the index number, in face of the extreme importance which it would acquire for the carrying out of a stabilization policy, would become an object of a struggle between parties and pressure groups.6

The decisive factor is, however, that the stabilization of the price level is far from guaranteeing any stabilization of the cycle and may, indeed, in certain circumstances as was explained above (§ 15), only aggravate the evil. A stable economic system is not an economic system in which everything stands still but a system in which there is a continually moving equilibrium. Consequently the keeping constant of any single factor may lead to the most dangerous dislocations as was most recently the case in the United States. The criterion of the general price level thus fails completely. Better no credit control at all than one based on this treacherous and dangerous criterion! If the stabilization of the general price level through credit control—or by any other monetary means such as that of the “compensated dollar” proposed by Irving Fisher7—does in no way guarantee the prevention of an over-expansion of the economic system and therewith the maintenance of equilibrium which is sought, the same applies to similar criteria that have been proposed (the level of employment, the volume of production, the movement of commodity stocks, &c.).

Just recently the question of what is to be the aim of credit control, if it is to rid economic activity of the ups and downs of disturbances of equilibrium, has been considerably clarified. This has come mainly from the recognition that what we must aim at is not to stabilize the purchasing power of money by adjusting the volume of money and credit to changes in economic data, but that we must replace the ideal of stable money by the ideal of neutral money, that is, a money which exerts no influence on the structure of production and prices.8 It would have been equivalent to such a policy of neutral money if, recently in the United States, no attempt had been made to compensate the tendency to a fall in prices, coming from the side of production, by a policy of credit expansion. This would have prevented that credit expansion through which those responsible, in the belief that they were pursuing the ideal of stable money, let loose a gigantic boom and its consequent depression.

How to shape a monetary and credit policy which attains this objective of the neutrality of money is a question whose elucidation is at present only in its beginnings but which, following on the explosion of the price stabilization dogma brought by the world depression, forms one of the major tasks of present-day monetary theory. So much is, however, already clear that a neutral monetary policy must involve a much stricter preservation of the constancy of the amount of money than does a policy of stabilizing the value of money; we may even say that, contrary to all the traditional ideas of the necessity of an “elastic” monetary system, the keeping constant of the quantity of money must be the rule and the alteration of its quantity the exception. What are the exceptional cases which permit and even necessitate this alteration of the volume in the interests of the neutrality of money is a question which we cannot attempt to answer here. At all events, it is evident that the problem is an extremely difficult one, but perhaps some practical way out might be found by regulating the volume of credit in future in such a way as to stifle every tendency to a sudden and excessive increase of investment activity. The movement of investment activity will thus probably become the sole utilizable criterion of future credit policy if the latter is intended to be an effective tool of the stabilization of economic activity.

The current discussion on the concept of “neutral” money as contrasted with stable money unfortunately suffers from certain dogmatic and scholastic tendencies which are perhaps largely due to the attractive antithesis between those two terms. In reality, it is possible to exaggerate the contrasts between these two goals of monetary policy. For it can hardly be denied that most of the advocates of stable money also aim at a sort of neutral money. What they want is to get rid of inflations and deflations, i.e., of monetary disturbances of the economic process. So far there is no difference between the advocates of neutral money and those of stable money. Both want money to be neutral. Only the means they advocate in order to attain neutrality of money are different, because their conception of the neutrality of money is different. For this reason the antithesis of neutral money and stable money is rather confusing and not quite fair towards the stable-money school, but as it is now generally accepted no attempt has been made in the text above to replace it by another terminology. The great merit of the neutral-money school lies in the discovery that, under certain circumstances, a stable money may not be neutral, i.e., in the case when a general lowering of costs due to technical progress tends to lead to a lower price level without deflationary effects. As a practical issue, this may generally be rather an exceptional case, but it is actually a case which has been of the greatest importance in the immediate past. To stabilize the purchasing power of money under circumstances such as those in the United States from 1926 to 1929 is not to neutralize money but to make it a very disturbing factor. This is the one substantial result of the whole discussion, but beyond that everything is highly controversial. In other words, the neutral-money school is able to demonstrate in a special case, which is of the greatest importance in modern conditions, what neutral money is not, but as to what it really is this school has not arrived at any definite conclusion. The concept of neutral money is a very useful one because it circumscribes the ideal aim of any rational monetary policy and also because it may prevent the latter from falling into serious errors, but it would be shutting our eyes to the realities if we were to ignore that it does not as yet provide any definite rules upon which monetary policy could be based. In this the old stable-money policy was obviously superior, as it did at least provide a rule of thumb for practical purposes. There is no need, therefore, for the Neutral-Money School to look down superciliously on the Stable-Money School, the less so since there is a great danger that their exultation over the discovery of the phenomenon of a relative inflation (the American case of the last boom) may make them blind to the possibilities of monetary disturbances brought about by deflation. That is just what is happening at the moment. We should expect that the advocates of neutral money, in order to live up to their ideal, would vigorously demand a re-expansion of money and credit at the present moment of the most destructive deflation, but, inconsistently, not a few fail to do so.

Added to the difficulties of finding the correct objective of credit control, there are the equally serious difficulties of finding effective means for successfully carrying it out. To estimate these difficulties, we must first realize that the bulk of modern credit money is created by the private competitive banks. Linked up with this is the question by what means, and in what degree, can these banks be induced to follow a different credit policy than formerly. It is evident that nothing much is to be expected from mere exhortations to the private banks when we reflect that bank managers are motivated by the object of making the largest possible profits, so that any single bank can hardly proceed differently from the banking system as a whole. If the banking system as a whole adopts an expansive policy in the boom, any single bank which was to proceed in the opposite direction would be driven out of business. Each bank waits for the others to make a start, with the natural consequence that nobody makes the start while there is still time. Conversely, in the depression the same situation stops any single bank from undertaking a credit expansion so long as the whole banking system has not come out of the period of contraction. In face of this state of affairs there is no other alternative than to steer the banking system in the desired direction by a superior authority. This superior authority is the central note-issuing bank which regulates the quantity of cash (to-day mostly bank notes) in existence through its credit policy.

For this purpose it has three tools at its disposal. The most important is the raising or lowering of the discount rate (discount policy). Since the dampening down of cyclical fluctuations through credit control depends on a timely attack on the expansionist tendencies setting in at the beginning of the boom, the manipulation of the discount rate as an instrument of trade-cycle policy would mean that the central bank would have to raise the discount rate earlier and more vigorously at the beginning of the expansion of credit and investment than has hitherto been the case when discount policy served primarily to defend the reserves held against notes. This has been very pertinently expressed by Hawtrey in the oft-quoted sentence: “So long as credit is regulated with reference to reserve proportions, the trade cycle is bound to recur.” Now discount policy is, in spite of its far-reaching effects (especially on commerce and speculation), far from being an instrument of universal application suited to all situations. In fact the effectiveness of discount policy is rather limited and this applies to the case where a restriction of the amount of credit (restrictive discount policy through the raising of the rate of discount) is in question as well as to the case where a credit expansion (expansive discount policy through the lowering of the rate of discount) is desired.

A lack of complete effectiveness of discount policy in the first case may lead to the adoption of the very drastic means of credit restriction by which the central bank does not leave the determination of the amount of credit to the automatic functioning of the discount rate but fixes itself the maximum amount of credit it will give and distributes it according to a certain rule (credit rationing). The credit rationing necessarily bound up with the restriction of credit introduces a qualitative control of credit quite apart from the merely quantitative control which the central bank exercises through its discount policy. In this way the central bank regulates not only the total quantity of credit but interferes at the same time with the application of credits and so takes on a planning function, a function which it is quite unsuited to assume since it would mean its becoming the central organ of a quasi-socialistic economy. It is usually explained that the distribution of credit is made according to “the economic needs of the community,” a notion which is extremely popular at the present time, but to which we must object that it gives only a description and not a solution of the problem. For these reasons alone the method of credit rationing is to be rejected in principle and should, therefore, only be applied in emergencies because it introduces an inflexibility into the economic system which may have the most dangerous consequences and may make banks which are inwardly sound unable to meet their obligations. Nevertheless, credit rationing is the rip-cord which may yet save the situation even when the safety valve of the discount policy fails. A further method of credit control available to the central bank are the so-called “open market operations” which consist in the central bank’s regulating the amount of credit it supplies through the purchase and sale of various kinds of securities. By purchasing securities it increases the amount of central bank money and by selling securities it decreases the amount. Although this instrument of credit policy is not foreign to the European central banks either, it has in recent years been operated systematically and on an especially large scale in the United States by the Federal Reserve System.9 It is important in the present moment, when the question is not one of restricting but of expanding credit, because it indicates to the central bank a way of augmenting the measure of credit expansion that can be achieved by a mere lowering of the discount rate (a measure that has recently shown itself to be very small). It should be noted here that the question of what are the effective means by which an expansion of credit can be secured represents a special problem which we shall treat later when we deal with measures for getting out of the depression.

In addition to the credit policy of the central banks, there is one other instrument of credit control consisting in the policy of varying deposit reserve requirements. Such a policy would mean that the banks would be forced by law to hold a minimum reserve against their deposits and that this minimum would be varied in accordance with the credit policy pursued by the central bank. Raising the reserve requirement, for example, would be tantamount to the central bank’s raising the discount rate or selling securities. This instrument of credit control has not yet been tested by practical experience, but it seems hardly questionable that it promises to be fairly effective in regulating the volume of credit, even in cases where the discount rate does not work satisfactorily.10

It should be noted, however, that this instrument of credit control is essentially a repressive instrument for checking the boom, while it is of not much use as an expansive instrument for stimulating recovery. It is obvious that it could alleviate the depression only if it effected a lowering of a legal reserve minimum which had already existed before the depression; there is no sense in starting with this kind of credit policy during the depression. But even then it would hardly make the banks more disposed to increase their credits, and as for the problem of finding enough borrowers it offers no solution at all. Thus we are again brought face to face with the problem of how to bring about an expansion of credit if the necessary inclination towards new investment is lacking. It is the old problem that it is easier to prevent a horse from drinking than to make it drink. We may conclude, then, that the chief value of this instrument of credit control lies in its use as an instrument for checking a progressive credit expansion even when the less drastic measures, especially the discount policy, do not bring satisfactory results.11 Thus it might have been very useful during the recent American boom. As an interesting fact, it may be mentioned that in Germany this instrument of credit control has been recently added—by the Reich Credit Law of 5th December, 1934—to the instrumentarium of the Reichsbank, and in the United States also similar measures have been widely discussed.

The list of instruments for regulating the volume of credit is not yet exhausted. There remains the final possibility of a Compensatory Budget Policy, i.e., a policy of varying public revenue and public expenditure in such a way as to exert a regulating influence on the total volume of credit. But as this is a rather roundabout method of credit control and is usually considered from a different aspect, we shall leave its discussion to the next section.

§ 21. COMPENSATORY BUDGET POLICY AND OTHER MEASURES.

Among the measures which are proposed alongside credit control for the smoothing out of cyclical fluctuations there is one that deserves special attention. This is the proposal that the State should so conduct its taxation and spending policy as to secure an evening out between good and bad times. This proposal is usually given the narrow formulation that the State and the public bodies under its domination should as far as possible postpone their orders to private industry from the time of the boom to the time of the depression. This formulation is, however, too narrow to convey the full significance of the idea. The emphasis should be laid not so much on the time distribution of the orders as on the fact that the State pursues a restrictive financial policy in the boom and an expansive financial policy in the depression, that is, that in the boom it retrenches expenditure, keeps revenues high, and accumulates reserves, while in the depression it consumes these reserves and also resorts to borrowing.

Since the public sector has, as we have seen, swollen to such large proportions as compared with the private sector of the national economic system, it would seem not unwise, so long as we accept this change of proportion between the two sectors, to connect the public sector with the circuit of economic activity in such a way as to make the manipulation of the public sector instrumental in counterbalancing the movements of the private sector. This is, in short, the idea of a Compensatory Budget Policy.12 Such a policy has both a quantitative and a qualitative side. A quantitative Compensatory Budget Policy means that the State regulates the total of its expenditure and revenue in accordance with the phase of the business cycle so that during the boom phase expenditure is restricted and revenue expanded with accumulating reserves as the consequence, while during the depression just the opposite policy is pursued. This implies that the State also acts as part of the national credit structure in a sense contrary to the behaviour of the private sector, that is, reducing its indebtedness during the boom and augmenting it during the depression and thus continually shifting to and fro from a debtor to a creditor position. The ultimate effect of such a quantitative Compensatory Budget Policy would be a regulation of the volume of credit, and this indirect method of credit control would seem to be very promising, as it apparently combines comparative smoothness with a high degree of efficaciousness, though this is not to say that it is immune from serious objections. The qualitative Compensatory Budget Policy, on the other hand, is not concerned with the total of revenue and expenditure but with the qualitative composition of the total, i.e., with the variation in the different kinds of revenue and expenditure. By shifting the weight of taxation and of expenditure now in this and now in that direction the State can, of course, do a great deal to give encouragement or discouragement wherever it deems it desirable in order to regulate the flow of economic life. Preeminent in this respect is the regulation of those taxes which exert a specially strong influence on production and enterprise (business taxes, turnover taxes, stock exchange taxes, &c). The introduction or augmentation of these taxes during the boom appears to be a useful means of restraining hectic buoyancy, while their reduction or abolition can do much to stimulate production and enterprise during the depression.

The idea of the Compensatory Budget Policy offers, then, a new principle of public finance, which may be called the cyclical principle of public finance, and may be added to the time-honoured list of our text-books. It is obvious that with the enormous growth of the public sector of the economic system and in view of its close interconnexions with the private sector the State has assumed new responsibilities in its financial policy beyond those which are described by the old canons of Economy, Justice, Certainty and so forth. The present depression has witnessed, in the first experimental trials with the new principle in many countries, signs of the States having become awake to these new responsibilities. It remains to be seen, however, what will happen during the next boom when the State is supposed to show the less popular reverse side of the expansionist budget policy of the present moment.

On the whole, there is no denying that the idea of the Compensatory Budget Policy merits favourable consideration. But, on the other hand, it will be wise to refrain from too dithyrambic enthusiasm. The present writer cannot help but feel rather uneasy at the idea of enlarging the responsibilities of the State to such an extent as to entrust it with the regulation of the business cycle by a means which raises not only general problems of State administration but also special political, social, and economic problems of budgetary policy where the State and the political institutions connected with it usually appear at their worst. This idea of a glorified budget policy is, of course, infinitely superior to the idea of economic planning proper since it would not meddle with the inner functioning of the free market, but even then it raises grave difficulties. Is the wisdom of the State so much superior to that of the private sector that it will make no mistake in diagnosing the different phases of the cycle and in deciding when to restrict and when to expand? If even central banks are known to be not infallible, will not those persons, parties, pressure groups, and institutions that are responsible for the budget policy, fall even much below the rather modest standard of the central banks?

Another grave danger already hinted at is that this principle is very apt to work one way only. It is, indeed, extremely likely that those responsible for the budget will eagerly relish the pleasures of expansion during the depression but be rather reluctant to undergo the mortifications of restriction during the boom. This danger might be diminished by the restraining influence of the debts incurred in the preceding depression, but grave doubts still remain. In view of these and other possible objections, it seems to be advisable not to dogmatize. In general, no efforts should be spared in order to reduce the present overgrown size of the public sector to reasonable proportions so as to render our economic system, from this side also, less top-heavy than it is to-day. For the rest, of course, the idea of the Compensatory Budget Policy should not be ignored but should be rather considered as one useful principle among others, without making it the dominant principle of trade-cycle policy. A special case is presented by the present depression where in some respects an expansionist budget policy would seem to be one of the most useful instruments for overcoming the deadlock.

If it is a sound proposal to manage the budget (including the budget of the public insurance schemes, especially unemployment insurance) in such a way that there is an accumulation of reserves, the question arises what to do with these reserves.13 The point is that they must be sterilized somehow if a checking (deflationary) effect is to be attained. Otherwise there is great danger that this sort of budget policy might make things even worse by adding to the monetary forced saving, which is the concomitant of the boom, the additional investment facilities of authoritarian forced savings. This would surely happen if the reserves were to flow into the capital or money markets so as to lower the rate of interest there and widen the possibilities of over-investment. The simplest way of avoiding this would be to keep the reserves in cash hoards. But there is a definite limit to the extent in which this method would be practicable. A slightly less efficient but more practicable method would be to hold the reserve funds as demand deposits and to leave them untouched until the advanced depression. This would be conducive to blocking up the banking system during the boom while the mobilization of such deposits would have an expansive influence during the depression. After what has been said earlier in this book (p. 123n.) on the functioning of the banking system, these conclusions will be readily understood. Leaving demand deposit accounts idle amounts to hoarding credit money, and making them active amounts to dishoarding credit money. If the public sector is to be made a compensating part of the credit cycle, working for restriction during the boom and for expansion during the depression, the thing to do. is to make the State an inactive “creditor” on a large scale during the boom and an active “debtor” on a large scale during the depression.

One of the fatal characteristics of the last boom was that in many countries the governments did just the opposite of what would be expected from a rational budget policy of the kind indicated above. Most conspicuous in this respect were the errors made in Germany up to the time of the present depression. It was precisely during the preceding period of economic expansion that the German budget was continuously being expanded by increased expenditure, alleviation of taxes, enlargement of public indebtedness, and the using up of reserves accumulated after the stabilization of the mark. On top of this, a large programme of public works was executed during the very same period of economic expansion. The worst part of it was the public building programme consequent on the rent-restriction policy under which the building market had largely been taken over from the private sector by the public sector of the economic system. The result was that, whereas before the war building activity had usually reached its peak in the later stages of the depression and had thus exerted a mitigating influence, it now reached its peak during the boom, so that the general economic expansion was enhanced and little was left over for the subsequent depression. This has been an experience which shows the danger of enlarging the public sector and diminishes our faith in the compensatory capacity of the State. A similar error was made in Germany (and elsewhere) with regard to unemployment insurance, very little being done to build up reserve funds for the subsequent depression. The continuous increases of insurance contributions which then became necessary during the depression were, of course, an extremely unwelcome addition to the forces making for depression. As an interesting incident it may be recalled that it was the parliamentary struggle over a trifling increase of the pay-roll contribution which overthrew the last parliamentary government in Germany in the spring of 1930. Taking all in all, we may say that, if we want to know how public finances should not be administered from the point of view of the trade cycle, we must turn to the budgetary policy of Germany during the last decade. On the other hand, however, we can plead for extenuating circumstances in the case of Germany, since the economic conditions in that country were so peculiar at the time that it was extremely difficult to pursue a policy that was anything like rational.

Turning now to other measures of business-cycle policy, we may say at once that the success of direct interferences with the structure of production, costs and prices aimed at the mitigation of the trade cycle is extremely dubious. What are the real facts of the case should have been amply proved by the circumstance that the most severe of all depressions has descended upon us just in a moment when capitalism has been disfigured by an excess of interferences of all kinds (protective duties, price stabilizations, subsidies, wage regulations, restrictions on immigration and emigration, restrictions on the movement of capital, &c.) until it is practically unrecognizable, and the power and number of monopolistic formations have reached a hitherto unknown peak. It is all so palpable that we should speak not of a “crisis of capitalism” but a “crisis of interventionism.” Any attempt to smooth out cyclical waves by measures of this kind can only effect the opposite of what is intended and increase the confusion.

Until not very long ago it was the fashion in many quarters to look upon the spread of large monopoly organizations (cartels, trusts, concerns, trade associations, &c.) as one rather promising instrument for smoothing out the trade cycle. Were not the excesses of competition largely responsible for the wild fluctuations of economic activity, and was not “orderly marketing,” “organized business,” and “elimination of wasteful competition” the way to domesticate capitalism into a manageable and well-harnessed animal? This was surely the way in which the more lyrical economists saw it, but it must be emphatically said that the hopes set upon the stabilizing influence of monopolistic organizations have proved rather ill-founded in the light both of reasoning and of experience.14 For it is obvious that holding certain prices rigid is not identical with economic stabilization but more likely to be detrimental to it, since, to take the case of the depression, the downward movement of the uncontrolled prices is thereby accentuated, and since stability of prices in certain industries means instability of production and employment. It is almost a common-place to-day that the growing lack of elasticity of our economic system has made the trade cycle not more, but decidedly less, controllable, but it is almost equally a truism that this development is largely due to the spread of monopolistic organizations on all sides.

A further point familiar from earlier discussion in this book is the fact that monopoly profits are very liable to lead to faulty investments since they are likely to be invested in the corporation’s own plant, even if the profit accruing therefrom is lower than the interest which would be gained by investing them on the capital market.15 Thus it is just the spread of monopolies which has made a not inconsiderable addition to the forces making for over-investment and, consequently, disequilibrium. Though it would be an exaggeration to hold monopolies responsible for the present crisis, our appraisal of the possible contribution of industrial combinations to the problem of stabilization must end in the conclusion that, in contrast to popular views which still tenaciously linger on and embody themselves in the present world-wide passion for organization and regimentation of industry, the growth of monopoly organizations is apt to intensify the boom and to delay the recovery. It means faulty investment of capital on a huge scale, and it means lack of elasticity of the whole structure of prices and costs. For this, perhaps, no better example could be found than the case of Germany where, as is well known, monopolistic development has always been especially strong, aided to a large extent by German tariff policy16 and by the German talent for administration and organization.17 Careful and impartial investigations have shown that in the period prior to the present depression the tendency of over-investment was most conspicuous in the great monopoly industries, especially in the iron and steel industry, which has, mostly by self-financing, built up a plant with a productive capacity far in excess of any reasonable estimates of potential demand. The cement industry also has been a much-discussed example of over-expansion. Later on in the depression, it was really a disaster that the German monopolies in the most essential raw materials and half-finished products did not adapt their price policy sufficiently to the changed circumstances, so that there arose a wide disparity of movement between the free (competitive) and the fixed (monopolistic) prices which has been so detrimental to the elasticity and adaptability of the economic process during the depression. Let us repeat then that Monopoly Capitalism or State Capitalism is not more stable that Competitive Capitalism but decidedly less so. Therefore, it would seem that it should be an important part of any rational programme of trade-cycle policy to break up the monopolistic and interventionist rigidity of our economic system instead of enhancing it.

This also involves the total rejection of the idea that protectionism might be a suitable method of economic stabilization. It is really impossible to imagine how tariffs could be conducive to combating the real cause of booms and depressions, i.e., over-investment financed by credit expansion. The existence of a tariff is a datum for the economic system of a country which will be assimilated after a while in a manner likely to reduce the wealth of the country concerned, but how it is to have a greater influence on the real causes of the trade cycle than other economic data remains a secret of the tariff-enthusiasts. On the contrary, it is to be feared that, by reducing the mitigating influence of international economic relations, it might enhance the severity of national disturbances of economic equilibrium. Another question is that of the influence of the introduction of new tariffs or the increase of old tariffs. These belong to the long list of random factors which might influence the real causes of the trade cycle in a direction incapable of being predicted in advance. Therefore, it is not a limine impossible that the introduction of new tariffs or the increase of old might be some help in overcoming the depression (see § 26).

It will not be out of place here to apply the foregoing conclusions to that type of economic system which, under the name of Corporativism or its terminological equivalents, is held in many quarters to-day to be the superior form of economic organization which promises to bring stability, justice, smoothness, intelligent co-operation, and, in short, all-round happiness.18 The curious thing about Corporativism is that, in spite of the verbose literature on this subject, nobody seems to be able to tell us exactly what it really means—a fact which is closely related to a further fact, i.e., that the subject of Corporativism plays a prominent role in countries where the totalitarian character of the State (Fascism) makes any real discussion wellnigh impossible. Indeed, the confusion on this subject is amazing, and it is still more amazing to find that very few seem to notice it. To any sober mind, however, it should be clear that Corporativism may mean one of two mutually exclusive things.

In the one case it means genuine economic self-government executed by the different branches of industries organized in great corporations after the pattern of the mediaeval corporations and guilds. In this case it is an extremely dangerous thing breaking up the national economy into a positive anarchy of uncontrolled pressure groups, and also a thing which, as a general principle of organization seems rather impracticable under modern conditions. Corporativism, in this sense, was tried in Germany immediately after the war as a sort of socialistic makeshift, but among those who know something of the experiences with the autonomous economic bodies created at that time there can be no possible divergence of opinion as to the utter and deterrent failure of this system. It was a hot-bed of corruption and of arbitrariness on an unprecedented scale. If capitalism is economic anarchy without chaos, then this system of genuine Corporativism is economic anarchy with chaos at its worst, and as such it is, of course, absolutely useless as an instrument of economic stabilization.

In the second case the State imposes its authority on this idyllic economic self-government, and then Corporativism is not genuine but is just another word for a heavily monopolistic-interventionist society adorned by collectivist phraseology. So far as the economic side is concerned, the innovation is purely terminological in character, a statement which, nevertheless, is not meant to imply that this terminological economic policy may not be very useful from a propagandist and political point of view. It is obvious that it is this meaning which Corporativism has in totalitarian countries to-day, since it would be preposterous to assume that the Fascist State would be willing to yield a single atom of its Absolutism to really autonomous corporations. The Italian Government certainly did nothing of the kind in creating the Corporazioni. As a careful study of the legal foundations of the Corporazioni shows, every care has been taken to bring all possible activities of the corporations under the strictest control of the State. It is evident, then, that in the case of a Fascist country it is quite inappropriate to speak of a Corporative State, since it is not the State that is “Corporativo” but the Corporation that is “Statale.” Consequently, the whole thing amounts, to all intents and purposes, to a wholesale cartellization of the national economy aided by all kinds of government intervention and subjected to strict supervision by the State. In accordance with what has been said above on Monopolism and Interventionism with reference to economic stabilization, it seems clearly impossible to look upon Corporativism as a useful instrument of stabilization. In fact, the economic situation to-day in countries which have adopted either Corporativism or some other form of glorified cartellization is much worse than that of many other countries without it. In so far as the N.R.A. Codes in the United States also involved universal cartellization, enforced and directed by the State, it seems safe to say that they have contributed to confusion rather than to recovery and stabilization.19

As for the ultimate possibility of economic stabilization by the aid of a Planned or Socialistic Economy, enough has been said on this subject on an earlier occasion20 to make clear the uncompromising attitude of the present writer.

§ 22. TRADE-CYCLE POLICY AND THE GOLD STANDARD.

Up to this point no attention has been given to the question of whether a trade-cycle policy on the lines depicted in the preceding paragraphs can be conducted on a purely national scale or whether it will encounter international complications which are apt to limit the possibilities of a national policy. It is this international aspect of trade-cycle policy which will be considered in this section.

It must be said at the outset that there do exist international complications which need very careful examination. The central question to be asked in this connexion is how far a trade-cycle policy conducted on a national basis is compatible with the Gold Standard and a policy of stable exchange rates. In answer to this question, the dominant school of thought, which owes most of its influence to the writings of Mr. Keynes, holds the view that we have to face a clear alternative between, on the one hand, a policy of internal economic stability and, on the other, a policy of stable exchange rates or, practically speaking, the Gold Standard, save for the case that the policy of internal economic stability coincides exactly with a corresponding trend abroad. If, the argument runs, the world as a whole is marked by boom conditions, with prices rising and the volume of money and credit expanding, the individual country in question must follow suit in order to observe the rules of the Gold Standard and to offset the heavy inflow of gold. On the other hand, if the world is passing through the depression phase with prices declining and the volume of money and credit contracting, the individual country cannot refrain from following the same course if it wants to maintain the Gold Standard and the stability of the exchange rates. In both cases it is assumed that the country is compelled by the rules of the Gold Standard to adopt a monetary policy different from that which it would like to adopt in order to smooth out the trade cycle. This doctrine has perhaps done more than anything else to spread the present distrust of the Gold Standard since, faced with the alternative, people have become more and more convinced that internal stability is, on balance, preferable to external stability.

As a matter of fact, there are to-day not a few theorists and politicians who seem to believe that the future will belong to that type of monetary system in which the goal of stable exchange rates will, in principle, be subordinated to the goal of stable prices and, consequently—though the inference is doubtful—of stable economic conditions at home. They believe, therefore, that the Gold Standard is dead as a door nail and that it will be permanently replaced by a frankly national monetary policy, in spite of the occasional lip-service they pay to the ideal of the Gold Standard and its theoretical virtues. Thus a sort of monetary autarky would be the model of the future as a corollary to the commercial autarky, and all this in the sacred name of Stabilization. Parallel with this goes the work of economists who tell us that the virtues of stable exchange rates are much overrated, and that the world does not sacrifice much in letting them fluctuate as they will. This whole trend of thought which is, in the opinion of the present writer, very dangerous, has, of course, been tremendously strengthened by the experiences of the present depression when it seems, to most people, strikingly obvious that no country can escape the alternative choice either of leaving the Gold Standard or of letting the depression take its sombre course. In face of this development, it seems highly necessary to scrutinize very closely the Doctrine of Alternative Stability which underlies this attitude.

In the attempt to define our own attitude, we shall begin by separating out that part of the ground which is uncontroversial. All parties agree that the alternative choice in question does not exist if the national credit policy runs parallel to the international trend of credit policy. If it is in the interest of national economic stability to expand credit, no collision with the Gold Standard is to be feared as long as this policy is in harmony with the international course of the trade cycle, and vice versa. So far, the awkward alternative does not exist, and the question arises as to whether it might not be possible to ensure a greater degree of international conformity by the much-heralded co-operation of central banks or by some international monetary scheme.21 We shall not enter here into this very intricate question, but shall rather direct attention to another point which seems to be somewhat neglected in the current discussion of this problem. We must not lose sight of the fact that the international course of the trade cycle—the world “conjuncture”—is not something hovering above the earth and falling down from the sky on all countries at the same time. What actually happens is that it begins somewhere and is subsequently transmitted to the rest of the world, and it is the mechanism of the Gold Standard by which it is primarily transmitted. Suppose that in one country a boom begins to develop, then, through the effect of an adverse influence on the balance of payments, gold will be drained away to other countries where, in accordance with the working of the Gold Standard, the increase of the gold reserves will give rise to credit expansion and thus create a boom there too. We have then two phases, in the first of which the outflow of gold accompanies a strain on the balance of payments and on the exchange rates so that the cyclical situation comes into conflict with the exchange situation, whereas, in the second phase, the effects of this process in the other countries tend to ease the tension so that the conflict automatically creates the forces which lead to its own eventual elimination. Stated thus, it is, of course, really too good to be true. We hasten to add, therefore, that several conditions must be fulfilled if this automatic self-adjustment is to work. If this were not so, we should obtain the absurd result that the course of the world “conjuncture” could be changed at any moment by any country.

But that the automatic self-adjustment really works under certain circumstances is proved by the experience that a turn of the cycle always starts in a particular country or in a particular group of countries though it may be transmitted rather quickly to other countries. If we want to ascertain the circumstances under which this process of automatic adjustment comes into action, we are led to a special problem of particular interest. For our present purpose it may be sufficient to remark that the effecting of the “ignition” depends not only on a certain minimum size of the country starting the movement and of its gold reserves, but also on a certain susceptibility on the part of the other countries where the non-monetary conditions of a cyclical turn must be already to some extent fulfilled. An example which, unfortunately, has assumed great importance at the present time may elucidate the meaning of this statement.

Suppose that in the spring of 1933 a spontaneous recovery had set in in the United States, it is hard to believe that this would have put the American Government before the alternative either strangling the recovery or of going off the Gold Standard. On the contrary, there is no doubt that in this case the aforementioned mechanism would have come into action: at first we should have got a certain pressure on the dollar exchange and, consequently, a certain outflow of gold, but by transmitting the cyclical impulse to the rest of the world the outflow of gold would have stopped itself automatically after a while. This would have had the further consequence that the American recovery would have obtained strong support from the course of events abroad, not to mention the heaven-sent opportunity of the World Economic Conference in London where the American Government could have made a strong and effective appeal to the other countries to further the expansive tendencies on the basis of the Gold Standard. There is not the slightest doubt that in this case we should have to search in vain for any alternative between the Gold Standard and an active trade-cycle policy. Exactly the opposite is true, since leaving the Gold Standard would have been positively detrimental to the process of economic recovery. The mechanism of the international transmission of the cyclical impulse being destroyed, the American recovery would have been left without the necessary support from the international economic recovery. Allowance must be made, of course, for the possibility that the economic expansion in the United States might have reached dimensions incongruous with the size of even the American gold reserves so that from this point onwards the Gold Standard and the national economic expansion would have become incompatible with each other. The situation in the United States at that time was, however, quite unique as the enormous gold reserves made possible a degree of economic expansion which would probably have been sufficient for the “ignition” not only in the United States but for the rest of the world as well. At all events, there was no harm in trying it. By taking the precaution of going off gold, the American Government would have resembled a man who, intending to go on a sailing-cruise, starts by plunging into the water in order to anticipite the risk of getting wet in the very remote case that the yacht might capsize.

In assuming that the economic recovery in the United States would have come spontaneously in the spring of 1933, we have so far spoken of a hypothetical case. This assumption was made in order to facilitate the understanding of the process and to bring home the fact that we are not dealing with extravagant guesses but with self-evident truths. The essential point, however, is that it makes absolutely no difference for the matter under discussion if the recovery did not come spontaneously but came as the result of deliberate policy. Everything we said, therefore, applies without any alteration to the actual case of the American policy since the beginning of the Roosevelt administration, and there is hardly any need to add that by doing the unnecessary and harmful thing of abandoning the Gold Standard, this policy has become the outstanding example of the fatal consequences of the Doctrine of Alternative Stability. The abandonment of the gold dollar by the Roosevelt administration must, indeed, be viewed as one of the most disastrous acts on record of any government and any country in recent times, disastrous both for the country itself and for the rest of the world.

Important as this reasoning is in certain cases, it can only narrow the scope of the problem of alternative stability but not do away with it altogether. If the forces of self-correction explained above do not work adequately, we are really faced with the question of whether all that a country has to do, in order to protect its economic stability against the troubling influences caused by a change in the data of external equilibrium, is to make up its mind to let go the exchanges. We come here to the heart of the argument of the Doctrine of Alternative Stability. Oddly enough, it has not yet received as much critical attention as it deserves. It should be clear, however, that the burden of proof is with the adversaries of the Gold Standard since prima facie there seems to be no reason why it should be possible for a country connected up with the world economy to insulate itself against outside disturbances by mere manipulation of the exchanges. In other words, it is difficult to see how mere manipulation of the exchanges could make the course followed by the trade cycle within the country the same as if there were no changes at all in the data of external equilibrium. Without exchange manipulation, these changes would have necessitated an immediate readjustment of the internal economic structure (changes in the direction of production and changes of the prices of the factors of production).

Now there is no doubt that such a process of readjustment may be very painful and detrimental to economic stability, in extreme cases becoming even an unbearable strain on the economic and social structure of the country. There is equally no doubt that the immediate necessity of the process might be averted by a manipulation of the exchanges. Nevertheless, it would be wrong to suppose that there are no counterbalancing items or that the chain of reactions will stop at this point. On the contrary, it is obvious that in this case also the economic process within the country will not behave in the same way as if there were no change in the data of external equilibrium. In this case also further consequences and repercussions will ensue, and the next task must be to analyse their effects on internal economic stability.

An analysis of this kind would have to start from the statement that, by leaving the exchanges free, the immediate pressure emanating from the change of the international data would be diverted from the producers and diffused by a rather intricate process over the national economy as a whole. The cyclical effect of this roundabout process of diffusion cannot be expressed in any general formula though there are good grounds for the surmise that in the short run the effect will be on the side of equilibrium rather than of disequilibrium. But as regards this point, we must again be on our guard against the all too common danger of thinking too much in mechanical terms instead of giving due weight to the decisive psychological factor. The ultimate effect of a policy of exchange instability will depend on the psychological reactions of those groups which really make up the economic process, i.e., the entrepreneurs, the consumers, the savers, and the investors. It is extremely likely, however, that on the whole the psychological reaction to a deliberate lowering of the exchange rates will engender an unsteady trend of business. In this respect—and in many others—a policy of bringing the exchange rate down to a new level of stability with one stroke will do decidedly less harm than a policy of continuous and erratic exchange fluctuations. It is more than probable that it is here that the main reason for the many disappointments of the New Deal is to be found. The prejudicial effect of unstable exchanges on the psychological disposition of the dominant groups is, without doubt, capable of being compensated by a large monetary expansion, but it is quite possible that this compensating dose may have to be made so strong as to cause the exchanges to fall further, thereby starting a vicious circle which might perfectly well end in a fully-fledged inflation of the pernicious kind. This danger becomes the more real because the international disturbances made inevitable by this development are apt to bring forth new conditions of instability and, finally, because the disappointment in the first results of this kind of trade-cycle policy is likely to lead to desperate experiments in economic planning which, adding to the confusion, augment the need for inflationary compensation. All this is again illustrated by the American example. In other words, an active policy of recovery, if combined with a policy of unstable exchange rates, may possibly only become effective after dangerous overdoses of monetary expansion which are tantamount to real inflation with a host of new disturbances following suit. It may be so, but, of course, it need not be so as the English example amply proves. Even in the case of England, however, it will be wise to postpone the final verdict and to wait and see what will be the ultimate effects of the disastrous chain of international disruptions which started in 1931.

Though we have not arrived as yet at any definite conclusions the foregoing analysis will have at least made it clear that the alternative between stable exchanges and internal economic stability is far from being exclusive and unequivocal. The “conjuncture” of a country connected up with the world economy is likewise connected up with the “conjuncture” of the world economy, and no monetary manipulation, much as it may mitigate and even neutralize for a while the immediate consequences, can do away with it.

There is one further point in the Doctrine of Alternative Stability which deserves critical examination.

The essence of this doctrine is the supposed conflict between exchange stability and internal business stability in the qualified sense made clear earlier in this section. When we come to ask the reasons for this conflict, we shall be told that it is the behaviour of the internal price level, consequent on the given cyclical phase, which endangers the exchange stability. If it is intended, for example, to bring about a recovery by credit expansion—the actual case to-day—the recovery will, according to the doctrine in question, be identical with a rise of the general price level which, in turn, is supposed to be identical with a certain pressure on the exchanges. Formulated thus, the intricate problems involved in the doctrine become clear at once, for it is a twofold identity which it supposes; the identity of a cyclical upswing with a rising price level and the identity of a rising price level with sagging exchange rates (for the national money), and of these two suppositions the one is just as problematical as the other. The point which is common to both cases is that the correlation which undoubtedly does exist, is allowed to cover up the existence of a fairly wide margin within which the process of recovery is able to move without raising the price level, and also the price level without raising the foreign exchanges. The whole mechanism works with a good deal of “play,” and so far as this is the case no incompatibility exists between the Gold Standard (stable exchanges) and an active policy of recovery. It is easy to imagine cases where the margin is large enough to allow a dose of credit expansion sufficient to give a complete turn to the trade cycle, a case demonstrated above by the recent American example.

Tackling first the problem of the supposed identity of the upswing with a rise of the price level, a reference to earlier passages of this book will convince the reader that this popular idea is, in this peremptory form, quite untenable. It is again the ghost of the “price-level complex” that is crossing our road, and we may exorcize it once more by stating that the trade cycle is not primarily a price-level phenomenon, since the economic process adjusts itself to the ups and downs of the trade cycle not only by price alterations but also by quantity alterations. Moreover, it is possible to favour by deliberate policy the adjustment made by quantity alterations (“Mengenkonjunktur” in the German terminology) and to repress the adjustment made by price alterations (“Preiskonjunktur”). This applies especially to the case of the secondary depression which was treated at length in § 16 of this book, to which the reader must again be referred. A marked rise of the general price level consequent on an inflationary credit expansion is the necessary pre-requisite of the boom ending in the subsequent crisis, but no rise of that kind is necessary in order to put an end to the depression by reabsorbing the idle reserves of productive capacity and man power. The contrary view rests on a confusion of the compensatory credit expansion necessary for overcoming the depression with the inflationary credit expansion responsible for the later boom. As the example of the New Deal shows, any attempt at overcoming the depression by spasmodic efforts at raising the price level is only apt to give a misleading and dangerous turn to trade-cycle policy. In so far as the Gold Standard hinders these attempts so that there does arise a real alternative between this kind of trade-cycle policy and the Gold Standard, it means that it places difficulties in the way of an ill-advised sort of trade-cycle policy, which is hardly a reason for regret. We may conclude, then, with special reference to the present situation, that a clear alternative does not exist between the Gold Standard and a compensatory credit expansion, but only between the Gold Standard and an inflationary credit expansion. In other words, the Gold Standard is an unequivocal hindrance to a trade-cycle policy which, by driving the boom to the boiling point by inflationary credit expansion, is itself liable seriously to endanger economic stability, whereas there probably exists a rather wide margin in which a compensatory credit expansion compatible with the maintenance of the Gold Standard can take place.

Turning now to the second assertion that a rise in the price level will exert a certain pressure on the exchanges, it will be clear to anybody familiar with the theory of international trade that this argument of the Doctrine of Alternative Stability bluntly assumes the familiar purchasing-power parity theory of foreign exchanges.22 Consequently, the Doctrine of Alternative Stability, or what is left of it after the foregoing analysis, holds good only so far as the purchasing-power-parity theory is valid. Even the more orthodox adherents of this theory, however, will admit to-day that it is only valid subject to a greater or smaller coefficient of deviation which interrupts the strict causal relation between the movement of the internal price level and the exchanges and creates a rather wide margin of indeterminacy. If, for example, the upswing actually leads to a rise of the price level, it is possible that the pressure on the exchanges to be expected from it may be either compensated or accentuated through a change in the coefficient of deviation, and it would have to be carefully examined whether the upswing itself may not influence the coefficient in the one or in the other direction. It is probable that such an influence does exist. Its exact nature, however, will surely vary with the economic structure of the country concerned. If we take the case of the highly industrialized countries which are dependent on large imports of raw materials, it is to be assumed that the upswing will change the coefficient against the country for a while since the increase in industrial activity will raise the imports of raw materials without an immediate compensation through a corresponding rise of the exports of finished goods. A particularly good example of this lag between the movement of imports and exports in the first stage of the upswing is the case of Germany. It means that in this case the upswing presents, whatever the circumstances, a short-run exchange problem which is usually solved by gold losses or by short-term foreign credits. In this case also the abandonment of the Gold Standard is a rather dubious device. But it must be admitted that there are a number of difficult problems waiting for a closer examination.

Let us now try to summarize the results of our analysis. We found that the Doctrine of Alternative Stability turns out on closer inspection to be rather vague and, stated in peremptory form, absolutely incorrect. It is not true that we always have a clear choice between internal economic stability and exchange stability. In all cases there is a certain margin which has to be examined very carefully before we can give any definite verdict. It would not even be an overstatement to say that in most cases a stable exchange policy is not only compatible, but actually complementary with a policy of internal economic stability. One of the many inferences from this statement is that the case for the Gold Standard is much stronger than commonly presented. Most advocates of the Gold Standard seem to accept the Doctrine of Alternative Stability and to defend the Gold Standard only by pointing to the other great advantages which can be set against the alleged disadvantage implied by the said doctrine. In my opinion, the Gold Standard would, in most cases, be worth even this price, but the point of our analysis is just that we actually get a heavy discount on this price. In my conviction, this discount is, on the average, so large as to make the case of the Gold Standard absolutely irrefutable. In other words, there is a margin of compatibility, though this will not usually be so wide as to make the Gold Standard compatible with any and every sort of business-cycle policy, the case most likely to bring the Gold Standard into conflict with the trade-cycle policy being that of a deliberate boom policy. As for this latter case, it will be conceded by everyone that this sort of incompatibility is entirely in line with a rational trade-cycle policy, since to hold the boom in check is directly in the interest of economic stabilization. It would be much more sensible to blame the Gold Standard for exerting its checking influence on the boom insufficiently or too late, and this is, indeed, one of the most serious cases of any conceivable incompatibility between the Gold Standard and a rational trade-cycle policy. What is a country to do if, in time of an international boom, it wants to check the boom within its territory and still cling to the Gold Standard? This really seems to be a dilemma incapable of solution, since a country which checks its own boom in the face of an international boom will find its gold reserves rising and will thus be forced either to expand credit again or to “sterilize” gold, which is equivalent to an infringement of the rules of the Gold Standard. Though in reality the dilemma will rarely be as clear-cut as this, it has to be admitted that it raises another problem of grave importance.

Much has been made in this connexion of the American experience during the last boom. It is said that the Gold Standard would actually have compelled the United States to expand credit to still greater dimensions than they actually did if they had not deliberately sterilized a part of the heavy inflows of gold during this period. The insinuation is that a more orthodox adherence to the Gold Standard would have engendered a still greater inflation and, consequently, a still worse collapse. This blow to the Gold Standard, however, is not as deadly as it seems since the situation was vastly more complicated than this view implies. Firstly, it is not true that the recent American boom was accompanied throughout by rising gold reserves. On the contrary, from the spring of 1927 until late in 1928 the American gold reserves were actually declining. Secondly, the working of the Gold Standard was heavily obstructed by the American tariff policy together with Reparations and Inter-allied Debts. Thirdly, what inflow of gold into the United States there was, was closely connected with the fact that Great Britain, at that period, did not observe the rules of the Gold Standard by a policy of contraction which should have been expected under the circumstances then prevailing. “So long as Great Britain, the centre tending to lose gold, was not contracting, the other centres were under no obligation, according to ‘the rules of the Gold Standard game,’ to expand” (Robbins).

§ 23. SUMMARY.

What is the precise result of our investigation into the possibilities of a rational trade-cycle policy aimed at mitigating the cycle as a whole? The answer is neither unduly optimistic nor patently discouraging. Since over-investment financed by credit expansion is at the bottom of the cyclical disturbances of economic equilibrium, it should certainly not be an impossible task to hold credit expansion within reasonable bounds in spite of the manifold difficulties discussed in the preceding paragraphs. To bring this about, the various methods of credit control and the Compensatory Budget Policy seem to be useful instruments though neither can be applied according to cut-and-dried rules. Much experimentation will still be needed in order to find out that technique of trade-cycle policy which will be the most smoothly working and, at the same time, the most efficacious one. So far as the present stage of experience and discussion allows provisional judgments, it seems that the policy of varying deposit-reserve requirements and the Compensatory Budget Policy are to be considered as valuable and promising additions to the technique of trade-cycle policy.

Of at least equal importance is the problem of the criterion according to which the instruments of control are to be applied. The reader cannot have escaped the impression that the problem of criteria involves the gravest difficulties, as is evident in the current discussion on neutral money versus stable money and on the interpretation to be given to these ambiguous terms. These difficulties can be solved best by remembering that it is the phenomenon of over-investment which is at the root of the trouble so that investment statistics will provide the best guide for the policy of control. Whenever the volume of investment climbs suddenly to the heights experienced in the United States during the last boom, it is high time to apply the brakes no matter what is happening to the price level. This seems to be the only practical solution of the problem of criteria available at the present stage of the discussion.

But the difficulties do not end here, and two other problems have to be considered, the one being the problem of the workability of a rational trade-cycle policy under the limitations of the Gold Standard, and the other the problem of the prospects of a rational trade-cycle policy from a political or practical point of view. As for the first problem, the analysis of the last section showed that though it cannot be entirely brushed aside it seems less real than is commonly supposed. Since the experiences of the last years have proved that a stable world monetary system is an indispensable prerequisite for the working of our economic order, it is reassuring to know that the monetary standard which achieves this most important end does not exclude a fairly reasonable degree of rational trade-cycle policy. An irreducible remainder is, however, left, in accordance with the sad philosophy that we cannot have everything, that every asset is balanced by a liability, and that not all sufferings on earth are capable of being cured.

As regards the second problem of the prospects of a rational trade-cycle policy from a political or practical point of view, something has already been said on it in connexion with the Compensatory Budget Policy. Let us repeat, then, that to know that a boom must be stopped in time in order to avoid disaster is one thing, but to get it done by those responsible for the trade-cycle policy is quite another. Rational trade-cycle policy is certainly not planned economy, or it ceases to be rational. It means steering the course of the entire economic process without infringing upon the working of the mechanism of the free market, but it has that in common with economic planning that we entrust the government or its equivalent with enormous power of economic control without any real guarantee for the wise use of this power. Quis custodiet custodem? Who plans the planners? And do all the enthusiasts of trade-cycle control clearly realize that it would make the course of the entire economic process a political issue with all the grave implications of this word? The old economic system of the Victorian age, which is now such an easy target for mockery, had at least that one great virtue that it was practically foolproof. Its very laissez-faire character, which now causes people to recoil from it in horror, had the great advantage that it was not at the mercy of wise or foolish governments or constituencies, and there can be no doubt that the latter is much worse than being at the mercy of the whims of a competitive market economy.

Though we cannot go back to this old economic system, it is well to remember its virtues in this respect so that we may see the difficulties of the present economic system in a more realistic and less romantic light, and may also draw the logical conclusion that it would be wise to restore, as far as possible, the resilience of our economic system and its faculty of automatic self-adjustment, and to restrict the field of deliberate control to the utmost minimum. This is one of the main reasons why the complete restoration of the Gold Standard with all its prerequisites is absolutely essential. In order to see this clearly, we have to recall that one of the greatest practical difficulties of a rational trade-cycle policy lies in the fact that it will be a rather arduous task to put through a restrictive policy during the boom when everything is going at its best and everybody is talking about a “new era” of permanent prosperity. Mild inflations are always vastly more popular than even mild deflations, especially with those who are pulling the strings of government. Therefore, the automatic safety brake provided by the Gold Standard has to be considered as an indispensable part of our economic machinery if we want to be safe against real disaster. We do not even trust the locomotive engineer enough to forgo automatic safety appliances, in spite of the fact that there are no personal economic interests of his at stake, and that his own personal safety depends on his sense of responsibility. How much less can we do without automatic safety appliances in the case of governments whose affairs are conducted in an atmosphere not entirely free from personal economic interests, and whose leaders are responsible only “before God and History,” writing their memoirs if anything has gone wrong! It is desirable that all planners, all popular writers on the “end of capitalism,” and all despisers of “orthodox” economics should take this to heart, and as far as the policy of trade-cycle control shares some of the dangers of economic planning, here is a lesson also for the more enthusiastic advocates of monetary management.

There is still another reason for damping the enthusiasm for any of the schemes of economic stabilization which are so popular nowadays. It is the inherent nature of these schemes that they are conceived more or less mechanically. Invariably the idea is to set up a framework of external economic conditions capable of bringing harmony into the economic process. Important as this may be, it must not be forgotten, nevertheless, that, in the last analysis, economic life is dependent on the psychological attitude of countless individuals, and the trade cycle also is, at bottom, a psychological phenomenon. Now the danger, which must not be overlooked, is that any deliberate and duly advertised policy of economic stabilization might exert an adverse influence on the psychological attitude of the individuals, by giving a treacherous feeling of security provided by the omniscient State and by inducing the individuals to recklessness. The fact that, during the last boom, there was never more talk about economic stability than just at the time when the temerity nursed in this very atmosphere of over-confidence was sowing the seed of the worst crisis tells its own tale. Thus we might venture to give voice to the paradox that it is in the very interest of economic stability to be rather sceptical about the possibilities of economic stabilization. Let us not promise more than the absolute minimum of everything that is warranted, let us not talk away all the dangers and difficulties that are to be envisaged—then, perhaps, something might really be achieved.

A last word of warning must be said on the subject of trade-cycle policy. Such a modest view of the possibilities of trade-cycle policy as that expressed in the text is apt to convey the pessimistic impression that the economist seems not very helpful in suggesting a solution of the problem of how to avoid a recurrence of the last disaster. If that is so, what about the prospects for our whole economic order? Is not trade-cycle policy the last vestige of hope we have for saving it from utter condemnation? The answer is a very emphatic no. The reason is very simple.

If a wrong trade-cycle policy in the proper sense of the term had been alone responsible for the present depression, it is hardly conceivable that it would have been anything like so severe and long-lasting. The whole complicated causation of the present depression is unimaginable in the absence of a number of factors which have nothing whatever to do with wrong acts of trade-cycle policy: the Great War with its host of disastrous economic consequences, the Peace Treaties with their political and economic partitions, Reparations and Inter-allied Debts, the Great Inflations, State intervention in defiance of all wisdom and reason, the illogical tariff policy of the United States and its equivalents in other countries, the reckless management of public finances, the political upheavals of every description, and so on all down the list. It is not easy to see how any trade-cycle policy, be it the wisest and most rational one, could have coped with the situation thus created, or, indeed, how any other economic system could have endured the terrible strain.

Just as we must fight against the very bad habit of treating our system of economic organization as a scapegoat for all errors of economic and general policy, so we must not expect trade-cycle policy to expiate what economic or general policy have sinned. A rational trade-cycle policy in a world of enormous irrationalities can hardly attain its ends. If the economics and politics of the world were more rational, the whole subject of crises and cycles would be decidedly less pressing and important. Thus we arrive at the conclusion that the best trade-cycle policy would be the rehabilitation of wisdom and reason in every act of economic and general policy, and we should let trade-cycle policy in the proper sense of the term take care of the rest. Even then it would be too much to expect the complete disappearance of cyclical fluctuations, but perhaps it is not too extravagant to hope that what is left of booms and depressions would not be much above the minimum which is at once both tolerable and rather indispensable for a certain speeding-up of economic progress.

2. MEASURES FOR OVERCOMING THE DEPRESSION.

§ 24. INTERFERENCE WITH THE STRUCTURE OF PRICES AND OF PRODUCTION (RESTRICTION).

Turning now to the measures which are proposed for overcoming a depression, we come to a question which brings us face to face with the most pressing difficulties of the day, and which can also best be treated from the standpoint of this present-day problem. We are dealing here not with the question discussed in the previous section of how the waves of the cycle can be smoothed out and future crises prevented by stemming the boom at the right time, but the question by what means the existing crisis, once it has come about, can be overcome. Unused human and material factors of production are available in abundance, but the inducement to bring them back into the flow of production is lacking. It follows that everything depends on somehow producing this missing incentive. Before the war this came about in the later phase of the depression of its own accord from the situation which gradually set in on the different markets, and there was nothing to prevent us from assuming, indeed everything constrained us to assume, that it would be the same again this time. It may be said that “it must stop raining some time,” but the discomforting and dangerous thing about the last depression was that this time it lasted such a terribly long time, much longer than corresponded to the objective economic conditions. The focal point of the whole question is thus whether and by what means the revival from the depression can be speeded up.

This gives us the rationale of State intervention but does not tell us the point of attack of such intervention. As regards this, there is a considerable variety of opinions. First of all, there are two schools which are in an almost irreconcilable opposition to each other. The one hopes for the overcoming of the depression through measures of liquidation and adjustment whose task it is to lower prices, costs, and incomes, either in particular or in general, while the other school expects that the end result of such a policy of liquidation and deflation will be an aggravation of the depression and recommends instead expansion.

To the first of these schools—we shall call it for convenience sake the restrictionist school—there belong those who hold the firm belief that the last crisis, even in its later devastating stages, must still be regarded as the inevitable reaction to a vast credit expansion, a reaction which has been unduly prolonged over several years and tremendously intensified by a great number of other factors, as, for example, various long-run economic tensions and political conflicts, certain degenerative tendencies of the capitalist system, and the lack of general economic elasticity caused by interventionism and monopolism, and untimely attempts at dodging the inevitable repercussions of the boom period. This school leans towards the laissez-faire outlook, severely condemning every attempt to shorten the allegedly salutary processes of liquidation and adjustment and vehemently urging the removal of all that stands in the way of the adaptation of the whole structure of prices and costs to the lower economic level demanded by the crisis. Its members do not deny that the crisis is characterized by a terrific process of contraction, very complicated in nature, and they may even reluctantly go so far as to apply the term “deflation” to this process. But they warn us that the phenomenon of deflation owes its origin to random and independent causes and they regard it as the inevitable manifestation of liquidation and readjustment. They beg us to rely on the well-founded hope that even this crisis will at the proper time give way, more or less spontaneously, to a new period of recovery, and that this will occur when the situation is ripe, i.e., when the crisis has fulfilled its purgatory mission and universal confidence has once again been restored. All that we can do, according to this restrictionist school, is to facilitate this mission by all possible means, leaving no stone unturned in the attempt to create a fresh atmosphere of confidence. There seems to be nothing for it but to go patiently through with the crisis unto the very end. Prices, costs, and incomes must be lowered over and over again, in accordance with the steady decline in the economic level; and at the same time State expenditure must be severely restricted, and if there is no other way of balancing the budget, taxes must be raised. Liquidation, adaptation, restriction, then, appear as the main features in the programme of this school of thought, which may be said to have been the dominant attitude in Germany under the Brüning Government and, in a less strict form, to be still the theory underlying the present economic policy of the countries of the Gold Bloc (France, Holland, and Switzerland).

The second school—we will call it the expansionist school—is not quite so easy to define since it contains a number of varieties ranging from a radical Left of wild monetary schemes to a conservative Right of well-dosed and carefully controlled credit expansion, and equally varied is the diagnosis of the present situation given by the adherents of these different subdivisions. The more moderate form of the expansionist theory may be summed up as follows: The present crisis is to be fundamentally and primarily regarded as a cyclical crisis, i.e., as the inevitable reaction of credit expansion and accumulation of capital in the leading countries during the last boom period. When regard is had to the unprecedented scale on which credit expansion and investment of capital had taken place a very painful reaction was to be expected. But had it not been for an unfortunate coincidence of various accidental factors, there would have been nothing to prevent the emergence in due course of a new equilibrium. These accidental factors which play such a prominent role in the more popular explanations of the crisis, and need not be repeated here, are responsible for the fact that a distinct degeneration of the crisis set in. Consequently, we have to distinguish between a primary and a secondary phase of the crisis, the latter being characterized by a vicious circle which constantly interferes with the attainment of a new equilibrium. We have, then, the cumulative process of recession which has been described at greater length in § 16 of this book. In view of this development, the policy recommended by the restrictionist school seems only to make the vicious circle worse. The only sensible thing to do, according to the expansionist school, is to stop the circulus vitiosus and to turn it into a circulus salutaris in which recovery may gain force by its own momentum so that the cumulative process of recession will be replaced by a cumulative process of recovery. The way to bring this about is expansion in a sense which will be explained more fully in the next section.

As for the respective merits of these two schools, enough has been said in the course of this book, especially in the section on the secondary depression (§ 16), in order to make clear the position of the present author. With due allowances for necessary refinements and modifications, there seems to be rather strong evidence of the general superiority of the expansionist point of view. Considering the great importance of the subject, however, it may be useful, even at the cost of some repetition, to add some further remarks on the pros and contras of the restrictionist viewpoint with special reference to the experiences of Germany.

In order to form an opinion on the policy of deflation and liquidation it must be first recognized that every depression is a depression of profits occasioned by the fact that the price curve and the cost curve cut. The immediate consequence is that a proportional fall of prices and of costs—including, especially wages—would be a completely ineffective measure, while a price fall below the fall in costs would only augment the disparity between prices and costs. So the idea that was openly and seriously pursued for a long time in Germany that the equilibrium of the economic system could be re-established by a general lowering—by say 20 per cent.—of the whole price, cost and income level is superficial in the extreme. The level would have certainly fallen all along the line, but nothing would have been done to improve the disparity between prices and costs. Indeed, there is a danger that this essentially purely nominal measure may lead to a still further upsetting of the equilibrium since the difficulties of the transition from one level to the other throw new sand into the economic machine and add to uncertainty and nervousness. This effect is so much the more probable since the policy of general cuts—if it is to be carried out systematically—makes interference with existing contracts (long-term employment, delivery and loan contracts) inevitable and thus gives a destructive blow to the moral and psychological bases of the economic system which must plunge it deeper still into the depression. With the thoroughness and systematicness characteristic of the Germans this policy was carried to its extreme limits by the Fourth Emergency Decree (of 8th December 1931) of the Reich Government so that it looked as though the country which had established the world record for inflation was now striving to reach the summit of achievement for “deflation,” only with the difference that this new attainment was held by many people at the time to be a thoroughly praiseworthy accomplishment. The present writer made no secret at the time of his opinion that—contrary to what these circles believed—the policy of all-round cuts in the advanced stage of the depression was mistaken. His view was that so long as this policy was not resolutely cast aside there would not only be no chance of an economic revival but that a further progressive decline of economic activity was certainly to be expected. The further course of the German depression under the influence of the policy of all-round cuts has confirmed this opinion in every respect. The prophecy that the cuts would lead to a constantly increasing contraction of economic activity, to a progressive aggravation of the financial difficulties and therewith to an ever more self-denying heroism of emergency decrees, unfortunately turned out to be true—for reasons which are obvious if we keep in mind what has been said at a previous juncture (§ 16) on the cumulative process of the depression.

Those who, in spite of this, still spoke, until quite recently, of a necessary process of readjustment of the economic system, and would therefore have liked to shape all public trade-cycle policy accordingly, forgot that the depression all over the world had long since passed the stage where the adjustment and “cleaning up” necessary for the revival is accomplished. The depression had long since become devoid of every necessary function and was therefore without sense. It had in fact deteriorated into a process of murderous and ferocious destruction. It had led to the irritating paradox that vast possibilities of production and a constantly increasing poverty of the masses were standing side by side, the only explanation being that the forces which normally connect up production and consumption in our economic system into an harmonious whole had stupidly misfired. A further process of cleaning up seems to give proof of its own justification by the fact that in the course of this process more and more firms collapse and thus provide new tasks for the work of cleaning up, but it is the continuance of this process, the continual contraction of economic activity, which is responsible for mowing down firms in ever quicker succession. The “cleaning up” fanatics resemble people who are clearing a forest of dry wood—a thing that is highly commendable and gives light and air to the living trees—but who in order to speed up the work set fire to the dry trees. The unfortunate result then is that the fire spreads to the healthy trees, drying them up beforehand by the rising heat of the forest fire. The further the fire spreads the more dry trees there are, but it is the fire that dries them up and so makes them ready for cleaning out. And it may be imagined that our forest workmen would still assert entirely in good faith that it is still a “cleaning up” fire—by the side of which we may rub our hands in grim satisfaction—and not a raging forest fire!

It is not only the idea of a necessary “cleaning up” which lies at the back of the policy of cuts but also the widespread feeling that previously we have been living beyond our means and must now reaccustom ourselves to poverty and a simple life. The ascetically inclined even welcome the depression in so far as it helps us to relearn the virtue of self-denial, and at the same time the sentiment gains ground that those who still allow themselves this or that pleasure are obviously behaving out of keeping with the spirit of the age. Fewer and fewer people dare to display their wealth, and this new style of living eventually becomes the fashion. Tendencies to level up incomes which are more often based on vague sentiment than on calm consideration are combined with the puritanical wave. Almost every country, it seems, has at some time during the last depression gone through a period of being plagued by this puritan bad conscience about “too much spending” and the cry for a “drastic reduction of expenditure all round.” In Germany the atmosphere was thick with it during the chancellorship of Brüning, and the British “Economy Stunt” of 1931-32 seems to have amounted to the same thing. At the present moment the French are similarly afflicted.

Now it is undoubtedly correct that in the period before the crisis there was not the right proportionality everywhere. Not only the State but also many individuals—especially the middle classes—were living beyond their means. But to draw from this the conclusion that the whole standard of living must be lowered if we want to return to healthy conditions is premature. Is the present situation characterized after all then by a scarcity of goods instead of by an overflowing abundance of them? Are we not almost suffocating under the increased productive capacity which has been created by the progress in technique and organization of the last decade? Is not recovery from the depression synonymous with getting rid of the surplus of goods and productive capacity? Can a further reduction of consumption really be the way out? The ascetic eulogizing of self-denial and thrift as great and timely virtues is thus, contrary to the popular view, pernicious, since it results in demolishing a productive system which is adjusted to the production of an exceedingly abundant supply of goods.23

It is more difficult to prove unequivocally the error of another notion bound up with this same train of ideas, a notion which commences by claiming the necessity of increased capital accumulation and arrives thus at the recommendation that there should be a restriction of consumption and a lowering of income. It is clear, however, that it must be incorrect when we recall the earlier discussions of saving and investment (Chapter IV, page 97 ff.) and the real dynamics of the depression (Chapter IV, page 119 ff.). Economically considered, saving means the releasing of means of production, and the services of labour, for the production of future goods.24 Now nobody will deny that such a freeing of the means of production had taken place during the last depression to a great extent, only, unfortunately, these factors of production which had been set free were not being applied to the production of future goods, and the result was that the whole economic process, and with it the volume of money savings, was contracting. What was lacking then was not savings—in the sense of reserves of productive capacity available for the re-expansion of the economic system—but investments which would make use of these reserves and thus produce a rebuilding up of the shrunken economic process, accompanied by an automatic increase in the accumulation of money capital. A policy which pursues the aim of increasing savings leads to a continued shrinkage of the national income and is therefore self-frustrating. If we were to make the start of the economic recovery dependent on the economic system’s being sufficiently enriched with money capital provided out of savings beforehand, if we were to pursue a policy stubbornly directed towards raising the amount of savings at all costs, we should as things are at the time of a secondary depression be promoting the permanent duration of the depression.

There still remains the question whether it would not be helpful if we were at least to lower the level of wages. It is now beyond all doubt that the wage level was raised too high in many countries in the course of the last boom and that harmful effects have followed. Accordingly, we have to recognize the necessity of making the regular apparatus of wage adjustment again flexible. There is agreement on this question even among the labourers. Here, again, there is thus nothing to be said against the re-establishment of the elasticity of the labour market if it is earnestly accompanied in like measure by the restoration of elasticity in other spheres in which State intervention and monopolistic formations have produced immobility. It is quite another question whether in the last phase of the depression the lowering of the general level of wages is a measure suitable to preparing the way towards economic revival. This question must be answered in the negative so long as the “slack” created by the cut in wages does not give an incentive to the revival of activity in other parts of the economic system. So long as this is not the case, all cuts lead only to an aggravation of the depression since they cause a falling off in demand without putting any new demand in its place in other spheres. In other words, pursued within the framework of a restrictionist policy and without simultaneous measures of expansion, wage-cutting is liable to aggravate the depression. Considering the level of wages which has now already been reached, it is anyhow very doubtful to-day whether a general lowering of wages—which only had a function as part of a trade-cycle policy so long as it was connected with a policy of expansion—is any longer needed in order to secure the necessary “play” for a revival of economic activity.

The final question is whether a restrictionist policy might not be based on considerations of external equilibrium, that is, of the foreign exchange situation. We propose to deal with this question in the next section in connexion with the possibilities of an expansionist policy.

§ 25. EXPANSION: ITS NATURE AND SIGNIFICANCE.

It cannot be the purpose of this section to go into a monotonous repetition of the description of the nature of the secondary depression which is such as to call for expansion as the logical remedy instead of restriction. It is to be feared, however, that to leave matters there would promise little hope of advancing the embittered discussion between the restrictionists and the expansionists beyond its present unsatisfactory point where both schools are lined up against each other like the Montecchi and Capuletti. Or to use another simile: The restrictionist school may be compared to a well-meaning and experienced mother, who, standing no nonsense, accepts the diagnosis that her patient is still suffering, even after long years on a sickbed, from the effects of his debaucheries and feels it her duty, for fear of a fatal relapse, to harden her heart against his desire for plenty of food. According to the expansionist school, on the other hand, the lamentable condition of the patient has no longer anything to do with the debaucheries of the distant past, but is the result of a dangerous edema brought about by a long process of undernourishment. Both diagnosticians, standing by the bedside of the poor patient, are fervently protesting that the patient will be killed, the one being accused of luring him on to fresh debauchery, the other of leaving him to die of hunger—in spite of the intentions of both being the best in the world.

Though the expansionist school is, in the natural course of events, everywhere gradually gaining the upper hand, and modifying fairly perceptibly the stern attitude of the restrictionists, it is still a matter of urgent necessity to stop the scientific warfare between the two schools, with its reciprocated abuse of “sadistic deflationists” and “foolhardy inflationists,” and to work for a reconciliation that will be something more than a weak compromise.

With this end in view it should be pointed out that each school comprises a variety of opinions and that the most satisfactory solution of the whole problem will be found in a judicious combination of all that is essentially sound on both sides. And so we are finally compelled to realize that the division into two schools is rather clumsy and superficial and hinders a better understanding of the problem. To begin with, it should not be denied that the restrictionists are absolutely right in their diagnosis of the primary crisis and in their opposition to premature attempts at re-expansion. And it seems certain that their general attitude will once again become extremely sound when the circle has swung round and a new boom of an inflationary character is in sight (which may come sooner than it is expected to-day). Furthermore, the majority of expansionists cannot but offer their sincerest approval of the restrictionist’s insistent demand that the machinery of our economic system should be cleared of the cartloads of sand which, in the form of tariffs, price-fixing, subsidies, valorization schemes, foreign exchange control, manipulation of wages, monopolism, &c, have been so liberally thrown into it during the last decade.

All this goes to show that the advocacy of a policy of expansion is not inconsistent with that of a policy of readjustment, which wise expansionists will indeed favour. Expansion and readjustment are not only compatible with each other, but must be combined if the best possible result is to be assured. On the one hand, there is no great chance of successfully combating the manifold interventions and economic rigidities unless the economic pressure is being relieved by expansion and the first signs of recovery are being felt; the opposite course means putting the cart before the horse. It is just the atmosphere of hopeless depression where an economic policy thrives which plunges deeper and deeper into the muddy depths of interventionism and tears our economic system into pieces. The lamentable failure of the late World Economic Conference in London (1933) with its great and very laudable efforts in preaching a reasonable commercial policy is one of the outstanding proofs of the truth of this statement. In fact, it is not too much to say that expansion is necessary to save capitalism from complete decay and give force to the struggle against the hysteria which is all too prevalent a feature of the present time. On the other hand, expansion is extremely apt to lead to a dangerous development unless it is combined with a number of restrictive and liquidating measures.

The greatest confusion of all, however, in the issue between restrictionism and expansionism has been created by the completely erroneous, though very popular, notion that advocacy of expansion means advocacy of a drastic rise in the general price level (reflation). The reader will by now have become sufficiently familiar with this “price-level complex” to understand why Expansion is not to be interpreted as Reflation. This interpretation is the more dangerous since it is very apt to lead to the still less defensible notion that Expansion is to be interpreted as Devaluation. It is true that it is impossible to imagine a business revival without an expansion of credit. That is what the restrictionists need to realize. But it is easy to imagine—and this is what many expansionists need to realize—a business revival without a perceptible rise of the general price level. Moreover, it is to be feared that if a higher general price level is the objective, business-cycle policy may be led into the maleficent belief that going off gold and lowering the external value of the currency is a good way to. achieve this goal. This is exactly what has recently happened in the United States. There is no reason whatsoever why the Americans should have tampered with the external value of the dollar to bring about a marked recovery, and there is every reason why they should have refrained from doing so in order to save themselves and the rest of the world a great deal of unnecessary trouble.

Evidently, the policy of expansion—by which is meant an effective expansion of credit, leading to an expansion of the volume of production, incomes, and demand—can be carried fairly far without bringing about a marked rise of the general price level because, at this stage of the depression, it will be a compensatory credit expansion and not an inflationary one. It is expansion—or re-expansion—that is wanted, not reflation. There is only one serious objection which might be raised here. The advocates of reflation might point out that a mere policy of re-expansion seems incapable of solving the urgent problem of general over-indebtedness, and that, for this reason alone, a sharp rise of the general price level is indispensable. There is no denying the fact that the general over-indebtedness constitutes a most urgent and grave problem which must be solved in one way or another to pave the way to recovery, but it can hardly be said that reflation presents the only or even the best solution. It is only one among a number of other solutions and is far from being the most recommendable of these.

The first solution is to do nothing and to let things take their natural course. In this case, we leave the task of bringing the volume of debts down to the level of the contracted volume of production, prices, and incomes to the institution of bankruptcy or to individual debt settlements. Though this is the normal solution corresponding to the inherent nature of our economic system, the depression is, in most countries, too far advanced by now to make this course feasible, quite apart from considerations of social justice. There is no sense any more in aggravating the depression by this rough and cruel method. The second solution is the all-round relief of debtors by legal reductions of the rate of interest or of the amount of the debt itself. This compulsory method is the ultimate consequence of any determined policy of deflation (restriction), i.e., of a policy aiming at regaining equilibrium solely by the contraction of costs. It is hardly necessary to say, however, that it is a very crude and mechanically working method which, by causing disturbances on the credit markets, is liable to retard recovery and, by scaring borrowers, to work ultimately against the very interests of the debtors even. A very deterrent example of this was the deflationary policy of the Brüning Government in Germany. The third solution is reflation, i.e., the reduction of the real value of the burden of debts by a lowering of the purchasing power of money. But this also is a very clumsy and inorganic method very much inferior to the fourth solution of re-expansion, i.e., of making the burden of debts again bearable not by raising prices but by augmenting the volume of production and turnover so as to adjust it to the large volume of indebtedness. It must be admitted that the problem of agricultural indebtedness has special features, but this is the concern of a constructive agricultural policy which should not be allowed to push the business-cycle policy off the sound road of re-expansion rather than reflation as it has done in the United States.

So we see that the expansionist can and, as I think, must join whole-heartedly with the restrictionist in his stand against reflation, and, consequently, the restrictionist should learn to differentiate more carefully between his adversaries and to realize that most of his polemic efforts are wasted on propositions which are attacked just as much by a number of expansionists. What has been said, from an expansionist point of view, against reflation applies a fortiori to devaluation. Since this notion plays such an important role in the current discussion on the right method to combat the depression, some additional remarks may not be out of place.

As regards the usefulness of devaluation in combating the depression, two different ideas have to be clearly distinguished. The one idea is that the devaluation of the national money may itself be an efficient instrument for abating the crisis; the other is that it may be an indispensable prerequisite for credit expansion.

Regarding the first idea, it is not always made clear how the devaluation of the currency can work the miracle of putting an end to depression. The reasoning underlying this idea is for the most part a particularly confused set of half-baked notions about some causal relationship between the internal purchasing power of money and its foreign exchange value. A sober examination of the problem shows that there are only two possibilities which can give any grounds for the expectation that the devaluation of the currency would be an effective remedy against depression.

The first is that it might restore the external equilibrium of a country and thus give a new impulse to economic activity. It cannot be denied that, under certain circumstances, devaluation might be a rather smooth way of restoring the external equilibrium of a country, though a number of factors are to be reckoned with which are liable to exert a disturbing influence. There are other ways of doing it which are at least worthy of consideration, but there are certainly cases where, on balance, the method of devaluation might be defended as the least evil. England, the Dominions, the Scandinavian countries, and Finland might be cited as examples, and there can hardly be any doubt that after the majority of the countries have devalued, devaluation may be a practical way of restoring external equilibrium for the few gold-parity countries which are still left. But apart from this special problem of the present moment, we are faced here with a very difficult dilemma. For, on the one side, devaluation will work the more safely the greater and the more important is the country or the block of countries which puts it into practice, while the devaluation of the currency of a “country” like the unhappy city of Danzig, is a real tragedy tinged with comedy.

On the other side, however, the greater and the more important is the country the more disastrous will be the effect on the world as a whole. This is precisely what the break in sterling did. Undoubtedly, England could afford to devaluate its currency together with the Empire, but we must remember what a terrific shock it was for the whole world to find that even the pound and the Bank of England were no more the proverbially solid rock. All lenders and investors became scared. Nothing, it seemed, could be trusted any more except gold, and thus the effect on the whole world of the devaluation of the pound and the other currencies was an all-round international contraction of credit and a general scramble for gold. Gold, as the last anchor of confidence, rose in value everywhere, which was equivalent to a further decline of prices measured in gold, and then with the breakdown of the machinery of international credit the formidable Juggernaut of sky-high tariffs, quotas, exchange control and clearing arrangements was set in motion. The devaluation of the pound and later of the dollar, consequently, meant nothing less than further deflation for the rest of the world with its inevitable repercussions on England and on the United States. We may be ready to grant England every possible excuse, but it should be clear that what the world needs now is a complete rest from monetary shocks and a gradual return to the normal.

The second possibility that devaluation may work per se as an effective remedy against depression is still less real. It rests on the idea that, even if there is no external equilibrium to be restored, devaluation may act as a stimulus to economic activity by raising the internal price level. This idea is a very muddled one, because if the external equilibrium of the country had not been disturbed and there is no increase of the volume of money and credit taking place simultaneously with the devaluation, how can devaluation raise the internal price level? The one chance is that it may create the belief in a permanent rise of the price level and thus, by a sort of shock tactics, really give rise to a speculative boom characterized by rising prices.25 But as long as there is no real expansion of credit—which has, however, a slight chance of being evoked by the speculative boom—a dangerous reaction is bound to occur sooner or later. This is exactly what happened in the United States during the first year of the New Deal until a real expansion of credit was started.

So much for the idea that devaluation per se would be an efficient instrument for abating the crisis. Let us see whether the case for using devaluation as a prerequisite for credit expansion is any stronger. Here we are touching upon a question which has already been dealt with at greater length at an earlier stage of the discussion (§ 22). We repeat, then, that the need for devaluation could arise only if the policy of expansion were to bring about a rise of the price level and a disturbance of the balance of payments. It would be wrong, however, to suppose that anything like this is necessarily bound to happen. It is a common error to mistake the compensatory credit expansion, which is necessary for stopping the depression, with the inflationary credit expansion of the boom period and to forget that the former draws on the unused productive reserves which correspond to the deficit of purchasing power engendered by deflation. It is not easy, therefore, to see why a tendency towards rising prices should be expected. It is even possible that the fuller use of the productive resources might tend to lower prices. Allowance must be made, of course, for cases where it would not be wise to rely on this hope or where the actual level of prices and costs is too high compared with the competing countries. Even in these cases, however, it would not be necessary to depreciate the external value of the money since it would still be possible to cope with the situation by lowering wages. It is true that, without a simultaneous policy of expansion, wage-cutting is almost certain to aggravate the depression, but as part of a policy of expansion it might not only fail to do this but might even become an indispensable condition for real success. It can be argued, moreover, that it might be easier to lower wages in the atmosphere of a buoyant programme of expansive reconstruction than in the drab atmosphere of a melancholic programme of restriction and retrenchment, the more so if the workers are confronted with the uninviting alternative of devaluation. In all this, regard has always to be had to the fact that whether a simultaneous policy of lowering costs is really necessary depends on the special circumstances of every country.

As a last point, it might be argued that the policy of expansion may possibly jeopardize the stability of the foreign exchanges by evoking distrust in the future stability of the currency and thus causing a flight of capital. This is certainly a point which is of no little importance, and every care should be taken with regard to it in the technical execution of the policy of expansion. On the other hand, however, there is certainly a good chance that what there is of a tendency in this direction might be compensated by the confidence-inspiring effect of a decline in the number of unemployed, bankruptcies, or political riots. It should not be forgotten, in this connexion, that the recent attacks on the countries of the Gold Bloc were able to gain strength only on account of the growing distrust in the economic and political future of those deflation-ridden countries. Furthermore, it is to be observed that in countries where the banking system is closely connected with industry as in Germany, Switzerland, and Austria, the crisis in the sphere of production immediately impairs the position of the banks, spreading distrust among their depositors and thus putting a strain on the balance of payments. There comes a moment, therefore, from which time onwards a policy of expansion on the basis of the Gold Standard encounters growing difficulties instead of being made easier by the lapse of time. On the other hand, it is to be surmised that a recovery in the sphere of production, by thawing frozen industrial assets and thus improving the position of the banks, acts in the direction of reducing any danger for the Gold Standard that might come from this quarter. Summing up this argument, we may conclude, then, that it is very questionable whether devaluation is a necessary prerequisite for carrying through a policy of expansion. On the contrary, it is highly probable that it will introduce a dangerously disturbing element, for reasons which need not be repeated here.

Despite his unsparing efforts to explain the rationale of expansion, the author cannot overcome the uneasy feeling that there may still be people who vigorously decry expansion as inflation. They are so obsessed by the fear of inflation that every enlargement of the volume of money and demand, no matter under what circumstances it occurs, is characterized by them as inflation, and all such expressions as “expansion” or “reflation” are, in their eyes, nothing else but a terminological smoke-screen to disguise the invariable policy of inflation. Now, the present author has every sympathy with the fear of the terrible scourge of inflation, and during the Great Inflation in Germany he was among those economists who spared no effort to divert the monetary policy of the government from its catastrophic course. That was a time for sounding the alarm-bell. During the last boom also, there was every reason to worry about inflation, and it is more than probable that after the present depression there will again come a time—perhaps very soon—when it will behove the economist to be on the look out for renewed inflation. But there has never been a more inappropriate time to worry about inflation than the present depression when the world is suffering from the worst case of the opposite evil, i.e., deflation, and it is doubtful whether the devastating effects of this deflation do not actually surpass the devastating effects of the worst inflations. Are we really to believe that there is no middle course between the “arctic hell” of deflation and the tropical heat of inflation? Is it arson to kindle a cosy fire in a freezing room? Of course, there is always the danger that we may set the house on fire, but is it not pathological pyrophobia to leave the fire in the stove unkindled by reason of such a remote danger? If the scaremongers had their way, we should apparently have to submit to an unlimited degree of economic contraction, and if deflation had been driven so far that the last bank note were to disappear from circulation it would be “inflation” to put it back into circulation again. I am not in the least scared by the fact that expansion does mean an enlargement of the volume of money and credit, and ardently hope, moreover, that it will be so, since it is the only way to get out of a depression. In the present situation not to want an increase of circulating media is simply tantamount to not wanting recovery. Consequently, if recovery should unexpectedly set in spontaneously, the same logic demands that it should be strangled deliberately.

Thus there is no getting away from the fact that recovery is expansion, and the only point to be discussed is whether we should wait until it comes spontaneously or whether we should do something to bring it about deliberately. And, finally, how often must it be repeated that at the present moment credit expansion, drawing as it does on the unused reserves of productive capacity is a compensatory one, and that it will become inflationary only when recovery has developed so far as to absorb all those reserves? In saying this, one must be quite aware that the danger of inflation may, after a while, become a real one. Neither is it to be denied that a crude form of the policy of expansion might harbour some danger in this direction, i.e., if it is carried through in a manner and under circumstances which make the attempts at “ignition” unsuccessful. But it is possible to exaggerate these dangers since wherever a policy of expansion—with the possible exceptions of Germany, Italy and Japan—has been launched, no real symptoms of inflation have as yet become noticeable. The big inflations after the war have left, moreover, such a powerful impression on the contemporary mind that most people seem to underrate the time which usually elapses before inflation grows to any perceptible dimensions, just as it is common to underestimate the enormous elasticity of our economic system. Therefore, it is well to recall how long it took even in Germany and under the most adverse circumstances before the first signs of inflation became visible during the war.

Resuming the general trend of the exposition on the nature of expansion, we note that it is neither reflation nor devaluation nor—least of all—inflation. In all these respects, it is certainly not what most of the adversaries of expansion imagine it to be. But still less is it Planning. To confuse a policy of expansion with Planning shows exactly the same lack of discrimination as that which leads people to believe that there is an exclusive alternative between internal or external stability (the Doctrine of Alternative Stability) or between deflation and inflation. This general lack of discrimination with its crude mental patterns is really one of the great curses of our times and cannot be too strongly attacked. No progress is to be hoped for unless we cease to think in terms of these crude alternatives with their futile polemics. This is what is most badly needed in the discussion of the issue between laissez-faire and Planning. A policy of expansion is certainly not laissez-faire, but is it therefore Planning?

Let us start with attempting to give a clearer definition. The term “Planning” no doubt owes much of its present popularity to the fact that it is being used more and more in a sense which covers almost every conceivable activity of the State in economic policy. Since some sort of activity on the part of the State is demanded by almost everyone to-day, the looseness in the use of the term “Planning” is very useful for advertising it and for coaxing the masses into the belief that the world is headed towards Planning. The term itself is very helpful in carrying through this cunning manœuvre since it is difficult to imagine any act of economic policy which does not involve some sort of a “plan.” Even the imposition of a protective tariff is based on a preconceived plan of the structure of production of the country in question, but obviously it would be absurd to say that a protective tariff means Planning. The same is true in the case of the construction of public roads or State railways, and even the public works which are so popular nowadays as a remedy against depression hardly constitute a planned economy. Most cities have been built according to some sort of plan, and the monetary and financial policy of many countries has also assumed more and more the character of regulative measures which take into account the course of the entire national economy.

If all these things are “planning,” then the term becomes absolutely meaningless. We should then have had planning since the dawn of history, for economic life has always been subjected to certain rules and collective influences. And then, of course, capitalism would be a Planned Economy too, since the legal and institutional framework of this economic system also has been created in the light of systematic reasoning involving a preconceived idea of the competitive economy as a whole. Capitalism has been deliberately “planned” as a system which needed no further Planning. We conclude therefrom that if the term is to retain any meaning at all it must not be applied to an economic policy characterized by a “plan,” for that is true in the case of any economic policy, even in that of economic Liberalism whose plan it is not to “Plan.” Therefore, it is not the “plan” as such which characterizes Planning but a certain method of executing it, i.e., the method which is the contrary of that of the competitive market economy. While the latter is based on the complicated interaction of spontaneous decisions of all groups on the market, it is the essence of Planning to replace this mechanism of spontaneous reactions by commands from above and to hand over the all-important decision as to the allocation of the productive forces of the community to the office of a governmental department.

All this goes to show that the term “Planning” is extremely misleading, and badly in need of being replaced by some other term such as will really express its contrast to the market economy. Perhaps “Office Economy” would not be bad, or “Command Economy,” or even “Red-tape Economy.”26 But if we keep to the term “Planning” we should not tolerate any vague use of this word and must demand that it be strictly reserved for denoting an economic policy which replaces the mechanism of the free market by governmental command. Planning in this sense must be distinguished from such kinds of intervention as are in accordance with the inner structure of our economic system (conformable intervention), which leave intact the market mechanism itself and attain their objective not by contravening the rules of this mechanism but by making use of them. To this type of conformable intervention there belongs the traditional tariff policy, as contrasted with a policy of quotas, clearings, or exchange controls which present examples of non-conformable intervention or Planning.27 Sunday-rest regulations are again a case of conformable intervention while price-fixing is an example of a non-conformable intervention. A good test of whether or not an intervention belongs to the non-conformable category (Planning) is the well-known fact that measures of this kind are liable to start a chain of repercussions necessitating more radical acts of intervention until we finally arrive at a Collectivist Economy pure and simple, a fact which is well illustrated by the experiences with the policies of fixing maximum prices, especially in house rents after the war, and by the present trend in international commercial policy. Partial Planning, therefore, tends to develop into Total Planning by its own motive force.

It is clear then that for trade-cycle policy the choice is not between laissez-faire and Planning but between laissez-faire, a conformable trade-cycle policy and Planning. The laissez-faire case can be discarded as impracticable since it is obvious that something has to be done to overcome this depression and to prevent the recurrence of another. There remains the choice between a conformable business-cycle policy and Planning. Here at last we have a clear alternative which we cannot escape: either we want to overcome the present depression by setting again in motion the normal mechanism of reactions of the market economy or, if we think that we must have recourse to Planning, we must recognize that we have to replace the entire mechanism of the market economy by collectivist Office Economy. We must make up our minds as to the direction we are taking and not count on the possibility of an easy compromise. If we recoil, not without justification, from total Office Economy we have to realize that the success of whatever we may do depends on the reconstruction of the mechanism of the market economy. First of all, we must know that, whether we like it or not, we are dependent on the entrepreneurs and their optimistic mood, that we must not drive them to exasperation and at the same time be surprised that recovery will not come. Not only, then, is judicious activity in combating the depression compatible with forgoing any idea of Planning, but, on the contrary, combining it with Planning is a sure way to compromise any success of an active policy in combating the depression. It must be clearly understood that the whole philosophy of expansion is based on a framework of economic reactions which would be destroyed if a country embarking on such a policy should at the same time try to remodel its economic system on socialistic or— what is closely related to it—on autarkistic lines. The experiences especially of Germany in recent years seem sufficiently to prove that a policy of expansion eventually stultifies itself if it disturbs by all kinds of non-conformable intervention the mechanism of economic reactions which it is calculated to resuscitate. Again, the disappointments of the New Deal in the United States must be largely imputed to the same cause. All the wails over the shortcomings of the competitive system and all the vague yearning for the better organization of production cannot get away from the fact that, as long as we do not take the foolhardy plunge into the total Office or Command Economy, all measures of Planning are liable only to hinder recovery. The importance of this statement is not impaired by the other fact that our competitive market system (“capitalism”) possesses such an incredible vitality and such an astounding elasticity that it can digest a considerable number of obstructions before it succumbs. It is, indeed, hard to kill, but some countries have already come quite near to the breaking-point.

It is from the same point of view that we must treat the present tendencies, noticeable in many countries, to subject the volume of production and the establishment of new plants to a strict governmental control.28 When there is over-production and unused productive capacity, would it not be sensible to order a reduction of output and to prevent newcomers from invading overcrowded industries? Not at all. Leaving aside the special case of the restriction of agricultural production, it may be said unhesitatingly that this revival of the medieval principle of numerus clausus is a very short-sighted interference with the dynamic forces of our economic system which should be stimulated instead of being strangled. If there are enterprising persons to-day who have enough optimism and courage to undertake new investment we have every reason for rejoicing, for that is just what we need in the interests of recovery. They should be encouraged instead of being intimidated, even if they are uncomfortable competitors for the old-established firms and a danger to vested interests. If the State does not leave it to individuals to decide whether one line of production is to be preferred to another it kills the economic reactions on which we must rely in our hopes for recovery unless the State takes over the complete control of the national economy. And the fear of a misdirection of investment? This is again one of those economic scares based on a narrow and static view of the economic process. Capitalism is an economic system which, when its dynamic forces are in full swing, can afford to sow its seeds on barren ground, and the best way to bring those forces into full swing is to let capitalism sow its seeds. The waste of misdirected investment during the secondary depression is a trifle compared with the additions to the total wealth concomitant with recovery, and it is just those experimental investments which are usually essential for turning the tide. The development of capitalism is unthinkable without faulty investments, and perhaps most of us would not have been born were it not for the stormy growth of the productive forces brought about by recurrent waves of experimental investments, directed at one time towards railways, at another towards electrical or other lines of investment. To fight against the whole of this illiberal spirit of jealous narrow-mindedness and of thinking in terms of the status quo instead of in terms of potentialities is not the least important part of the philosophy of expansion.

The issue between laissez-faire, a conformable trade-cycle policy and Planning may be summed up as follows. In certain circumstances, it is just as wrong to rely on the natural respiration of economic life resuming automatically as it is wrong to club it to death and then to make attempts at replacing the natural organism by an artificial one made of tin and wire. Both the uncompromising Liberal and the Planner—each is wrong where the other is right, and right where the other is wrong. The uncompromising Liberal is right in his recommendation to stick to the essential principles of our competitive market system, but he may be wrong in relying on the automatic mechanism of this system for overcoming the secondary depression; the Planner is right in demanding an active policy against depression, but irremediably wrong in suggesting Planning as the right method. Why not combine what is right on both sides? Why should it not be possible to agree on a policy of reanimating the natural respiration? That is just what the policy of expansion will do so long as it is strictly confined to conformable intervention.

To avoid any possible misunderstanding this section may be concluded by the remark that the conflict between the expansionist and the restrictionist school gives way when a spontaneous recovery really begins to develop. Since the artificial measures advocated by the expansionists are to be merely a temporary makeshift for a spontaneous recovery there is no point in insisting on them when the latter is already under way.

§ 26. THE TECHNIQUE OF EXPANSION: SOME RECENT EXPERIENCES.

The essence of the technique of the policy of expansion conceived in a manner explained in the last paragraph consists in compensating deflation by re-expansion in a way which anxiously avoids interfering with the process of the market economy. No uniform prescription can be given for achieving this end. The technique of expansion must be adapted to the special circumstances of each country, without any dogmatic views on the invariable merits of this or that method. In milder cases, there may still be a chance of stimulating private initiative by various measures of a “provocative therapy,” combining a “cheap money policy,” aided especially by a vigorous Open Market Policy, with special incentives to new investment (e.g., tax exemptions for installing new machinery or for building purposes, propaganda, new tariffs for special industries,29 or—still better—opening new outlets for exports by diminishing tariff barriers). The case of Great Britain is the outstanding example of such a policy, but it is doubtful whether it would have been successful in many other countries.

Similar attempts in the United States under President Hoover and in Germany have clearly failed. If private initiative does not respond sufficiently to the incentives offered to it, so that the effect of “ignition” fails to appear, there is no other way than to complement this policy by public initiative in enlarging the volume of credit and demand. If the private entrepreneurs do not make use of the new credit facilities, in other words, if private borrowers are not to be found in a sufficiently large number, then the State must step in as an extensive borrower in order to make credit expansion really effective and thus to help drag the market economy out of its present deadlock. Or to use expressions employed earlier in this book: the public sector of the national economy has to be enlarged to make up for the contraction of the private sector and to start a process leading to the re-expansion of the latter. As soon as the re-expansion of the private sector is sufficiently under way so that the economic circuit, relieved of its torpor, is working again, the expansion of the public sector must be stopped and must even be turned into contraction if private expansion assumes anything approaching inflationary dimensions.

The general principle, then, of a policy of expansion by public initiative is to start credit expansion by using the State as the pioneer in starting up new borrowing in place of the scared entrepreneurs. Once this general principle is understood, it is only a technical question how to execute this programme. To this end two broad courses are open. The one is to bring about deliberately a regular budget deficit by the abolition or lowering of taxes or by raising expenditure or by both. The other is to borrow in order to finance large public works or, in other words, to create a budget deficit by expenditure of an extraordinary and special nature. Both methods have their advantages and disadvantages which have to be weighed up against each other without any dogmatic preferences or political prejudices.30

The first method of deliberately creating a regular budget deficit appears especially advantageous if the budget deficit is brought about by abolishing or lowering those taxes which, as explained on an earlier occasion (§ 21), fall most heavily on production and enterprise (business taxes, turnover taxes, stock exchange taxes, &c). In this way two birds would be killed with one stone. An expansion of credit would be effected as a result of the State’s additional demand for credit, and at the same time a very strong stimulus would be provided to private initiative, causing an expansion of credit in the private sector also. This method thus presents an attractive combination of the policy of expansion by public initiative with the “provocative therapy” applied to the private sector. This is equivalent to saying that it has the great advantage of departing in the least possible degree from the normal behaviour of our economic system. Connected with this is the other appreciable advantage that it is most conducive to creating a psychological atmosphere of normalcy which gives little chance to all sorts of wild reformers of hysterically hailing the beginning of a “new epoch.” Finally, this method has the merit of working promptly and without the need of a new and costly organization whereas it takes a considerable time to develop a programme of public works. On the other hand, it has the great psychological drawback that it does not sugar the bitter pill of a budget deficit. To cover regular expenditure by increasing public indebtedness seems to run counter to the most sacred principles of orthodox public finance. It takes strong nerves cold-bloodedly to stand the sight of such a budget deficit in all its naked horror, and most people perhaps would prefer to draw over it the merciful veil of public works. Whatever we may do to mitigate these fears, we have to accept them for the moment and to shape our programme according to them. This psychological drawback becomes especially important if the budget deficit has to be covered not by short-term advances but by government issues offered for public subscription. In this case it is to be feared that a mere budget deficit to be covered by these bonds will seem less attractive to the imagination of the public than public works. Shining automobile roads, water-dams or cleared slums look rather nice on posters inviting the public to buy government bonds while the mere gap between revenue and expenditure lends itself less readily to artistic propaganda. These are some of the psychological points which have to be very seriously considered. It has to be kept in mind, moreover, that making an excusable exception of the principles of conscientious administration of public finances might render it very difficult later on to bring those principles back to the respect which they deserve. It is certainly extremely dangerous to make, even for a short while and under exceptional circumstances, the spirit of financial recklessness respectable—though in these times of the secondary depression there is nothing that is not dangerous, most of all the policy of letting things drift.

A rather interesting experiment with a very mild form of this method was made in Germany towards the end of 1932 under Chancellor von Papen. It was based on providing incentives for new investment by private entrepreneurs. These incentives consisted mainly of certificates to be given to business men in return for payment of those taxes which, as explained above, may be regarded as a direct burden on production, in the sense that their removal may be expected to react promptly on the willingness of entrepreneurs to undertake new investment. The certificates (Steuergutscheine) were to be redeemed at a later date, together with a certain agio, and they were made rediscountable at the Reichsbank so as to give them the character of negotiable paper of the most liquid type. What in effect the plan amounted to was that the most burdensome taxes (business taxes, turnover tax, &c.), while not actually being abolished, were transformed into liquid assets. The whole system was rather complicated, but its meaning can be summed up by saying that in the place of these taxes there was instituted a forced loan, the titles to which, thanks to the collaboration of the banking system, could be sold or employed as collateral. In other words, a certain amount of taxes were virtually abolished, but the financial burden of this abolition was temporarily shifted from the State to the banking system, which would expand credit to the corresponding degree. This assumed that business men would employ their certificates, not for paying off or consolidating old debts—improving their own liquidity thereby—but for making new investments in working or fixed capital. The behaviour of the entrepreneur of course constituted the real problem. While he might or might not respond to the stimuli administered to him, on the whole it appeared likely, at that time, that the degree of response would be insufficient to render the pull effective. The only result would then be an improvement of private balance-sheets and an increase of the public debt, without any visible alleviation of general economic conditions. For these reasons, the Papen Plan did not prove, indeed, a great success. The success would undoubtedly have been much greater if the government had had the courage to abolish the taxes in question without the roundabout way of the tax certificates. In this case a prompt expansion of credit would have been ensured, regardless of the uncertain behaviour of the entrepreneurs. For this reason it has been a very illuminating experiment.

The advantages of the first method are, to a large extent, the disadvantages of the second method (i.e., the method of public works), and vice versa. It takes rather a long time to develop the latter, and it gives rise to new and costly organizations. It must be considered as a further disadvantage of this method that it is very apt to create the impression of a marked departure from the normal behaviour of our economic system so that there is much unnecessary talk about Planning and the dawn of a “new era,” though, on the other hand, it can be argued that it may be the least harmful diversion of the socialistic leanings of our times. A much discussed point is whether public works mean a waste of productive resources. As contrasted with the first method, it could be argued that in the case of public works we have at least something to show for the budget deficit, or, to put it in another way, public works might be said to bridge the gap between saving and investment by raising investment instead of decreasing (or wasting) saving. There seems to be some misunderstanding here, however. The difference in the primary effects of the two methods must not be mistaken for a difference in their ultimate effect which is to overcome the depression by setting the normal circuit of economic life again in action and by equalizing saving and investment on the highest possible level of investment compatible with the volume of voluntary savings. The fact that in the case of public works the primary (“pulling”) effect is connected with the construction of public roads or other things is really not so important since the first method also will give rise to new investments, which may perhaps be more in accordance with the preference scales of the community. It is just this point which many adversaries of public works have in mind. It is, indeed, not always easy to find, in the necessary amount, projects for public works which can be defended as compared with the private investments evoked by the first method. This comparison as regards a possible waste by public works is an essential point. Compared, however, with the waste of doing nothing at all, any waste in executing more or less unnecessary public works appears rather insignificant. Consequently, the only people who are entitled to criticize the possibly wasteful character of public works are those who can suggest a better method of expansion. Compared with the first method, public works have the advantage that they represent a form of budget deficit which facilitates the task of abating the psychological shock of such a bold course and of letting it appear less reckless and adventurous, though there will be differences, in this respect, from country to country. A last point to be considered is whether the very fact that public works attack the problem of the economic deadlock from outside the private market system, might not, apart from its psychological drawbacks, offer some advantage of a more mechanical character, since it transfers the starting point into a non-competitive sphere, perhaps avoiding thereby a good deal of primary friction.31

The conclusion to be drawn from this discussion of the two methods of public expansion is that their respective advantages and disadvantages are so much in the balance as to make it impossible to say beforehand which is superior. As a general rule, therefore, it seems advisable to combine both in the manner best suited to the special circumstances of each country. In both cases, it is an essential condition, however, that the government should raise the funds for its programme in a way which really ensures an expansion of money and credit. Nothing would be gained, therefore, if the funds were to come out of savings which would have been invested in any case. That is the reason why there is some doubt as to the usefulness of raising the funds by placing long-term issues on the capital market. This method would result in expansion only under one of two conditions. Either there must be bank advances to contractors or to the subscribers to the loans issued by the government, or, if this is not the case, the funds must come from hoards (including idle deposits) which would not have been invested save for the special attractions of the government issues. The prospects of the latter are not too bright since there is no reason why anybody who is prepared to invest should not have other almost equally attractive opportunities for investment. Idle money might be lured out to some extent, but as this must of necessity be rather small, only a fraction of the public expansion necessary for an effective “pull” can be financed in this way. The bulk, therefore, must be financed by short-term advances the technique of which will not be discussed here. This is, moreover, the method which exactly corresponds to the financial situation at the time of the advanced depression when an exceedingly low rate of interest prevails on the money market while the rate on the capital market remains relatively high. It seems, therefore, logical for a policy of public expansion to draw by preference on the easy money market instead of the still rather tight capital market. Repulsive as this idea must seem from the point of view of the normal principles of sound finance, there is, indeed, a special virtue, at this extraordinary period, in preferring short-term advances to long-term notations for financing public expansion. The consolidating of these advances later on during the full development of recovery has the additional advantage of exerting a checking influence on the boom.

These, then, are the broad principles of a policy of expansion. It cannot be said too often, however, that complete success depends upon the skilful and considerate hand with which it is executed with a view to the special conditions of the country, its general atmosphere, and the mentality of the people. It must be combined with a general economic policy which, marked by circumspection and sober consideration for continuity, is susceptible of inspiring confidence and optimism. A riotous political atmosphere, regimentation, economic rigidity, monetary instability, cynical boasting of unorthodoxy in economics and politics, legal insecurity, and lack of respect for contractual obligations—all these and many other things are fatal for a policy of expansion. The combining of expansion with the breaking up of economic rigidities, the balancing of orthodox with unorthodox measures, a minimum of new constructions and a maximum of conservatism, should be the guiding principle for a wise policy of expansion.32 The less we hear of “reconstruction” and “new epochs,” the more we avoid creating the impression that we need a new money or credit system,33 a new State, a new philosophy and newer and better economics, the greater will be the prospects of success. There is, however, a great danger in retarding the policy of expansion, for the longer we wait the more probable it becomes that the growing hysteria will finally result in a crude and reckless sort of expansion, if not in the complete upheaval of the economic and political structure of society.

While the success of a policy of expansion is fairly conspicuous in the case of Great Britain, of Sweden, of Australia and a number of other countries, there are some countries whose experiences are not so encouraging. Pre-eminent in this respect are the United States and Germany. Though much has been said already on the recovery programme of these two countries on various occasions in this book, it seems pertinent to refer to them again in a more coherent manner.

Everybody who was convinced that the economic recovery of the world was to be expected predominantly from a policy of expansion in the great creditor countries, felt relieved when in the spring of 1933 the Roosevelt Administration seemed determined to launch such a policy. But from the beginning the effect was spoilt by the fact that the Roosevelt Administration, influenced by a set of particularly confused ideas, pulled at levers which brought disorder into the whole mechanism of recovery, almost up to the present day. This confusion was a twofold one. Besides confusing re-expansion with reflation (in the sense explained on an earlier occasion), the Roosevelt Administration made the second mistake of pursuing this wrong goal by an equally wrong means, i.e., by abandoning the Gold Standard and depreciating the dollar, without going far, at first, in real expansion. Valuable time was lost in all kinds of monetary manœuvres for making the depreciation of the dollar really effective, while the opportunities of the World Economic Conference in London in the summer of 1933 were deliberately wasted. The inevitable reaction to the speculative boom brought about by the devaluation of the dollar gave rise, later on, to the familiar chain of more or less radical interventions which added considerably towards impairing the elasticity of the economic system and shaking the general confidence and optimism which were already undermined by the monetary instability. Small wonder that, in the face of these attacks on the mechanism of reactions of the American economic system and on the psychological attitude of the groups most important for recovery, the New Deal had a rather wavering success. It is rather a wonder, and altogether a credit to the vitality of American capitalism, that, in spite of these obstructions, a considerable measure of recovery has been achieved. But the great chance offered to the Roosevelt Administration in 1933 has been definitely missed. At that time it could have laid the foundations of a solid recovery and earned the gratitude of the whole world if it had combined a policy of effective expansion (by public works, lowering of burdensome taxes, incentives to new private investments, subsidies to farmers and other destitute groups, &c.) with a policy of adjustments in prices and costs and of staunch maintenance of the Gold Standard, ensuring by such a combination of boldness and confidence-inspiring conservatism the transmission of the igniting spark from the public to the private sector of the community. On the strength of the more encouraging development later on, the danger that the unfortunate combination chosen by the Roosevelt Administration for its policy of recovery might eventually result in an enormous volume of public indebtedness and in the economic systems being made inflexible and unmanageable by interventionist ossification, seems to have been averted, but in the meantime untold harm has been done to the country itself and to the world as a whole. No better proof of these views could be found than the fact that recently a very hopeful recovery has promptly set in immediately after the obstructive parts of the N.R.A. policy were removed and the dollar brought to rest.

Owing to the lack of exhaustive and reliable information, it is very difficult to give any approximately exact account of the German policy of recovery, the more so since the political implications of this case are very apt to lead even the most unbiased observer astray. On the whole, it seems safe to say that the success of the Third Reich’s policy of recovery was until quite recently much greater than most of its political adversaries believed, but also that it is not quite as great nor quite as certain as its representatives usually affirm. The error of the first group which has been in the habit of counting on an early breakdown of the German recovery programme is very interesting, as it throws some further light on general questions treated in the course of this book. The belief that the economic policy of the Hitler Government was heading for an early disaster reminds us somewhat of the well-known opinion, held by many people at the outbreak of the Great War, that the war could not last more than a few months. In both cases the enormous elasticity of capitalism was seriously overlooked. It is true that the greater part of the public expenditure of the Hitler Government has been unproductive and, looked at from the standpoint of its primary effect, even positively wasteful, especially the expenditure on rearmament. But, owing to the secondary effects of this expenditure and to the existence of large idle capacity and man-power, the result, surprising only to the superficial judge, was, up till recently, that the population had on the whole certainly not been made much worse off by it, though this result was largely obscured by the simultaneous process of depriving certain groups of the population of their means of livelihood for political reasons.

It is, therefore, not the programme of public works and the other stimuli connected with it that are to be blamed, nor the expansion of credit which is sometimes incorrectly called “inflation.” Not that the Hitler Government embarked on a policy of expansion is the bad thing, but that it did so under circumstances and by a combination of political and economic measures which gave small chance of ultimate success. Like the United States—but to a much greater degree and in a much more disquieting manner—Germany is an outstanding example of a rather ill-fated policy of expansion. It illustrates extremely well the truth of the statement that once expansion has become the subject of mass cries and mass discussions it is in great danger of being finally executed under the worst possible circumstances and in a crude and ill-considered manner. By creating a dangerous political atmosphere inside and outside of the country and by trying to remodel its economic system on autarkistic and heavily interventionist or even socialistic lines, the Government went far in destroying the framework of economic reactions on which the philosophy of expansion must be based.34 On top of this the German Government evidently went further in expansion than would have been defensible even under better circumstances. Since there is, despite the great cost of public expansion, still little sign of private initiative having been aroused to the necessary extent, and since also there are small signs that the financial mechanism of the country has come any nearer to normal working order, expansion in Germany is still largely confined to the public sector, with small hope of any change for the better in the immediate future. Economic activity in Germany is still dependent to a large degree on continued public expansion, while it should be expected that, with the progress of the policy of expansion and with increasing activity in the private sector, public expansion would gradually become less important for the total economic activity. But with the public debt rapidly accumulating, it becomes pertinent to ask how long this course can be pursued.

In the case of Germany, there is a very real danger that the ultimate result of the experiment may consist of a gigantic volume of public indebtedness and of the economic system’s being made inflexible and unmanageable by interventionist ossification. In spite of the opinion, widely held in Government circles, that the normal working of the German economic system, based on private initiative and the freedom of markets, is to be restored as soon as possible, Germany has become not less but more entangled in the web of artificial constructions and interferences. The most fatal flaw in the whole process is undoubtedly the foreign-trade situation. Even under the conditions prevailing before the new régime, it was to be expected that a serious strain on the balance of payments would result from an internal business revival, engendering, as it does, increased imports of raw materials without a simultaneous rise of exports of industrial goods and without any appreciable reserves of gold or foreign exchange. To bridge this “import gap” Germany would have to rely for an intermediate period on foreign credits. Unfortunately, however, things took a fatal turn in two directions. Firstly, exports fell off at a catastrophic rate, owing to various reasons, among which the autarkistic tendencies of German Commercial Policy, especially in agricultural products, have been particularly conspicuous.35 For years and years the warnings of the more far-seeing people against this trend had been ridiculed and decried by the advocates of economic nationalism, but the experience of the last years has been sufficient to turn this spirit of mockery into the greatest anxiety. At the same time, the wholesale cartellization of German industry as a solid by-product of semi-socialistic ideologies together with the enhancement of the cost of living by agrarian protectionism and with the devaluation of leading currencies increased the difficulties of German industry in competing on the world markets. While the “import gap” was widened by these tendencies, the chances of getting new foreign credits fell off, at least temporarily, almost to zero point. It is this desperate situation around which centres the greater part of the German difficulties at the present moment, and the manifold interventions to which they give rise are bound to react in turn very unfavourably on the internal conditions of economic recovery, as, e.g., the heavy tax on industrial turnover recently introduced in order to create a fund for export bounties. Since the expedient of devaluation is also not without its drawbacks in the case of Germany, the prognosis for this type of a policy of expansion must, with all allowances for the elasticity of capitalism, be rather reserved.

It is well, however, to refrain from all the gloomy prophecies which are so current now in many quarters. Many of the unfavourable factors might possibly take a turn for the better in the immediate future. The credit embargo against Germany can and will not last for ever, and the change in this respect will be accelerated by an improvement of the external and internal political atmosphere. At the same time, it is quite conceivable, under present conditions in Germany, that German protectionism might be modified in order to widen the export markets. All this may possibly be combined with a cautious devaluation of the mark preparatory to a reduction of exchange control.36 When the situation in foreign trade has been improved in this way, there is good reason to believe that the internal market also will be freed from many fetters. That is not to say that all these things will happen, but they may happen, and then there would be a chance that economic activity in Germany might be stabilized on a rather high level. In the case of Germany, therefore, all prophecies are more or less futile, though it must be said that the prospects are becoming increasingly bad.

It seems fit to conclude this short survey with some remarks on the situation in France since it is a good illustration of many points of general interest. France was one of the last countries to be hit by the present depression, but the development during the last two years leaves no doubt that it has now entered the phase of the secondary depression with its familiar vicious circle and even with its political and social implications. France has now, roughly speaking, reached the stage of Germany under Chancellor Brüning when it became impossible to avoid a growing budget deficit, and it is very ominous that in France also the difficulties of budgetary policy are slowly undermining the bases of the parliamentary and democratic system. On the other hand, however, the economic and financial position of France is still so strong as to make a policy of expansion fairly easy, even perhaps without devaluation and abandonment of the Gold Standard. The French difficulties, therefore, are more of a psychological character. Public opinion in France has not yet awakened to the truth that the rather uninviting choice between Brüning and Roosevelt does not exhaust the possibilities, and that a middle course, consisting of a policy of expansion combined with a steady policy of monetary stability and of economic conservatism, offers the best chances of success. France is just the country where the general principles of a sound policy of expansion, as explained in this and the preceding sections, seem to be especially applicable. Even the extremely sensitive mentality of the French population towards everything with the faintest smell of economic “unsoundness” should not be an unsurmountable obstacle to a fairly skilful policy of expansion with some eye for “window-dressing.” It seems that M. Flandin, when he was Prime Minister, had grasped the situation and the suitable means very well so that it was very unfortunate for the country that he was not allowed to pursue his policy. Under these circumstances, there is every reason to fear that the political convulsions accompanying the unchecked progress of deflation may, in France also, finally end in a crude policy of expansion as the result of exasperation and demagogy.

3. SYMPTOMATIC MEASURES (PALLIATIVES).

§ 27. UNEMPLOYMENT RELIEF.

We understand by symptomatic measures all those measures to which recourse is had in the depression in order to mitigate its social and economic effects without serving to bring about recovery. To these belongs first and foremost the task of in some way providing for the masses of unemployed, a task which must be performed even if in itself it offers no direct solution for getting out of the depression.

This assistance to the unemployed may take the form in the main of enabling them to exist by giving them goods or paying them money (unemployment relief). This may come from sources in the nature of self-help (trade unions) or from private charity. Where this is inadequate or comes up against other obstacles, the State or the local authorities may take over the relief of the unemployed as is to-day the case in greater or less degree in all the countries of leading economic importance in the world. The public unemployment relief may take either the form of relief grants or the form of unemployment insurance.

The necessity of providing for the unemployed in some form or other is just as self-evident as is the limitation of the extent to which this can take place having regard to the fact (among others) that the relief should not be so high as to undermine the willingness to work. We must look on the unemployed workman as a man who is making his way along a lengthy and often quite impassable track towards the profitable re-employment of his labour power. It is a matter of course that on this journey through the wilderness he must be provided with the necessities of his travel, but these must, unfortunately, not be so liberal that they cease to spur him on towards the attainment of the ultimate objective. This is a principle which has been sadly sinned against in some countries in recent years.

There is still another and much wider aspect of unemployment relief which has an important bearing on economic stability. What I have in mind is the unquestionable fact that unemployment relief, much as it is demanded by social justice, political common sense, and simple charity, has the drawback of making the wage system more rigid. A wage level above the competitive market level, or regional maladjustments of wages, could not be maintained if the pressure of unemployment consequent on these maladjustments were not neutralized by unemployment relief. From this aspect, unemployment relief appears as a sort of “valorization” for human labour, taking charge of the storage of this “product” for the purpose of “orderly marketing.” There is, therefore, no getting away from the fact that systematic unemployment relief tends to add to the rigidity and—so far as this rigidity is inimical to economic stability—also to the instability of our economic system. It must be said, however, that in times of enormous mass unemployment, such as accompanies the secondary depression, the rigidity of the wage system can no longer be considered as one of the major causes of depression and unemployment. The elasticity of demand for labour has by then so much decreased that in many cases even a wage approaching zero would not restore the equilibrium of supply and demand on the labour market; cases of a negative wage even are not altogether inconceivable in a period like this. It must be said, moreover, that it would be rather unfair, at this time, to attribute the rigidity of wages, to any appreciable degree, to unemployment relief. Unemployment benefits, especially in times of tenacious mass unemployment, can never be so high as seriously to damp the desire of every normal man to prefer any job at any reasonable wage to long-term unemployment. Accordingly, it is precisely in the period of tenacious mass unemployment that this objection against unemployment relief loses its force. Just at this time, unemployment relief appears as an almost unmitigated boon so far as this aspect is concerned. Needless to say, it is a very wasteful and objectionable policy as compared with a policy directed against the real causes of the secondary depression. It is an avowedly symptomatic measure. But if unemployment relief is financed out of funds which would otherwise have remained unspent or by an outright credit expansion, it may even exert a positively mitigating influence on the depression, though it could hardly be recommended as a deliberate instrument of public credit expansion.

As regards more normal times, it might be argued in favour of unemployment relief that, granted the creation or perpetuation of unemployment by this “valorization of labour,” the labouring class as a whole would nevertheless benefit by it so far as the combination of higher wages with some measure of unemployment resulted in a larger aggregate of wages than lower wages with little or no unemployment. To this it must be replied, however, that the benefit of the labouring class as a whole is an unreal entity unless the aggregate of wages is being “pooled” between the employed and the unemployed. Otherwise there is a very real conflict of interests between these two classes, and this conflict is apt to increase with growing unemployment. One way of pooling the total of wages is the more equal division of labour by shortening working hours. We shall return to this suggestion in the next section.

A very important question is whether unemployment insurance or unemployment “doles” are to be preferred. The first is undoubtedly superior to the second in so far as it is based on self-help and responsibility of employee and employer and does not degrade those who receive assistance into recipients of charity. Moreover “doles” mean a direct charge on the exchequer. On the other hand, there is the restraining fact that the experiences of all countries at the present time indicate a failure of the principle of pure unemployment insurance. This failure was unavoidable for two reasons. The first is that on account of the violence of the fluctuations on the labour market and the uncertainty of every forecast, the risk of unemployment escapes any estimate of the precision necessary for insurance, with the result that in times of need the unemployment insurance scheme is either thrown back on government contributions or, counter to the principle of insurance, must gradually reduce its payments and introduce the “means test.” The second reason is that in the case of insurance against unemployment the occurrence of the event insured against is not independent of the conduct of the insured person so that insurance against unemployment comes critically near to insurance against fire in a country where arson is allowed.37

§ 28. OTHER MEASURES.

Everybody feels that the mere support of the unemployed is an extremely unsatisfactory form of unemployment assistance especially because of its demoralizing effects. It is consequently not difficult to understand that other methods should have been contemplated in order to lighten the lot of the unemployed, measures which amount to reabsorbing them in some way or other as working limbs of the society without having to wait until the end of the depression. Such measures include the following:

1. Proportional sharing out of the amount of employment available. The methods proposed for attaining this end are: (a) the shortening of working hours (spreading of the work) which would result in turning the fully employed workers whom it adversely affects and the unemployed workers whom it reabsorbs into short-time workers. This already takes place to a considerable extent spontaneously. So the question is only whether the extent of short-time working should be augmented by government force. The most radical proposal of this kind is the proposal for the introduction of the forty-hour week. It we want to judge these efforts rightly, we must realize at once that we cannot reject them in principle. The very fact that many entrepreneurs proceed in this way of their own accord partly in order to avoid dismissals and partly in order to be able to take on additional employees should bring us to the conclusion that the universal application of the practice is at least worthy of consideration especially if it appears that public relief to the unemployed to-day decides many employers no longer to utilize the method of short-time to the extent that was usual in former times, but to leave the care of the unemployed to the public authorities. The universal application of the principle is open, however, to grave doubts. As soon as it is clear that there can be no question of shortening working hours and then compensating this by wage adjustments (or only under the assumption that the productivity of labour is increased in which case the shortening of working hours as a palliative loses its sense) it is plain that it imposes a sharp reduction of earnings on those who were previously fully employed. The peculiarity of this reduction of earnings, however, is that in contrast to a general reduction in wage rates it brings no relief to entrepreneurs—on the contrary it causes expense and difficulties. That this is a dubious procedure is all the more obvious if we have to count with the possibility that a general reduction of wage rates must take place eventually. It has then the effect of demanding a considerable sacrifice from the employed workmen on behalf of their fellow-workmen in the same trade without its bringing the relief to the firms which is necessary in order to make them profitable.

This doubt must be given double weight if the proposal is one of spreading the work by government force. It is not only the justified aversion to an increase in politico-social regimentation and a further strengthening of the power of social bureaucracy which speaks against it, but also the fear that it will be extremely difficult for the responsible authorities to judge competently the technical and organizational possibilities of executing the proposal, especially as conditions vary not only from industry to industry but also from firm to firm. Finally, one should not over-estimate the amount of employment that it will provide.

(b) The suppression of “unwarranted double earning,” a measure which is extremely popular and whose questionableness is very inadequately realized. Even the question as to what a “double earner” really is is difficult to decide. We must first know what a “single earner” is! How much is any one man allowed to earn? How much work may any one person do without becoming a “double earner” and a nuisance to society? What is the normal level? Everybody knows that these are absurd questions to which we can give no answer. But they serve to bring out the questionableness of the whole concept of the “double earner” and it appears that the attack on the “double earner” is tantamount not only to a punishment of hard work but also to the levelling up of earned incomes, to a “Bolshevism from below,” to the suppression of the free disposition over labour, and therefore to a further approach to a “white ant” community. It should be carefully noted that it is only earned incomes that are concerned since in the eyes of the populace it is not the adding together of incomes but the adding together of more than one “job” that holds out the challenge to “double earners.” A man becomes an alleged nuisance to society only by the fact that because he is more hard working than others he receives a higher income than others in the same class. But the man who receives an unearned income escapes this ex-communication by the people. He is left unmolested and this must be so as long as we do not want seriously to turn to Bolshevism all round. The poor devil who struggles then by the sweat of his brow to work his way above the poverty level will be pushed back into the grey mass of “single earners” while the levelling up of the great unearned incomes can only concern us theoretically from afar off if we do not want to explode the whole structure of society.

It is even more serious than this. If we are going to call “double earners” those who take away work from others by working “too much,” it really makes no difference whether this extra work is done as a second “job” or within the framework of the regular course of employment. The man who works hard simply becomes a “double earner” whose attention must be drawn—according to the opinion of the fanatical enemy of “double earning”—to the fact that his hard work is socially undesirable. For the same reasons it makes no difference whether the man who. “takes work away” from others is an employee or whether he works on his own. Even a fruit-seller who sells more fruit than the average “takes work away” from others and prevents an unemployed man from having the wherewithal to keep himself. Ought we then to control the distribution of the quantity of work in the independent trades and how can we proceed to do this? We should arrive at the most absurd results, and, moreover, it is very doubtful whether any measures taken against “double earners” would be effective. What guarantee can we provide that the man from whom we take away one kind of work will not now apply his services, which have been released, in some other way which is possibly even more undesirable than the first? It is indisputable that there are ample opportunities for using these services elsewhere (household duties, working at home, gardening, repairing door-bells and wireless sets, &c). Consequently the number of vacancies which would be created by such a measure is to be estimated at a very low figure. These doubts, to which we could go on adding, should prohibit any radical measures in this direction. This does not mean to say that regard should not still be had to circumstances of “double earning” in taking on or dismissing workmen.

2. Productive relief works, under which we understand all measures which are aimed at creating a demand for labour which does not spontaneously arise on the market. The fundamental principle on which they are based is that it is better to provide the unemployed with some kind of useful work than to leave them in idleness giving them relief payments and letting their labour power lie unutilized. This cannot, of course, apply to work which competes with normal production, and it must, moreover, be work that does not necessitate any great capital expenditure (digging!) since any extra amount over and above unemployment relief would reduce the available capital in the economic system and so produce unemployment somewhere else, except in the case where a credit expansion is undertaken which changes the whole aspect of productive relief works. In these circumstances the possibility of carrying out productive relief works is very limited especially as their total costs are, as a rule, not inconsiderably higher than the costs of the same projects when undertaken by private industry. Any real relief to the labour market is, therefore, not to be expected from productive relief works. But some form or other of such works seems useful as a means of testing the willingness to work of those in receipt of relief.

3. Compulsory labour service, which has been advocated for a long time in many quarters for the purpose of keeping a part of the unemployed out of idleness. It means fundamentally the universal application of productive relief works and is consequently just as problematical as the latter especially as the compulsory labour service is intended to apply not only to the unemployed but also to the whole of the population in certain age groups. The measure is, moreover, open to the following main objections: difficulties in the organization and in the proper limitation of the range of persons included, interruption of the ordinary occupational training of those liable to service, the removal of labour from the work which corresponds to its occupational ability, its suitability and inclinations, and of which it has become an organic part in accordance with the requirements of society and the labour market, and, lastly, a disproportionately high expenditure on organization. Finally, the idea of forcing people (even those who have employment) to work at a time of a surplus of labour resources has something illogical about it.

4. Land settlement. One of the products of the unsystematic thinking about the problem of unemployment is the idea—which is widely supported because it appeals to deep-rooted instincts—that we should permanently transfer a part of the unemployed on to the land. The notion at the back of this is that it will be impossible ever again to get industry working at its full capacity. It assumes that industrial over-production is a permanent phenomenon for which the only remedy is a movement “back to the land.” This notion is based on a very strange and quite inexplicable misunderstanding of the present situation, which is not characterized by the fact that the agricultural foundations of the economic system have turned out to be too small as compared with the industrial superstructure but quite the reverse. If there is any branch of economic activity which is faced by the prospect of a long lasting overproduction and chronic depression it is agriculture all over the world. A return to agriculture might have some sense if the agricultural countries pari passu with the advance of their own industrialization had continually decreasing agricultural surpluses to dispose of, but the actual fact is that they are stifling under these surpluses. If there is a tendency which even the most superficial consideration could not overlook, it is that the food requirements of the world, with a decline in the rate of population growth and increasing productivity in agriculture, can be covered with an ever smaller amount of labour. When the world trade-cycle again turns upwards, the increasing purchasing power of the world will fall to the benefit of industrial products in far greater measure than agricultural products and it might happen that many of those who are to-day eager to settle on the land would turn their backs on the land with its toil, self-denial, and hardships and take up the new openings for employment in industry. Then the “reagriculturalization” would change to “reindustrialization” an oscillation which is surely not very purposeful.

We should, indeed, do all we can to facilitate the way back to the land and the soil of those who have a keenness and love for agricultural life and who begin to despair of everything in the town as a consequence of their unemployment. Furthermore, giving smallholdings to industrial workers who cultivate them in their spare time is certainly desirable in order to give greater independence and security to the industrial workers and to make their existence less “proletarian.” So far, land settlement is undoubtedly a means of, to some extent, alleviating the depression, but we must not be carried away by a romanticism which has no foundation in hard fact.38 Before all, it must not be thought that we can in this way evade the task of overcoming the depression by the means which is proper and adequate to the system.

Finally, it must be said that a policy of land settlement may defeat its own purpose if it is connected with agrarian protectionism. The latter makes for unemployment in two ways : firstly, by damaging the export industries, and, secondly, by reducing the demand for those agricultural products of which the urban consumer will buy less when food is made dearer by agrarian protectionism. Those products with the higher elasticity of demand (e.g., butter, eggs, meat, &c.,) are, moreover, exactly those which represent not only a higher nutritional value but also a higher labour value. The case is still worse when protectionism is especially high for grain production as in Germany. It is not surprising, therefore, to find that agrarian production in Germany increased, from 1925 to 1933, by 27% while at the same time the number of persons employed in agriculture decreased by 4%, to say nothing of the increase of unemployment in the export industries brought about by the same policy.

5. Labour Nationalism. One of the worst consequences of a prolonged depression is the emergence of the idea that every foreigner who holds a job in the country is withholding this job from a native worker, thereby augmenting unemployment and making it necessary to dismiss him or to drive him out of the country. It is that same spirit of looking at the total work to be done as a fixed and definite quantity which, as we saw, manifests itself in the popular drive against everybody who has been lucky enough to snatch more than a proportionate share of the whole “labour pie.” But in the case of Labour Nationalism this perverted idea is much aggravated by the fact that here it is the foreigner who is sneaking into the national sanctuary of those who have the privilege to toil. In this case, therefore, the common spirit of envying other people their “jobs”—which is itself closely related to a crude over-production theory—is allied with all the feelings which go with nationalism. It is small wonder then that it is nowadays so popular that it becomes not inapt to speak of Labour Autarky. This state of affairs is one of the most disquieting and even alarming things of the present time, and it is hardly less disquieting that most people give little thought to it. Not everybody seems to realize that the total number of foreigners living, and mostly working, in the civilized countries constitutes a real “nation of foreigners” equal in number perhaps to the inhabitants of England or Italy, and, what is more, that this interchange of men is not the least important part of our complicated economic system, to say nothing of its spiritual implications. Still worse, with the spread of Illiberalism in government there is a constantly growing number of emigrants who have been deprived of the citizenship of their native countries, so that, if this “Autarky in men” becomes general, they will simply have nowhere to go. since there is no legal place for them on this blessed earth.

These objections of a more general character to Labour Nationalism as a palliative against unemployment are enormously strengthened by the fact that even as a mere palliative it seems very questionable. Quite apart from the fact that in many cases the foreign workers are specialists whose replacement by native workers would greatly damage the country, it is to. be feared that to prevent foreigners from working would deprive the country of a great part of its most energetic and inventive persons, since those who go abroad are usually not the duller but the more enterprising type of the inhabitants. But there is a still wider aspect of the matter which cannot be emphasized too strongly. It is the economic narrow-mindedness around the whole conception of a fixed and definite quantity of work to be distributed in equal shares, a conception the wrongness of which surely does not need to be proved once again at the end of this book. It constitutes the very impotence of an economic policy which is exhausting itself in accepting the “shortage of work” without the imagination and courage to see the latent possibilities of work and make them actual by restoring economic equilibrium. And it is the ominous alliance of narrow-mindedness, impotence, and Illiberalism which has made the atmosphere of the world so unbreathable in the last ten years. But it is never too late to learn that a brighter future is to be expected not from coercion but from freedom, not from regimentation but from individual spontaneity, not from autarky and war but from free international intercourse and peace, not from restriction but from expansion.

 

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39 It is a curious fact that in economic affairs the artifical things usually attract greater attention than the spontaneous ones, presumably because the latter are taken more or less for granted, but also because the artificial things are mostly done by dictatorial governments who know how to secure publicity for their activities. What Russia has accomplished through the Five Year Plan is really a trifle as compared with the spontaneous investment waves of capitalism and it is an open question what capitalism would have achieved in Russia under the same circumstances. While the Russian reconstruction was astonishing the world, the reconstruction of the devastated areas in France, for example, went on almost unnoticed.

40 The problem of unemployment is beyond the scope of this book. From amongst the extensive literature on the subject we may mention : W. H. Beveridge, Unemployment, A Problem of Industry, new ed., London, 1930; A. Mahr, Hauptprobleme der Arbeitslosigkeit, Leipzig and Vienna, 1931; H. Clay, The Post-War Unemployment Problem, London, 1930; A. C. Pigou, The Theory of Unemployment, London, 1933.

41 On this see : F. Neumark, Konjunktur und Steuern, Bonn, 1930; H. Fick, Finanzwirtschaft und Konjunktur, Jena, 1932; J. Lescure, Des Crises Générales et Périodiques de Surproduction, 3rd ed., Paris, 1923, pp. 288-296; H. Dalton, Unbalanced Budgets, London, 1934; H. Laufenburger, “The Interplay of Taxation and Economic Fluctuations,” Index (Stockholm), May 1935.

42 These and the other figures are quoted from E. Wagemann, Zwischenbilanz der Krisenpolitik, Berlin, 1935. It is worth noting that in Germany the percentage of the national income taken by public expenditure has risen during the depression to still higher figures (30 in 1930, 32 in 1931, and 35 in 1932), while the national income decreased at a precipitous rate.

43 From among the spate of literature on the subject of credit policy and the trade cycle may be cited : J. M. Keynes, A Treatise on Money, London, 1930; J. R. Bellerby, Control of Credit, London, 1924; A. Schmitt, Kreditpolitik und Konjunkturpolitik in Theorie und Praxis, Jena, 1932; L. A. Hahn, Kredit und Krise, Tübingen, 1931; D. H. Robertson, Banking Policy and the Price Level, third impression revised, London, 1932; D. H. Robertson, “Theories of Banking Policy,” Economica, June 1928; G. D. H. Cole and others, What Everybody Wants to Know about Money, London, 1933; R. G. Hawtrey, The Art of Central Banking, London, 1932; “Monetary Policy and the Depression” (Royal Institute of International Affairs), London, 1933; and the aforementioned writings of F. A. von Hayek. Cf. also the present writer’s article “Kredit und Konjunktur,” Jahrbücher für Nationalökonomie und Statistik, March-April 1926.

44 See G. Haberler, Der Sinn der Indexzahlen, Tübingen, 1927, and also the same author’s “Die Kaufkraft des Geldes und die Stabilisierung der Wirtschaft,” Schmollers Jahrbuch, 55th year, 1931.

45 Irving Fisher, The Purchasing Power of Money, 2nd ed., New York, 1922.

46 Cf. Hayek, Prices and Production; D. H. Robertson, “Theories of Banking Policy,” Economica, June 1928; Koopmans, “Zum Problem des ‘neutralen’ Geldes,” Beiträge zur Geldtheorie, edited by F. A. von Hayek, Vienna, 1933; G. Haberler, op. cit.; A. Mahr, “Neutrales oder wertstabiles Geld?” Weltwirtschaftliches Archiv, July 1933; Bilimovic, “Zum Problem des ‘neutralen’ Geldes,” Zeitschrift für Nationalökonomie, VI, 1935; A. Cabiati, “La moneta ‘neutrale’ in un libro del Dr. Hayek,” in his book Crisi del Liberismo o errori di uomini? Turin, 1934; “Economic Reconstruction,” Report of the Columbia University Commission, New York, 1934.

47 Since 1932 open-market operations have been one of the main instruments of the expansionist policy of the Bank of England, and since 1933 also of the Reichsbank.

48 Such a policy has to be distinguished from the long-established American practice of protecting the security of bank deposits by minimum legal reserve requirements. The object of this is to regulate the liquidity position of the banks while the measure envisaged in the text above is intended to regulate the volume of bank money in accordance with the phase of the business cycle. The reserve percentage in the former case is fixed while in the latter it is variable.

49 The policy of varying reserve requirements against deposits has been discussed above only as an instrument of the (quantitative) control of credit for mitigating cyclical fluctuations. Its appraisal from this point of view does not exclude that it may be exposed to serious doubts in other respects, especially as it may dull the sense of responsibility on the part of the banks.

50 This policy is the main idea behind the “Compensatory Economy” which W. Lippman has very ably described in his recent book The Method of Freedom (London, 1934), as the only way out of the awkward alternative between laissez-faire and planned economy.

51 A detailed and well-balanced treatment of this question may be found in Professor Hansen’s paper “The Flow of Purchasing Power” in the Report of the Columbia University Commission on Economic Reconstruction (New York, 1934, pp. 210-237).

52 Cf. J. Dobretsberger, Freie oder gebundene Wirtschaft? Zusammenhang zwischen Konjunkturverlauf und Wirtschaftsform, Munich, 1932; H. Lieser, Kartelle und Konjunktur in ihrer wechselseitigen Beeinflussung, Vienna, 1934.

53 Cf. p. 106.

54 Cf. W. Röpke, German Commercial Policy, London, 1934.

55 Cf. H. Levy, Industrial Germany, Cambridge, 1935. See, however, the present author’s review of this book in Economica, February 1936.

56 Cf. the author’s article “Fascist Economics,” Economica, February 1935.

57 It is important to note that present-day Austria, guided by the sociological teachings of modern Catholicism, is making use of the corporative principle in a quite different and very interesting manner which, by largely confining it to the moral and political sphere, precludes the dangers indicated above.

58 pp. 73-75.

59 A detailed treatment of this question may be found in Mr. Keynes’ Treatise on Money, vol. II. Cf. also E. Hantos, Die Kooperation der Notenbanken, Tübingen, 1931.

60 For a fuller and critical treatment see G. Haberler, The Theory of International Trade, London, 1936, and B. Whale, International Trade, 2nd ed., London, 1934 (more elementary).

61 It is pleasing to find that the “Economy Stunt” has been rejected on the same lines by the late Professor Cannan, in his customary pungent manner, in his paper on “Too Little Saving,” published in his book Economic Scares, London, 1933. “It is no advantage to society,” says Professor Cannan, “to do without flowers unless it is to get something better instead. The flower-gardeners at present give society flowers and receive in return the bread and beer and other goods and services on which the money they get in exchange for flowers is expended by them. If they are told, that they can leave off producing flowers because society has resolved to ‘economize,’ but that society will continue to pay them as much as before, nothing will happen so long as they live and continue to receive their pensions in idleness except that society will have no flowers. Evidently there is no sense in the advice, ‘Dispense with flowers,’ unless it is to lead to something more really desirable being produced in their place. Here lay the fatal objection to the great Economy Stunt. There was not the slightest reason to suppose that there was any need to redistribute the forces actually in employment. The preachers of the Stunt revelled in denouncing this, that, and the other employment as unnecessary or unimportant, but always completely failed to say what were the more necessary and important employments into which the persons and machinery now employed in what they said were unnecessary or unimportant ways should be drafted. . . . What was wanted was not to change the employment of the actually employed, but to re-employ the unemployed in their old work or in something substituted for it” (pp. 79-80). Professor Cannan rightly draws attention also to the important point that the expenditure for consumption is less likely to be influenced by this propaganda than the expenditure for capital goods, so that it tends to deepen the gap between investments and savings which, as we saw, is the prime cause of the secondary depression.

62 Cf. the present author’s little book Die Theorie der Kapitalbildung, Tübingen, 1929. He has again great pleasure in noting that the argument above runs parallel to Professor Cannan’s reasoning in his paper on “Too Little Saving.”

63 It has to be noted that, in the absence of a considerable expansion of the volume of money, it will not be easy to prevent the exchange value of the currency from going up again unless devaluation starts a flight of capital from the country.

64 The same reasoning applies to the popular contraposition of “Profit Economy” and “Want-satisfying Economy” which is equally illogical. Our present economic system is also essentially a want-satisfying economy since profit depends on the degree in which the wants of the consumers are being satisfied. In calling our competitive market economy a “Profit Economy” we denote the special method of satisfying wants. It would be logical, therefore, to speak of the socialist form of want-satisfying economy as “Office Economy” or “Command Economy.” Whether wants are better satisfied by the method of Profit Economy or by that of Office Economy is a separate question.

65 Cf. especially G. Haberler, Liberale und planwirtschaftliche Handelspolitik, Berlin, 1934.

66 An excellent treatment of this question may be found in Professor Robbins Great Depression, loc. cit., chap. vii.

67 Though there is still as much reason as ever for condemning protectionism of any kind it can hardly be denied that the use of tariffs as an equilibrating instrument during a depression cannot be dismissed as a priori unsound. During this period—but only then—it may serve two purposes. Firstly, it may help to restore the external equilibrium of a country without having recourse to devaluation and too much wage-cutting. Secondly, a little protection here and there may give a stimulus to new investments as was remarked above in the text. In this case, the Free Trade argument is not quite convincing since the social loss brought about by protection may be more than compensated by the social gain derived from the reduction of unused productive capacity. The whole problem has been widely discussed especially in England during recent years. Cf. : Beveridge, Tariffs: The Case Examined, London, 1931; Keynes, Essays in Persuasion, London, 1933, pp. 271-287; Robbins, The Great Depression, chap, viii; G. Haberler, The Theory of International Trade, London, 1936, pp. 259-273; Th. Balogh, “Löhne, Arbeits-losigkeit und Zölle,” Weltwirtschaftliches Archiv, October 1931; E. F. Harrod, International Economics, London, 1933, pp. 194-201.

To admit tariffs as a possibility in “provocative therapy” is not to say that it is a particularly recommendable one. Its worst side is that tariffs, once introduced, are very hard to remove. Furthermore, it will be difficult to keep this remedy within the very restricted limits where it does more good than harm. There are other and less dangerous methods than this, and it is quite arguable that a policy of public initiative is to be preferred to this method of giving encouragement to private initiative. Finally, the tariff method is applicable only if there were hitherto no tariffs or only very low tariffs. In cases where tariffs have already become the backbone of industrial monopolies, the interests of recovery will be better served by removing or substantially lowering them rather than by introducing new tariffs. In the opinion of the present author, there is always a strong presumption in favour of a policy of expansion by public initiative combined with a policy breaking up all kinds of market rigidities.

68 Cf. R. G. Hawtrey, Trade Depression and the Way Out, new ed., London, 1933, pp. 126-144.

69 The effect of public works on general economic activity does not differ from any other form of credit expansion, as soon as the primary effect has really led to credit expansion in the private sector. There is, therefore, no need for a special theory of the secondary effects of public works. Cf. however : J. M. Keynes, The Means to Prosperity, London, 1933; R. F. Kahn, “The Relation of Home Investment to Unemployment,” Economic Journal, June 1931; J. M. Clark, “Aggregate Spending by Public Works,” American Economic Review, March 1935; M. Mitnitzky, “Economic Effects of Changes in Consumers’ Demand,” Social Research, May 1934; H. Neisser, “Oeffentliche Kapitalanlagen in ihrer Wirkung auf den Beschäftigungsgrad,” Economic Essays in Honour of Gustav Cassel, London, 1933, pp. 459-477.

70 A good example of this judicious combination seems to be the recovery programme of Australia on which a competent authority (Professor Copland, International Affairs, January-February 1934) says : “It is not unreasonable to say that the success of the Australian plan lay in its neat balance of orthodox and unorthodox measures. Deflationary elements created confidence in the capacity of the governments to make necessary adjustments, the inflationary elements prevented these deflationary forces from causing further slackening of enterprise and laid the foundations for financial recovery, which always precedes economic recovery.”

71 For this reason we must be extremely distrustful of all the more or less cranky monetary schemes like “stamp money” and such like. Cf. the delightful paper by Mr. H. T. N. Gaitskell on “Four Monetary Heretics” in Professor Cole’s What Everybody Wants to Know about Money, London, 1933.

72 Cf. the author’s “Trends in German Business Cycle Policy,” Economic Journal, September 1933, where the development was predicted along the lines explained above.

73 Cf. the author’s book on German Commercial Policy, London, 1934. It should not be forgotten, however, that the foundations of the autarky have been laid by former governments, and this not without assistance from socialist circles.

74 As regards Germany’s chance of getting rid of its present system of exchange control, two points have to be reckoned with : firstly, the desperate foreign debt situation, and, secondly, the internal political pressure which, as it makes wealthy persons desirous of leaving the country, is incompatible with a free exchange market. A huge foreign loan of several billions of marks and a change of the political factor, therefore, appear to be indispensable prerequisites for any return to economic normalcy.

75 For a fuller and more technical treatment of the problems and experiences of unemployment relief cf. : W. Beveridge, Unemployment; A Problem of Industry, new ed., London, 1933; A. C. C. Hill and I. Lubin, The British Attack on Unemployment, Washington, 1934; R. G. Elbert, Unemployment and Relief, New York, 1934; O. Weigert, Administration of Placement and Unemployment Insurance in Germany, New York, 1934; G. Colm, “Methods of Financing Unemployment Compensation,” Social Research, May Ì935; F. Wunderlich, “Insurance or Relief,” Social Research, May 1935.

76 Even in Germany where the policy of land settlement has been pursued with particular energy since the war, people have come to realize that land settlement can at best do no more than to diminish the drift to the cities and to give “subsistence holdings” to industrial workers. Ambitious hopes that land settlement might be a real cure for unemployment had to be abandoned. Cf. Christopher Turner, Land Settlement in Germany, London, 1935.

• 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.
• 39This 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.
• 40Exactly 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.
• 41Exactly 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.
• 42We 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.
• 43We 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.
• 44Almost 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.
• 45It 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.
• 46The 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.
• 47This 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)—
• 48The 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.
• 49As 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.
• 50export trade,
• 51This 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.
• 52To 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.
• 53To 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.
• 54The 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.
• 55The 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:—
• 56The 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).
• 57The 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).
• 58The 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.
• 59A 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.
• 60In 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.
• 61The 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.
• 62The 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.
• 63This 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.
• 64This 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.
• 65Over-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?
• 66Over-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?
• 67In 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.
• 68In 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.
• 69In 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.
• 70The 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.
• 71The 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.
• 72Just 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.
• 73Just 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.
• 74Dr. 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.
• 75Dr. 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.
• 76Though 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.