Interest and Prices

THE ENIGMA OF BUSINESS CYCLES

By KNUT WICKSELL

Translated from Swedish1 by C. G. Uhr

When I gave the lecture I am now going to deliver the title “The Enigma of Business Cycles”, I did so without any pretence of being able to solve this riddle for you and rather in the hope of having it solved to my satisfaction with your help. In my reflections on this subject2 I have come to the conclusion that the decisive criterion for judging the tenability of various theories of crises must be obtained from experience, and from experience in a field where, unfortunately, official economic statistics give us no enlightenment. Perhaps I shall be fortunate in getting the guidance I seek from this audience among whom there are many who possess great practical experience of business life.

In order the better to delimit my subject, I must first ask leave to exclude from the field of my observations everything that has to do with the influence of monetary and credit systems on crises. No doubt this influence is great: crises obtain their true character only when they are sharpened into money-or credit-crises.3 The general lack of confidence, concern over one’s personal security, etc. paralyze at such times what we call the velocity of money turnover, and from the same cause many other types of media of exchange experience a much more restricted ability than in ordinary circumstances. But this aspect of the matter is also the one in respect of which economists, both theoretically and practically, have made most headway. The remedy, as seems to be generally agreed, lies in having a sufficient reserve of legal tender—whether of metal or of paper money is a matter of indifference—which is put to use only in times of economic recession and of threatening panic, in order, for the time being, to meet the urgent shortage of credit. This is an economic discovery by means of which, as we may hope, crises will for all time have lost some of their worst impact.

I must also bypass the question of the alleged periodicity of crises in its stricter meaning, namely the view that they recur at entirely regular intervals. If this view were well founded, then one would hardly be able to think of any other explanation for this condition than one that must be connected with external natural phenomena. W. S. Jevons’ well-known sun-spot theory is, as far as I know, the only attempt in that direction. It is probably also true that this theory is not altogether abandoned, for I have met at least one economist who still holds to it, namely the son of the great Jevons, who is a lecturer and writer on economics in England. Yet it seems to me that this theory rests on rather weak supports; neither its explanatory cause, the regularity of sunspots—and even less their influence on the size of crops—is undisputed, nor is the fact to be explained: the interval between the more well-known world crises, which at times has been 10, at times 11, and again only 7 years, etc.

On the other hand, if one is satisfied with a less strictly construed cycle, the sporadic occurrence of crises at irregular intervals, then one can conceive of its causes as inherent partly in external circumstances belonging to economic life as such, causes I shall touch on at a later point, and partly in the internal structure of the economy viewed from a material and a psychological standpoint, namely the period of time necessary for completing large economic undertakings and the time that is required before a general, optimistic outlook on the market is changed to a pessimistic one, and vice versa. In passing I might call your attention to an attempt by the Italian economist Vilfredo Pareto to derive such a rhythmic movement from the phenomenon of consumption as such, a rhythmic fluctuation in demand and supply of consumers’ and capital goods which one habitually refers to as good and bad times. Pareto has in mind an individual who habitually consumes a part of his income and saves the rest. The pleasure of consumption tempts him to increase his consumption, and the feeling of security for the future which he derives from his accumulation of savings tempts him to increase his saving. According to Pareto, these two forces set up a periodically alternating increase and decrease of his consumption and of his saving (or investing) respectively. Now if perchance the behaviour of many individuals is influenced in the same direction, then, the consequence would be a wave-like movement in the aggregate. The calculation by which Pareto tries to support this notion rests, however, on a mathematical error—for even the greatest of mathematicians are not always immune from error; but even without any mathematics, one can readily see that his reasoning must be erroneous. The psychological element, which unquestionably plays a large role in crises, is directly related to people’s ignorance and deficient foresight. It is excessive optimism which in good times gives rise to wild speculation and unsound ventures, just as it is excessive dejection in bad times which excessively paralyzes business activity. If the individual or society could forecast the future with certainty—and that and nothing else is what Pareto assumes—then there is something contradictory in thinking that either consumption or capital formation might temporarily exceed the proper measure and thereby occasion reactions. As a matter of fact, the increased illumination in the economic field which is due in part to commercial statistics, in part to publicity concerning the position of banks and large business enterprises (publicity that has taken the place of the former secrecy), may be one of the major contributory reasons why crises in our day do not manifest themselves with the same violence as formerly.4

If we turn to more well-known theories of crises, then doubtless the most popular among these, in fact the only one ever to have enjoyed any real popularity, is the familiar so-called overproduction theory. In scientific economics, it seems to me, a rather purposeless controversy has been carried on for a long time about whether or not general overproduction is possible or conceivable. If we take the concept of overproduction in its original, simple meaning, namely of a temporary condition when more is produced than is simultaneously consumed—so that consequently production exceeds the current effective demand—then we must admit that overproduction, far from being impossible, belongs, on the contrary, to the everyday and necessary phenomena of economic life.5 At all events this is, of course, the case with that kind of overproduction which depends on the changing of the seasons. How would it be if there were no substantial overproduction of grain during the summer, of fish during the fishing season, of timber during particularly snowy winters, etc.? To be sure it is more difficult to explain how in certain conditions general overproduction can occur for several years running, but this problem should not be regarded as insoluble.

To my mind there is no question that the latter type of overproduction is closely related to crises and “bad times”. The contradictions only arise when, as is usually the case, one views or considers overproduction as the effective cause of bad times. In that case one usually reasons that during so-called good times production in all its branches is so greatly stepped up that after a while it exceeds society’s capacity to consume, the inventories thereby accumulated being kept liquid for a time by speculation and with the aid of credit. But at last the latter fails to do further service, and bankruptcies, deflation, lay-offs and mass unemployment are then the consequence. Economic life drags itself through a number of “bad” years until the commodity surplus has had time to vanish, prices begin rising once more, and the same cycle begins all over again. The Socialist Friedrich Engels expresses this very general conception of the sequence of events in the following drastic terms:

“Trade stagnates; markets are over-full; goods lie about in quantities as large as they are unsaleable. Cash disappears from sight; credit vanishes; the factories are shut down. The working masses go in want of means of subsistence because they have produced too much subsistence means; bankruptcy follows bankruptcy, and liquidation sale follows liquidation sale. The stagnation lasts for years. Means of production as well as products or goods themselves are wasted and destroyed on a mass scale and the accumulated masses of goods are disposed of at greater or less fall in value until production and exchange gradually are set in motion once more. By and by, the movement is speeded and reaches a trot. The industrial trot increases to a gallop and the latter increases further to a reinless stampede, a complete industrial, commercial, financial, and speculative steeple-chase, in order, after some neck-breaking leaps, again to land—in the grave of the crash. And thus this sequence recurs all over again.”

But actually, has this vivid description—which is praised by Bergmann in Die Wirtschaftskrisen, p. 379 note—anything to do with reality? It impresses me rather as a piece of economic romanticism, not to say an adventure story. First of all: is it really possible to increase society’s production ad libitum, as it were? If this were the case, why does it not occur as a normal thing, always and continuously? For it is difficult to imagine that such a simple skill as that of consumption should ever fall short in society. To be sure it may be lacking in a certain social class, for instance among the workers, but then it ought to be all the greater among the rest, among the “capitalists”. But more than that, is it possible that such an excessive production takes place precisely during a period of expansion, during the boom? The most characteristic feature of such a period, and the feature of it which has been most fully proved statistically, is, as is well known, the large-scale conversion of mobile or liquid6 capital into fixed capital: new enterprises, production of new machinery, ships, railway rolling stock, etc. One gets a good, although naturally a far from precise, conception of the great fluctuations in this field if one observes the issues of new shares and other securities on the stock exchanges during good and bad times. Thus, according to a table given by Herkner (in the article “Krisen” in Conrads Handwörterbuch), the sum of these issues in Europe and America during 1871—1873, three particularly prosperous business years right after the Franco-Prussian war, was not less than 31.4 thousand million marks, while during the three following depression years, 1874—1876, they amounted only to 7.6 thousand million marks. Similar fluctuations, if not always as clearly marked as this, characterize later crisis periods. But these new ventures with all that they imply, do in fact involve a large-scale withdrawal of labour and other means of production from production of the usual objects of consumption, from production of “present goods”. On the other hand, there is fairly general agreement on the fact that during good times the consumption of all sorts of ordinary goods rises greatly in accord with the increase in money income, although, because of the rise in prices, consumption does not increase in the same proportion. Thus, on the one hand, we have a diminution of means of production available for production of ordinary daily necessities, and, on the other hand, we have a strongly increased consumption of these necessities. And despite this it is said that there is excessive production so that inventories increase more and more! Also it is difficult to imagine how such overproduction, if it really existed, would be compatible with the rise in prices which generally is characteristic of the upswing. Finally there is the additional circumstance that in times of upswing the money rate of interest generally rises. Its rise can be quite great in the case of an approaching or imminent crisis, and is thus connected with the conditions in the money market. However, the money-rate is by and large only a mask or a form of expression for the real rate of interest on capital, and a high real rate indicates a relative dearth of circulating real capital. But what constitutes circulating or mobile real capital if it is not commodities’. How, then, can there simultaneously be an excess of commodities and yet a dearth of mobile capital?7

The contradictions do not become less but rather more if, instead, we turn our attention to the contraction period, the downswing. According to the usual view the accumulated excess of commodities ought, during this period, by and by to melt away through consumption—for “the large-scale destruction” of products most likely belongs to the world of fantasy. But it is during the downswing that consumption is diminished while at the same time, because of the cessation of new ventures, a large amount of means of production becomes available for production of the ordinary necessities. How can this be consistent with the reduction of stock holdings, i.e., with a rate of consumption which continuously exceeds production? The only possible explanation must be that there is extensive unemployment during the downswing, but it seems that the views concerning the extent of unemployment are somewhat exaggerated and are not fully borne out by trade union statistics. Finally, there remains something absolutely inexplicable in these conditions, namely the formation of capital during the downturn. It is generally agreed that during good times the formation of capital, no matter how great it be, is not sufficient for the conversion of liquid into fixed capital that is then in progress on the greatest scale, and that in part this conversion takes place at the expense of capital which has been accumulated during the previous quiet times by means of saving and which now comes to use.

But in what form has this capital been accumulated? As far as I know, the literature of economics gives no answer to this question. L. Pohle touches on it somewhat in his work on crises (Bevölkerungsbewegung, Kapitalbildung und periodische Wirtschaftskrisen, Göttingen, 1902), but in the end he avoids facing the question. Cassel (“Om kriser och dåliga tider” [On Crises and Depressed Times] Ekonomisk Tidskrift, 1904) considers that the primary form of capital formation during times of depression must be the creation of “a large quantity of unused means of production”. But on the whole the latter means the same as creation of new fixed capital, and this is not particularly characteristic of contraction periods, nor would it give rise to a disposable fund of capital. A rather common view is that the unused capital is accumulated as a stock of money in the vaults of the banks. But even if one is willing to characterize the transfer of a certain quantity of exchange media from the general public to the vaults of banks—and really there is nothing else at issue here—as capital formation in the economic sense, then these funds are altogether too small to be able to exhaust the quantity of saving we are talking about. For instance, some ten million pounds sterling in the vaults of the Bank of England is probably no more than what the British people save in the course of a few weeks ! So far as I can see, there is no alternative here : mobile or liquid capital which is not immediately invested and converted into fixed capital, can take no other form than that of accumulated stocks of commodities. Cassel rejects this thought, asserting that “those goods which serve our immediate needs are for the most part of such a nature that they are not suited for production in advance”. This, however, is saying much too much, and for that matter, it is not only a question of “goods that serve our immediate needs” but also one of raw materials and of semi-finished goods which can be stored for a shorter or longer period before they are processed into finished articles of consumption. Cassel himself points out that “liquid or mobile capital” has a “slower turnover” in times of depression than otherwise. But, fundamentally, this comes to the same as I am saying, for a “slower rate of turnover” consists precisely in the fact that raw materials and semi-finished goods remain stored longer in the warehouses of manufacturers and finished goods remain longer in their or in merchants’ stock-rooms.

It is easy to see that the whole thing, the entire sequence of good and bad times, becomes much simpler if the prevailing view is inverted, so that overproduction, or inventory-production as I prefer to call it, far from being characteristic of good times—being their dark side and the cause of crises and depressions—on the contrary is regarded as belonging to depressed times and as constituting the brighter side of the latter, insofar as it provides the necessary prerequisite for the ensuing upturn. The only thing that in this case calls for an explanation is perhaps the sudden decline in prices during and soon after a crisis. This, however, need not depend on excessive inventories. It can just as well or even better be explained by diminished demand and reduced credit. No manufacturer or merchant is inclined to sell his merchandise at rock bottom prices simply because his warehouses are full. But if he needs money and cannot obtain credit, then he must sell his goods at whatever price they will fetch, whether he has much or little of them. (Moreover, the big price fluctuations for the most part affect mainly certain raw materials which are construction materials for fixed capital, iron, timber, bricks, coal, and so forth.) Similarly, it is not when the warehouses are empty that manufacturers begin to take courage and to think about expanding their production. From a theoretical standpoint this should rather occur as soon as sales once more exceed output, in other words when inventories have reached their greatest, not their smallest, magnitude.

But, now, what do statistics tell us concerning all this? Unfortunately only too little or rather nothing at all. So far as I know there are no comprehensive statistics concerning the size and fluctuations of inventories between good and bad times.8 We must have recourse to probabilities. In a great many cases there can be no doubt that reduced sales must, as it were, automatically give rise to increased inventories, namely in all cases where the production of raw materials takes place in advance and cannot be interrupted, as in agriculture, sugar-refining, lumber production, and so forth. And the same thing naturally holds true of machine industries insofar as a reduction or temporary shutdown of operations occasions a corresponding loss of interest on the capital that his been sunk into them. If wages and raw material prices have also gone down substantially, as is mostly the case during a depression, and if in addition the interest rate has fallen, then storage of products in inventory even for several years running may become a very profitable speculation. Again, that, as the overproduction theory would have it, manufacturers in general should indulge in such absurd behaviour as to produce for inventory when production costs are high and then sell their inventories at sagging prices, seems a priori not likely to be true.9 But, as we have said, the decisive proof concerning this can only be given by statistics—by statistics we do not yet possess. It occurs to me that more detailed banking statistics might give us valuable information about this. If the formation of capital assumes essentially different forms during good and bad times, then this ought to reveal itself in the different types of collateral the banks accept during these two periods.10

In such circumstances, there can, strictly speaking, as yet be no question about establishing a theory of economic fluctuations and crises, only a question of more or less likely hypotheses, the real value of which is to serve as a guide for investigation of the actual reality. And the following observations are intended only as a working hypothesis as one would call it in the natural sciences.

It seems to me we can more simply find a clue to the real nature of the problem if we turn it round and ask ourselves how an economy would have to be constituted in which economic fluctuations and crises do not occur at all. Then we soon find that this is only conceivable on the assumption of a stationary economy. If production and consumption recur year after year to about the same extent, then great slumps or dislocations are eo ipso excluded. The unavoidable fluctuations in weather and other conditions of nature may for the greater part, if not entirely, be disregarded, and those changes that a rising culture, technical and other improvements imply, may yet be compatible with an organic development that on the whole occurs gradually. What so greatly differentiates our modern communities from those of stationary type is, of course, above all the rapid population increase which has been in progress for more than a century in almost all European and most non-European countries. The steadily increasing consumption demand which arises from this cause presupposes and calls forth an ever expanding production. But, as I shall now try to show, the development of production cannot conceivably continue at the same steady rate of increase as the rate of population growth ; it must necessarily exhibit an alternation of acceleration and retardation. According to the vulgar view, nothing is easier than to increase production, provided one has sufficient and profitable sales. But, of course, this is actually true only from a private business standpoint. For the economy as a whole, on the contrary, a general increase of production is a most difficult and, in the long run, an insoluble problem. For an increase in population per se involves a corresponding increase of only one factor of production, namely labour (or at most labour and capital), while the other factor, the available quantity of natural resources, remains unchanged. It is as if someone tried to serve a limitless number of persons from one and the same pot of porridge simply by giving them a corresponding number of spoons. It takes more than that if production shall not hopelessly fall victim to the law of diminishing returns; there must be discoveries and inventions, technical and commercial improvements, new methods, to outwit nature and obtain from her treasures in ever increasing measure. Now, if one only looks at the number of patent applications granted, then there is no lack of inventions, but the great, epoch-making innovations, which substantially raise humanity’s ability to produce, are palpably less frequent. And even if an invention gives rise to a whole train of others whereby it is elaborated and supplemented, then it is no less the case that a successful invention actually closes the road for others in the same field. When the progress of agricultural chemistry a century ago taught us how we could abolish the system of keeping fallow fields and how to convert swamps into tillable soil, it was equivalent to an increase in the area of fertile soil. But once the fallow field system has been abandoned and the swamps have been sown, then no further invention, however brilliant, can give us this result once more. Within industry, next to the invention of the steam engine, nothing has been so revolutionary as the introduction of the blast-furnace, whereby the consumption of coal per ton of pig-iron was reduced to a small fraction of what was used formerly. The consequence of this was an extraordinary saving of productive power. But once this is done it can subsequently only be a question of being able to save a fraction of the fraction by means of inventions which may, by themselves, perhaps be far more ingenious.

It is in the nature of things that new, great discoveries and inventions must occur sporadically, and that the resulting increase in output cannot take the form of an evenly growing stream like population growth and the increase in consumption demand. As soon as the rate of increase of output begins to lag, a hitch will immediately occur in the development of the economy. For my part, until I am shown something better, it is in this that I discern the real source of economic fluctuations and crises, which, in their present form, belong entirely to modern times. Yet I do not mean to say that good times will come as soon as we have learnt new methods of production, and again bad times when we have to get along for the time being with the old methods while in the meantime population and consumption demand grow. The matter is not quite so simple. New inventions must mature, technically and economically, and gain the confidence of the business world. This naturally occurs more easily to the extent that a general feeling of confidence pervades the market. But above all, new inventions, of whatever kind they be, almost always require for their materialization a great deal of preparatory labour, creation of new facilities, etc., in a word, they require capital. Now if this capital is not saved until the moment that it is required for use, then—if we ignore the possibility that a particular country may have recourse to foreign capital—this can only occur by such a severe curtailment of current consumption that, from a consumption point of view, the upswing-period can hardly be called a “good” time. However, if capital is lacking, then the upswing is weakened to a corresponding degree. Only if capital, i.e. stocks of commodities, is accumulated during the previous quiet period, is it possible for a real and extended good period to occur. During such a period labour and other means of production are used on a large scale for creating new installations, and consumption and production demand alike are fully satisfied, partly from accumulated stocks. This is also the only correct method for really profitable investment of capital. It might seem that investment in fixed capital is always to be preferred to inventory production, which allows invested capital to be in use without earning interest. It has been maintained that opportunities for investment in fixed capital are not lacking even in depressed times provided people would only be satisfied with the lower rate of interest which then prevails. But here it is forgotten that the investment of capital for a longer period of time is always accompanied by risk and the risk does not necessarily become less simply because the chances of gain are small. On the other hand savings which are absorbed only in the form of commodity inventories, may after a short period be liquidated and then, perhaps, obtain a favourable placement in fixed capital. The definition which I would tentatively like to submit is, therefore : quiet times are periods when relatively few opportunities occur for profitable investment and consequently capital is to a considerable extent accumulated in disposable (i.e. in commodity) form, and active times are those periods when the accumulation of liquid or mobile capital, as well as capital that is released or created for the first time, is invested in durable capital goods (and consequently stocks of commodities are diminished and melt away).

Of course this is only the abstract core, the skeleton, of the concrete reality which may assume extremely variegated forms in different circumstances. So far as the actual transition between these periods is concerned, there is no necessity that it should take the form of a crisis. The transition from slump to boom seldom has the character of a crisis, although it has occasionally been referred to as such. Neither does the transition from boom to slump necessarily have the nature of a crisis provided the accumulated and newly-formed capital is sufficient for the demand. But a crisis can hardly be avoided if new ventures have been started on a scale that gradually makes the available capital insufficient. And this crisis is reinforced by the psychological factors which exert an influence on the money and credit market in such circumstances—the excessive lack of confidence which replaces the all too widespread reliance on willingness to extend credit, and so on, matters sufficiently well-known not to require further discussion here.

However, if this view is at all correct, it follows that we must take a very different view of both good and bad times, and especially of the latter. Bad times are certainly to some extent a reaction to good times, especially from a psychological point of view. But bad times are to a far greater extent the necessary prerequisite for good times, and to the extent we recognize this, the former lose, both theoretically and practically, their “bad” character. Overproduction no longer appears as a frightening spectre, an evil which must be avoided at all costs, but rather as a good and a necessary condition which ought to be encouraged as much as possible. For it is not possible to get too much of what is desirable, too many goods and necessities. It is an entirely false idea that commodity stocks, no matter how big they be, will not in due time be consumed. To be sure, it is a risky thing for a private entrepreneur to produce for inventory. For by so doing he ties up capital on which he himself must pay interest without receiving any return. This can only be profitable under two conditions: either a substantial reduction of wages and raw material prices, or a significant reduction of the interest rate. For several reasons, the latter alternative is much to be preferred. Hence the task is one of providing cheap credit for all who are willing to produce for stock in times of depression. Among other things this will contribute to the reduction of unemployment to a far greater extent than the few and inadequate emergency projects which are initiated at such times by local and other government authorities. In depressed times when they usually suffer from an excess of cash, the banks should reduce their loan rates of interest early and energetically, just as they should raise them early, at the outset of good times, both in order to prevent excessive speculation and unsound ventures and to stimulate saving at a time when most people indulge a certain propensity to waste and ostentation. Finally, to obviate the social-psychological disturbances which without doubt also play a primary role here, we must insist on the greatest possible frankness in making information available from all fields of business enterprise.

To be sure, a great deal remains to be done in these respects, but it is also true that a good deal has already been done. If I am not mistaken, in late years there is evidence of a tendency to schedule certain kinds of production more and more for the quiet times when there is not much business. This is especially true for that type of “inventory production” which at the same time implies fixed investment of capital, namely the usual types of construction activity. This, however, does involve the risk that for some years houses may be standing empty and yield no interest on the capital invested in building them. A start in this direction was made by a number of capitalists in Chicago after the crisis of the year 1873, with considerable success, and it is said that Germany’s big construction companies are following the same plan.

It is well known, as we have said earlier, that on the whole crises have lost much of their former acute character during the last decades. The sad parallelism which was formerly observed at every crisis between depression periods and increase in pauperism, in the death rate, in crime, has been relieved, as Tugan-Baranowski points out (Braun’s Archiv, Vol. XIII), at least in England, by a heartening reduction of these figures during both good and bad times. Tugan-Baranowski ascribes this above all to the activity of the trade unions, which maintain unemployed members from their funds and thus prevent the scaling-down of wages. But it is more likely that in this case we are dealing with the combined effect of all those economic improvements that distinguish contemporary production from that of former times : the perfection of credit institutions, the concentration of capital, the mobility and international character and increased publicity of business life, public regulation of banks and corporations, and so forth.

Yet it is clear that such measures can only have a limited effect. They can mitigate the violence of business cycle fluctuations, and perhaps they may even prevent genuine crises and panics. But in the long run it is evident that they can do nothing about the main problem of adequately providing for the satisfaction of an ever-growing consumption demand. Here the solution must be sought in technical inventive genius, and even the latter, if we demand too much of it, must at last founder on the resistance of natural resources. Then the law of diminishing returns must again come into its own; the marginal productivity of labour and along with it, under free competition, wages must decline, perhaps even below the subsistence minimum, so that the propertyless must be maintained by means of charity. This would be a condition which, to be sure, is not necessarily one of overpopulation—for aggregate production may be sufficient for all even though marginal productivity has declined—but in any case it would be a condition which is closely related to that of overpopulation.

That this truth has remained hidden for such a long time from modern man is perhaps most directly the consequence of that series of fortunate events which, at the same time as the natural and technical sciences began to flourish, placed at our disposal, as their fields of exploitation, new continents several times the size of Europe and in addition an enormous—though not inexhaustible—source of power which had been accumulating in the earth’s interior during past eons, namely coal. By the combination of these circumstances we have had time, for a century or more, to become accustomed to regard as a normal course of things a development which, by reason of its very character, is and must remain a very rare exception. So far as the northern countries are concerned, a force which unfortunately is of even more temporary nature has played its role during the last half-century, namely the forced utilization of the timber stands of our forests, which grew and spread for several centuries and which were previously inaccessible or regarded as valueless.

We must leave in abeyance whether at present we have come to “the beginning of the end”. But this eventuality cannot be so remote that it does not deserve consideration. And we should above all else consider whether such a development, essentially extensive in character, is not, after all, fundamentally an economic mistake, a Sisyphus-labour, which is likely to have as its result that an ever greater mass of human beings must engage in an ever harder struggle for existence, rather than, as surely ought to be our programme, that the fruits of an intensive use of resources should become evident in an ever greater measure of well-being also for the great mass of the population.

Although these reflections are very closely related to our topic, to dwell upon them further would take me too far afield. Therefore I return to my starting point and pose as a subject for the ensuing discussion the question: Is overproduction an evil or a good thing; are accumulating inventories characteristic of prosperous times as a sort of by-product of such times and the inventories themselves the cause of depressed times; or, on the contrary, do inventories increase during depressed times, and is this increase, taken in conjunction with technical and economic improvements, a necessary prerequisite for prosperous times?

POSTSCRIPT

I have followed the advice Mr. Kiaer gave me during the discussion following my lecture, namely to try to find out, by private investigation, how the size of inventories fluctuates in some typical cases. I have followed his advice to the extent of sending letters, in which, after briefly stating the nature of the issue, I asked for data concerning both the total amount of production and the size of inventories during a sequence of years, to some twenty-odd large enterprises in different branches of Swedish industry. In most cases I have received courteous answers, often accompanied by a valuable account of the general condition of the industry in question. In some cases it was also possible to give the statistics I asked for. It seems to me that both these accounts and the statistics speak decisively for the correctness of my general view and against the viewpoint I criticized above, although the statistics furnished to me are, of course, far too meagre to serve as empirical proof for either one or the other position.

Thus writes the manager of one of our largest cotton spinning and weaving establishments : “... according to my view it is definitely during times of poor trade that manufacturers add to their inventories. During good times, when the demand is great, they are never able to keep up with consumption. In poor times, on the other hand, when sales are slow, manufacturers have to put up with seeing their inventories grow . . . The view mentioned earlier (the overproduction theory) rests, I am convinced, on a confusion of cause and effect. During good times, consumption exceeds production and because of this the manufacturer is easily tempted to expand his plant too much. When the recession comes, he neither can nor wishes to raze the new part of his factory, and then it is this additional production that causes inventories to pile up in the store. But one cannot therefore say that goods are put in inventory in good times because of an increase in production.

“In the cotton industry, for example, a time of slow sales began about 1899 and continued until 1905. At least with us, and, as I have reason to believe, also with our competitors, the consequence was that inventories grew on an increasing scale during these six years, and this despite the fact that in 1901 we reduced production about 30—40%. Because of this reduction, our inventory was not as large in 1902, but it increased again, especially in woven goods, as soon as we increased production (1903—1905). However, the industry experienced a turning point from about 1906; consumption increased daily and inventories decreased about 50%.”

These opinions are supported by the statistics reported for the years 1897—1906. Inventory of woven goods increased from 12,000 bolts in 1897 to 44,000 in 1904, but fell to 20,000 in 1906.

A representative of another large firm in the same industry expresses himself in a similar vein. “So far as our industry is concerned”, he writes, “there is no question that prosperous times imply reduced inventories. This has its natural explanation in the fact that a textile mill is built for a certain amount of production which cannot be increased appreciably without a corresponding increase in machinery. It is only in particularly depressed conditions that we reduce our production, and then generally by working ‘short time’.”

The same appears from the more comprehensive statistics which the Association of Cotton Manufacturers made available to me. Inventories of unbleached damask in mills which were not specified as to number but were reported as “usually the same mills”, rose from 57,000 bolts in 1898 to 182,000 in 1903, but fell to 83,000 in 1906 and to 65,000 in 1907.

In the clothing manufacturing industry, one of our best-known producers was kind enough to report on annual production and inventories, however only in money-value terms, for the last 25 years. The same picture is found there. With certain fluctuations, annual production has on the whole continued at a fairly constant rate. Inventories increased rapidly during the mid-1880’s, but declined toward the close of this decade, then increased again during the early 1890’s, at which time they comprised considerably more than half of the annual production, but declined toward the end of the 1890’s to slightly more than 25% of annual production, increased again from 1900 only to decline again in the most recent years. In this case one finds almost regularly that inventories increased when annual output was reduced. This indicates that the increase in inventories depends .almost exclusively on reduced sales, and hardly ever on stepped-up production.

The figures from another clothing manufacturer who sent in a report from 1889 onwards are less decisive. In this case inventories are smaller throughout, indicating that manufacturing mainly seems to proceed on an order basis. It is natural that in such an industry as that of clothing manufacture the information relating to changes in inventories is necessarily very incomplete, for we have no way of allowing for changes in the small but very numerous stocks held by retail clothiers and tailors.

As for the paper and pulp industry, the manager of one of our oldest paper mills submitting statistics for the period 1902—1906, years which, according to him, are also typical of a longer period, writes: “Our experience shows definitely that when business conditions and sales improve there is not a corresponding increase in inventories, but rather the contrary, as is shown by the fact that after the two good years 1905—1906, finished goods inventories declined to approximately one-third the magnitude they had reached at the close of the poor year 1901.”

At another, larger paper mill where output was increased by more than 60% during 1900—1906, it is true that even during these years inventories increased also in a relative sense so that toward the end of the years 1904—1906, they comprised, respectively, 9.5%, 11.5% and 12.5% of the annual output. But according to the report this “depended largely on the introduction of new products and of products of different quality in order to make possible an increase in sales”. For that matter, it is true that in the paper-and-pulp industry, which has flourished greatly during recent years, one finds several exceptional circumstances. Thus, for instance, the manager of a paper mill chiefly engaged on the production of newsprint, reports that during the Boer War, when reader-interest increased greatly, the newspapers feared a newsprint shortage. So they put aside large stocks of paper “manufactured with machinery which ordinarily is used for production of other types of paper”. When peace was restored, reader-interest and circulation fell off. Then the newspapers reduced their editions and cancelled the usual orders on their contracts in order to use up their own stocks as fast as possible. The consequence was that orders for newsprint-producing machinery fell off considerably. A case such as this comes pretty close to the overproduction theory, but probably must be considered as an exception.

Detailed information from 1895 on has been sent in from a factory in the clay-goods industry which produces glazed clay-pipes and fire-proof tiles on a large scale. Its clay-pipe inventory was greatly reduced during the last part of the 1890’s, then it increased during the depressed years 1901—1903, to three times its former magnitude so that it comprised two-thirds up to four-fifths of the annual output; then it declined rapidly so that in 1906 it was only equal to one-fifth of the annual output. The same applies to its inventories of fire-proof tiles.

From the pig-iron industry I have, unfortunately, received figures from only one establishment, for the years 1887—1906. Its inventories of fuel, ore, iron and steel during the two years 1887—1888, both characterized as “depressed” years, were worth 3.2 million kronor (according to a report which states the inventories for the entire period in constant prices), and declined during the two following years, one “middling” and one “good” year, to 2.4 million kronor. They rose during the depressed years 1892—1894 to almost 3 million kronor and then sank during the following two years, “middling” and “good” respectively, to 2.65 million kronor. The fluctuations are less pronounced during the subsequent years, but on the whole “depressed” years are again accompanied by an increase and “good” years by a decrease in inventories.11

The material I have received from the wood-products industry, except for the paper-and-pulp portion thereof, has been altogether too scanty to permit me to draw any conclusions. Nor do I have any information concerning inventories of grain and other storable food products.

With respect to a comment made in the course of the discussion by Mr. Hagerup Bull, Assessor, that in depressed periods banks generally reduce their lending, I would like to remark that this does not contradict my hypothesis, since one may well assume that a good portion of the investment in inventories takes place by manufacturers using their own capital. In prosperous times, when (according to my hypothesis) inventories are being reduced, it is reasonable to assume that manufacturers deposit the proceeds from their sale in banks, and during depressed times they withdraw these deposits in order to produce for inventory. At the same time those entrepreneurs who have borrowed from banks during good times for new installations, repay these loans during poor times to the extent that the new plant comes into production and to the extent that shares are sold to the public. It would seem to be a natural and necessary consequence that in such circumstances aggregate bank loans are reduced.

Finally, I would like to point out something that I had not noticed earlier, namely that one writer, A. Spiethoff, shows, at least by some short comments, that he holds a view which agrees with mine, in his review of the works of Tugan-Baranowski and L. Pohle in Schmollers Jahrbuch for the year 1903, p. 351.

_____________

12 “Krisernas Gata”, A Lecture delivered on May 6th, 1907, at a meeting of Statsekonomisk Ferening (The Political Economy Club) at Oslo, Statsekonomisk Tidsskrifl, 1907, pp. 255—284. The discussion following the lecture is here omitted, but Wicksell’s Postscript, written after the meeting and as a result of the discussion, is retained.

13 Translator’s Note: As early as 1890 Wicksell expressed similar views to those in this paper in two articles, “Überproduction oder Übervolkerung” in Zeitschrift für die gtsamtcn Staatswissmschaften, 1890, Vol. 46, pp. 1—12, and “Tommc maver och fulde magasiner” (Empty Stomachs and Full Warehouses) in Samtiden (a Norwegian learned journal published in Bergen), 1890, Vol. 1, pp. 245—247 and 293—304. In these he attacked the prevailing “overproduction” and “underconsumption” theories of the trade cycle, and posed the problem, which is featured so prominently in the present article, of the behaviour of inventories over the cycle sequence. Wicksell’s last treatment of the business cycle is found in his “Note on Trade Cycles and Crises” in the second volume of his Lectures on Political Economy, pp. 209—214. This “Note”, which was added to the second edition of leaures about 1915, is largely a summary of the present article.

14 Translator’s Note: Wicksell’s use of the terra “kriser” or “crises” has not been replaced by modern terminology in this translation. In 1907 and even later, terminology concerning business cycles was very imperfectly developed. In German-speaking countries and in Scandinavia the term “crises” was used to connote business cycles in a general sense as well as “monetary crises” or panics. Interchangeably with “crises” such terms as “cycles”, “business fluctuations” and “good and bad times” were also widely used. This did not create much difficulty so long as the discussion concerned “real” magnitudes. But terminological difficulties arose when the monetary influence upon the “real”-phenomenon “cycles”, and also the “cycles” themselves were both discussed in terms of “crises”. Later on these two concepts were consequently given different names, reserving “crisis” for the monetary phenomenon and “trade cycle” or “business cycle” for the larger problem complex of economic fluctuations in which both “real” and “monetary” influences play a role. This distinction in usage is fairly evident in Wicksell’s “Note on Trade Cycles and Crises” of 1915, whereas it is absent from the present paper in which, with the exception of one or two passages where the meaning is unmistakable, “crises” mean “business cyclic” or “good and bad times”.

15 Yet it is also certain that much remains to be done in this sphere. Thus in the German wool industry in 1899 it happened that the price of combed wool yarn, which had been practically constant during the four preceding years, successively rose by more than 50% only to decline to normal prices or somewhat less than that during the following year. This occurred chiefly because people greatly over-estimated the reduction in the raising of merino sheep, and they exaggerated the alleged difficulty of producing a saleable commodity from other wool than merino. The price rise naturally resulted in colossal losses for those manufacturers who found it necessary to buy yarn during the period of high prices and later had to sell cloth when prices had fallen. Cf. K. Kuntze’s article “Die Wollindustrie”, in Schriften des Vereins für Sozialpolitik, vol. 105.

16 Other definitions of overproduction seem to me artificial and fundamentally meaningless. For instance, when one says that overproduction occurs as soon as the products cannot, or cannot in their entirety, be profitably marketed, then this is either merely another expression and a less direct one for what we say above, or else it contains a petitio principii. For the condition in question might have arisen from other causes, a temporary reduction in sales, a temporary rise in raw material prices, etc., without production per se necessarily having become too larg. Likewise, on this basis, one does not obtain any clear characterization of the opposite of overproduction, underproduction.

17 Translator’s Note: Wicksell’s use of the terms “sparmedel” (savings) and “rörligt eller fritt kapital” (mobile or free capital) requires comment. Sometimes he treated these loosely as synonymous although at the crucial points in his argument he dealt with them as the distinct concepts they actually are, see his footnote 3 within. This reflects his view that, via an efficiently functioning banking system, savings always have a corresponding real equivalent which in the first place takes the form of additions to inventories (primarily of raw materials and wage goods), which latter are what he called “mobile or free capital”. In his view inventories, or “free and mobile” real capital, exist primarily for “conversion into”—i.e. as raw materials for and as subsistence means for sustaining those who furnish the labour and land required for production of—fixed real capital. Thus an adequate supply of “mobile or free capital”, which presupposes a corresponding rate of saving, is a necessary prerequisite for carrying out the planned formation of fixed real capital without major economic disturbances.

Inventories can obviously be viewed as “mobile capital” from this perspective. Yet they are hardly “free” in any relevant economic sense, for all Wicksell meant by “free” in this context might be conveyed by the cumbersome phrase “not invested for long terms in specialized capital goods”. For that reason, and following the precedent set by Professor A. H. Hansen in his discussion of Wicksell’s theory of business cycles (cf. Business Cycles and National Income, p. 326), the adjective “liquid” has been substituted for Wicksell’s “free”. Hence, in the text “rörligt eller fritt kapital” has been translated as “mobile or liquid capital”.

18 To be sure, the relation between commodities, money, and what one calls mobile or “liquid” capital is in reality more complicated than this. In quite normal conditions the liquid capital is, as it were, invested in statu nascente, and does not have time to assume the form of stocks of commodities, or for that matter any other material form, because as soon as they are set aside, savings are immediately put at the disposal of entrepreneurs through the intermediary of the banks. But, from an economic point of view, this does not prevent inventory accumulations from representing a fund of savings, hence liquid capital, which can be invested, and (as soon as a suitable investment opportunity comes along) is invested while at the same time finished products and raw materials are used up in production and consumption.

19 In the lengthy questionnaire which the Vtrein für Sozialpolitik used as the basis of its well-known investigation of the crisis of 1900, we notice that there were no questions concerning the magnitude of inventories, and the data on this point which occasionally occur in the reports from various industries are most meagre. Such as they are, they generally indicate that inventory production occurs as a consequence of crisis, declining prices, and slumping sales, and not as their cause. Thus in the wool industry, the only one for which actual figures were reported, spinners’ inventories at the beginning of 1899 came to 167.3 (a relative figure, inventories of 1895 being equal to 100.0), but during the year they fell to 126.8, while at the same time orders on the books rose from 85.5 to 119.9. During the three first quarters of the following year inventories rose to 289 while orders sank to 60.6. During the earlier year, as we have already mentioned, prices rose incessantly, while during the latter they fell back and reached their lowest point in October).

20 I certainly do not deny that at times this can happen on the basis of miscalculation and that especially during good times overcapitalization may take place in some industries, because one phase of the trade cycle, which is per se temporary, is mistaken for a permanent condition. The German electrical industry furnished a very excellent example of this. During five years, 1895—1899, it so to speak “electrified” all of Germany (and a good part of the neighbouring countries), and at the same time it invested many hundred million marks in its own power plants. But when all streetcar systems had changed over to electric power, and when electric illumination had been installed everywhere where it could be installed, it stands to reason that the industry began to suffer a lack of new business.

21 Karl Helfferich has given an interesting account of the German money market for the years 1895—1902 in the investigation cited earlier. There he notes, p. 73, that the decline of trading on the stock market during the earlier half of 1900 was accompanied by an easing of the money market because “large amounts previously committed to speculation in securities, were now released and found use in the discounting of notes which have their origin in commodity transactions”. In this way it was possible, without putting further strain on the market, to make credit available for manufacturers whose inventories began increasing because of the slump in sales. Here I would only like to remark that stock exchange speculation does not absorb capital in any economic sense because the capital that is absorbed from the buyer of a security is at the same moment set free or rendered liquid for the seller. Actually capital is only absorbed by those enterprises on whose account new securities are issued. But, fundamentally, this comes to the same thing as I am talking about. For when the establishment of new ventures ceases or diminishes, then the formation of capital (savings activity) which constantly is in process in the meantime proceeds through the mediation of the banks in other directions, and especially into the creation of new and additional inventories.

22 Since this was written another report has been received from an iron-producer (a bariron producer). However, he reports only for the years 1902-1906 during which there were very small or practically speaking, no changes in inventories. In his report he refers to these years as middling to good years.

• 1]
• 2See the discussion in the Economic Journal, 1895 and 1896.
• 3*** Translator’s Note: Wicksell’s use of the terra “kriser” or “crises” has not been replaced by modern terminology in this translation. In 1907 and even later, terminology concerning business cycles was very imperfectly developed. In German-speaking countries and in Scandinavia the term “crises” was used to connote business cycles in a general sense as well as “monetary crises” or panics. Interchangeably with “crises” such terms as “cycles”, “business fluctuations” and “good and bad times” were also widely used. This did not create much difficulty so long as the discussion concerned “real” magnitudes. But terminological difficulties arose when the monetary influence upon the “real”-phenomenon “cycles”, and also the “cycles” themselves were both discussed in terms of “crises”. Later on these two concepts were consequently given different names, reserving “crisis” for the monetary phenomenon and “trade cycle” or “business cycle” for the larger problem complex of economic fluctuations in which both “real” and “monetary” influences play a role. This distinction in usage is fairly evident in Wicksell’s “Note on Trade Cycles and Crises” of 1915, whereas it is absent from the present paper in which, with the exception of one or two passages where the meaning is unmistakable, “crises” mean “business cyclic” or “good and bad times”.
• 4Yet it is also certain that much remains to be done in this sphere. Thus in the German wool industry in 1899 it happened that the price of combed wool yarn, which had been practically constant during the four preceding years, successively rose by more than 50% only to decline to normal prices or somewhat less than that during the following year. This occurred chiefly because people greatly over-estimated the reduction in the raising of merino sheep, and they exaggerated the alleged difficulty of producing a saleable commodity from other wool than merino. The price rise naturally resulted in colossal losses for those manufacturers who found it necessary to buy yarn during the period of high prices and later had to sell cloth when prices had fallen. Cf. K. Kuntze’s article “Die Wollindustrie”, in Schriften des Vereins für Sozialpolitik, vol. 105.
• 5Other definitions of overproduction seem to me artificial and fundamentally meaningless. For instance, when one says that overproduction occurs as soon as the products cannot, or cannot in their entirety, be profitably marketed, then this is either merely another expression and a less direct one for what we say above, or else it contains a petitio principii. For the condition in question might have arisen from other causes, a temporary reduction in sales, a temporary rise in raw material prices, etc., without production per se necessarily having become too larg. Likewise, on this basis, one does not obtain any clear characterization of the opposite of overproduction, underproduction.
• 6* Translator’s Note: Wicksell’s use of the terms “sparmedel” (savings) and “rörligt eller fritt kapital” (mobile or free capital) requires comment. Sometimes he treated these loosely as synonymous although at the crucial points in his argument he dealt with them as the distinct concepts they actually are, see his footnote 3 within. This reflects his view that, via an efficiently functioning banking system, savings always have a corresponding real equivalent which in the first place takes the form of additions to inventories (primarily of raw materials and wage goods), which latter are what he called “mobile or free capital”. In his view inventories, or “free and mobile” real capital, exist primarily for “conversion into”—i.e. as raw materials for and as subsistence means for sustaining those who furnish the labour and land required for production of—fixed real capital. Thus an adequate supply of “mobile or free capital”, which presupposes a corresponding rate of saving, is a necessary prerequisite for carrying out the planned formation of fixed real capital without major economic disturbances.
• 7To be sure, the relation between commodities, money, and what one calls mobile or “liquid” capital is in reality more complicated than this. In quite normal conditions the liquid capital is, as it were, invested in statu nascente, and does not have time to assume the form of stocks of commodities, or for that matter any other material form, because as soon as they are set aside, savings are immediately put at the disposal of entrepreneurs through the intermediary of the banks. But, from an economic point of view, this does not prevent inventory accumulations from representing a fund of savings, hence liquid capital, which can be invested, and (as soon as a suitable investment opportunity comes along) is invested while at the same time finished products and raw materials are used up in production and consumption.
• 8In the lengthy questionnaire which the Vtrein für Sozialpolitik used as the basis of its well-known investigation of the crisis of 1900, we notice that there were no questions concerning the magnitude of inventories, and the data on this point which occasionally occur in the reports from various industries are most meagre. Such as they are, they generally indicate that inventory production occurs as a consequence of crisis, declining prices, and slumping sales, and not as their cause. Thus in the wool industry, the only one for which actual figures were reported, spinners’ inventories at the beginning of 1899 came to 167.3 (a relative figure, inventories of 1895 being equal to 100.0), but during the year they fell to 126.8, while at the same time orders on the books rose from 85.5 to 119.9. During the three first quarters of the following year inventories rose to 289 while orders sank to 60.6. During the earlier year, as we have already mentioned, prices rose incessantly, while during the latter they fell back and reached their lowest point in October).
• 9I certainly do not deny that at times this can happen on the basis of miscalculation and that especially during good times overcapitalization may take place in some industries, because one phase of the trade cycle, which is per se temporary, is mistaken for a permanent condition. The German electrical industry furnished a very excellent example of this. During five years, 1895—1899, it so to speak “electrified” all of Germany (and a good part of the neighbouring countries), and at the same time it invested many hundred million marks in its own power plants. But when all streetcar systems had changed over to electric power, and when electric illumination had been installed everywhere where it could be installed, it stands to reason that the industry began to suffer a lack of new business.
• 10Karl Helfferich has given an interesting account of the German money market for the years 1895—1902 in the investigation cited earlier. There he notes, p. 73, that the decline of trading on the stock market during the earlier half of 1900 was accompanied by an easing of the money market because “large amounts previously committed to speculation in securities, were now released and found use in the discounting of notes which have their origin in commodity transactions”. In this way it was possible, without putting further strain on the market, to make credit available for manufacturers whose inventories began increasing because of the slump in sales. Here I would only like to remark that stock exchange speculation does not absorb capital in any economic sense because the capital that is absorbed from the buyer of a security is at the same moment set free or rendered liquid for the seller. Actually capital is only absorbed by those enterprises on whose account new securities are issued. But, fundamentally, this comes to the same thing as I am talking about. For when the establishment of new ventures ceases or diminishes, then the formation of capital (savings activity) which constantly is in process in the meantime proceeds through the mediation of the banks in other directions, and especially into the creation of new and additional inventories.
• 11Since this was written another report has been received from an iron-producer (a bariron producer). However, he reports only for the years 1902-1906 during which there were very small or practically speaking, no changes in inventories. In his report he refers to these years as middling to good years.
• 12Little success has been achieved up till the present in satisfying such an ideal. The progress of monetary theory and practice has not done much to secure the desired stability of the standard of value and of prices. Its failure is abundantly demonstrated by the history of prices of this last century, and particularly of its latter half. It is true that opinions differ as to the actual magnitude of the rise in the general level of prices (in terms of gold) that took place between the middle of the century and about the year 1873 and of the succeeding fall which has continued up till to-day—about the magnititude, that is to say, of the corresponding changes in the exchange value or purchasing power of money. But this is easily to be understood. In the first place, there is no reason why these changes should have proceeded equally in the different countries. It is, in fact, certain that, for various reasons to which we shall return later, the changes will be unequal. (This is probably the explanation of the minor deviations between the tables of prices constructed by Sauerbeck and Soetbeer, to which Sauerbeck has himself called attention.) Then we have the not unimportant difficulty of ascribing an unambiguous meaning to the conception of an average level of prices. Finally, there is the uncertainty as to which prices to take into account: whether to include only wholesale prices, as has usually been done up to the present, or also retail prices; whether to include only the prices of commodities or also the prices of services and, in particular, the wages of labour; and so on. In the next chapter we shall try to find a short answer to these questions.
• 13Little success has been achieved up till the present in satisfying such an ideal. The progress of monetary theory and practice has not done much to secure the desired stability of the standard of value and of prices. Its failure is abundantly demonstrated by the history of prices of this last century, and particularly of its latter half. It is true that opinions differ as to the actual magnitude of the rise in the general level of prices (in terms of gold) that took place between the middle of the century and about the year 1873 and of the succeeding fall which has continued up till to-day—about the magnititude, that is to say, of the corresponding changes in the exchange value or purchasing power of money. But this is easily to be understood. In the first place, there is no reason why these changes should have proceeded equally in the different countries. It is, in fact, certain that, for various reasons to which we shall return later, the changes will be unequal. (This is probably the explanation of the minor deviations between the tables of prices constructed by Sauerbeck and Soetbeer, to which Sauerbeck has himself called attention.) Then we have the not unimportant difficulty of ascribing an unambiguous meaning to the conception of an average level of prices. Finally, there is the uncertainty as to which prices to take into account: whether to include only wholesale prices, as has usually been done up to the present, or also retail prices; whether to include only the prices of commodities or also the prices of services and, in particular, the wages of labour; and so on. In the next chapter we shall try to find a short answer to these questions.
• 14In order the better to delimit my subject, I must first ask leave to exclude from the field of my observations everything that has to do with the influence of monetary and credit systems on crises. No doubt this influence is great: crises obtain their true character only when they are sharpened into money-or credit-crises.*** The general lack of confidence, concern over one’s personal security, etc. paralyze at such times what we call the velocity of money turnover, and from the same cause many other types of media of exchange experience a much more restricted ability than in ordinary circumstances. But this aspect of the matter is also the one in respect of which economists, both theoretically and practically, have made most headway. The remedy, as seems to be generally agreed, lies in having a sufficient reserve of legal tender—whether of metal or of paper money is a matter of indifference—which is put to use only in times of economic recession and of threatening panic, in order, for the time being, to meet the urgent shortage of credit. This is an economic discovery by means of which, as we may hope, crises will for all time have lost some of their worst impact.
• 15On the other hand, if one is satisfied with a less strictly construed cycle, the sporadic occurrence of crises at irregular intervals, then one can conceive of its causes as inherent partly in external circumstances belonging to economic life as such, causes I shall touch on at a later point, and partly in the internal structure of the economy viewed from a material and a psychological standpoint, namely the period of time necessary for completing large economic undertakings and the time that is required before a general, optimistic outlook on the market is changed to a pessimistic one, and vice versa. In passing I might call your attention to an attempt by the Italian economist Vilfredo Pareto to derive such a rhythmic movement from the phenomenon of consumption as such, a rhythmic fluctuation in demand and supply of consumers’ and capital goods which one habitually refers to as good and bad times. Pareto has in mind an individual who habitually consumes a part of his income and saves the rest. The pleasure of consumption tempts him to increase his consumption, and the feeling of security for the future which he derives from his accumulation of savings tempts him to increase his saving. According to Pareto, these two forces set up a periodically alternating increase and decrease of his consumption and of his saving (or investing) respectively. Now if perchance the behaviour of many individuals is influenced in the same direction, then, the consequence would be a wave-like movement in the aggregate. The calculation by which Pareto tries to support this notion rests, however, on a mathematical error—for even the greatest of mathematicians are not always immune from error; but even without any mathematics, one can readily see that his reasoning must be erroneous. The psychological element, which unquestionably plays a large role in crises, is directly related to people’s ignorance and deficient foresight. It is excessive optimism which in good times gives rise to wild speculation and unsound ventures, just as it is excessive dejection in bad times which excessively paralyzes business activity. If the individual or society could forecast the future with certainty—and that and nothing else is what Pareto assumes—then there is something contradictory in thinking that either consumption or capital formation might temporarily exceed the proper measure and thereby occasion reactions. As a matter of fact, the increased illumination in the economic field which is due in part to commercial statistics, in part to publicity concerning the position of banks and large business enterprises (publicity that has taken the place of the former secrecy), may be one of the major contributory reasons why crises in our day do not manifest themselves with the same violence as formerly.
• 16If we turn to more well-known theories of crises, then doubtless the most popular among these, in fact the only one ever to have enjoyed any real popularity, is the familiar so-called overproduction theory. In scientific economics, it seems to me, a rather purposeless controversy has been carried on for a long time about whether or not general overproduction is possible or conceivable. If we take the concept of overproduction in its original, simple meaning, namely of a temporary condition when more is produced than is simultaneously consumed—so that consequently production exceeds the current effective demand—then we must admit that overproduction, far from being impossible, belongs, on the contrary, to the everyday and necessary phenomena of economic life. At all events this is, of course, the case with that kind of overproduction which depends on the changing of the seasons. How would it be if there were no substantial overproduction of grain during the summer, of fish during the fishing season, of timber during particularly snowy winters, etc.? To be sure it is more difficult to explain how in certain conditions general overproduction can occur for several years running, but this problem should not be regarded as insoluble.
• 17But actually, has this vivid description—which is praised by Bergmann in Die Wirtschaftskrisen, p. 379 note—anything to do with reality? It impresses me rather as a piece of economic romanticism, not to say an adventure story. First of all: is it really possible to increase society’s production ad libitum, as it were? If this were the case, why does it not occur as a normal thing, always and continuously? For it is difficult to imagine that such a simple skill as that of consumption should ever fall short in society. To be sure it may be lacking in a certain social class, for instance among the workers, but then it ought to be all the greater among the rest, among the “capitalists”. But more than that, is it possible that such an excessive production takes place precisely during a period of expansion, during the boom? The most characteristic feature of such a period, and the feature of it which has been most fully proved statistically, is, as is well known, the large-scale conversion of mobile or liquid* capital into fixed capital: new enterprises, production of new machinery, ships, railway rolling stock, etc. One gets a good, although naturally a far from precise, conception of the great fluctuations in this field if one observes the issues of new shares and other securities on the stock exchanges during good and bad times. Thus, according to a table given by Herkner (in the article “Krisen” in Conrads Handwörterbuch), the sum of these issues in Europe and America during 1871—1873, three particularly prosperous business years right after the Franco-Prussian war, was not less than 31.4 thousand million marks, while during the three following depression years, 1874—1876, they amounted only to 7.6 thousand million marks. Similar fluctuations, if not always as clearly marked as this, characterize later crisis periods. But these new ventures with all that they imply, do in fact involve a large-scale withdrawal of labour and other means of production from production of the usual objects of consumption, from production of “present goods”. On the other hand, there is fairly general agreement on the fact that during good times the consumption of all sorts of ordinary goods rises greatly in accord with the increase in money income, although, because of the rise in prices, consumption does not increase in the same proportion. Thus, on the one hand, we have a diminution of means of production available for production of ordinary daily necessities, and, on the other hand, we have a strongly increased consumption of these necessities. And despite this it is said that there is excessive production so that inventories increase more and more! Also it is difficult to imagine how such overproduction, if it really existed, would be compatible with the rise in prices which generally is characteristic of the upswing. Finally there is the additional circumstance that in times of upswing the money rate of interest generally rises. Its rise can be quite great in the case of an approaching or imminent crisis, and is thus connected with the conditions in the money market. However, the money-rate is by and large only a mask or a form of expression for the real rate of interest on capital, and a high real rate indicates a relative dearth of circulating real capital. But what constitutes circulating or mobile real capital if it is not commodities’. How, then, can there simultaneously be an excess of commodities and yet a dearth of mobile capital?
• 18But actually, has this vivid description—which is praised by Bergmann in Die Wirtschaftskrisen, p. 379 note—anything to do with reality? It impresses me rather as a piece of economic romanticism, not to say an adventure story. First of all: is it really possible to increase society’s production ad libitum, as it were? If this were the case, why does it not occur as a normal thing, always and continuously? For it is difficult to imagine that such a simple skill as that of consumption should ever fall short in society. To be sure it may be lacking in a certain social class, for instance among the workers, but then it ought to be all the greater among the rest, among the “capitalists”. But more than that, is it possible that such an excessive production takes place precisely during a period of expansion, during the boom? The most characteristic feature of such a period, and the feature of it which has been most fully proved statistically, is, as is well known, the large-scale conversion of mobile or liquid* capital into fixed capital: new enterprises, production of new machinery, ships, railway rolling stock, etc. One gets a good, although naturally a far from precise, conception of the great fluctuations in this field if one observes the issues of new shares and other securities on the stock exchanges during good and bad times. Thus, according to a table given by Herkner (in the article “Krisen” in Conrads Handwörterbuch), the sum of these issues in Europe and America during 1871—1873, three particularly prosperous business years right after the Franco-Prussian war, was not less than 31.4 thousand million marks, while during the three following depression years, 1874—1876, they amounted only to 7.6 thousand million marks. Similar fluctuations, if not always as clearly marked as this, characterize later crisis periods. But these new ventures with all that they imply, do in fact involve a large-scale withdrawal of labour and other means of production from production of the usual objects of consumption, from production of “present goods”. On the other hand, there is fairly general agreement on the fact that during good times the consumption of all sorts of ordinary goods rises greatly in accord with the increase in money income, although, because of the rise in prices, consumption does not increase in the same proportion. Thus, on the one hand, we have a diminution of means of production available for production of ordinary daily necessities, and, on the other hand, we have a strongly increased consumption of these necessities. And despite this it is said that there is excessive production so that inventories increase more and more! Also it is difficult to imagine how such overproduction, if it really existed, would be compatible with the rise in prices which generally is characteristic of the upswing. Finally there is the additional circumstance that in times of upswing the money rate of interest generally rises. Its rise can be quite great in the case of an approaching or imminent crisis, and is thus connected with the conditions in the money market. However, the money-rate is by and large only a mask or a form of expression for the real rate of interest on capital, and a high real rate indicates a relative dearth of circulating real capital. But what constitutes circulating or mobile real capital if it is not commodities’. How, then, can there simultaneously be an excess of commodities and yet a dearth of mobile capital?
• 19But, now, what do statistics tell us concerning all this? Unfortunately only too little or rather nothing at all. So far as I know there are no comprehensive statistics concerning the size and fluctuations of inventories between good and bad times. We must have recourse to probabilities. In a great many cases there can be no doubt that reduced sales must, as it were, automatically give rise to increased inventories, namely in all cases where the production of raw materials takes place in advance and cannot be interrupted, as in agriculture, sugar-refining, lumber production, and so forth. And the same thing naturally holds true of machine industries insofar as a reduction or temporary shutdown of operations occasions a corresponding loss of interest on the capital that his been sunk into them. If wages and raw material prices have also gone down substantially, as is mostly the case during a depression, and if in addition the interest rate has fallen, then storage of products in inventory even for several years running may become a very profitable speculation. Again, that, as the overproduction theory would have it, manufacturers in general should indulge in such absurd behaviour as to produce for inventory when production costs are high and then sell their inventories at sagging prices, seems a priori not likely to be true. But, as we have said, the decisive proof concerning this can only be given by statistics—by statistics we do not yet possess. It occurs to me that more detailed banking statistics might give us valuable information about this. If the formation of capital assumes essentially different forms during good and bad times, then this ought to reveal itself in the different types of collateral the banks accept during these two periods.
• 20But, now, what do statistics tell us concerning all this? Unfortunately only too little or rather nothing at all. So far as I know there are no comprehensive statistics concerning the size and fluctuations of inventories between good and bad times. We must have recourse to probabilities. In a great many cases there can be no doubt that reduced sales must, as it were, automatically give rise to increased inventories, namely in all cases where the production of raw materials takes place in advance and cannot be interrupted, as in agriculture, sugar-refining, lumber production, and so forth. And the same thing naturally holds true of machine industries insofar as a reduction or temporary shutdown of operations occasions a corresponding loss of interest on the capital that his been sunk into them. If wages and raw material prices have also gone down substantially, as is mostly the case during a depression, and if in addition the interest rate has fallen, then storage of products in inventory even for several years running may become a very profitable speculation. Again, that, as the overproduction theory would have it, manufacturers in general should indulge in such absurd behaviour as to produce for inventory when production costs are high and then sell their inventories at sagging prices, seems a priori not likely to be true. But, as we have said, the decisive proof concerning this can only be given by statistics—by statistics we do not yet possess. It occurs to me that more detailed banking statistics might give us valuable information about this. If the formation of capital assumes essentially different forms during good and bad times, then this ought to reveal itself in the different types of collateral the banks accept during these two periods.
• 21But, now, what do statistics tell us concerning all this? Unfortunately only too little or rather nothing at all. So far as I know there are no comprehensive statistics concerning the size and fluctuations of inventories between good and bad times. We must have recourse to probabilities. In a great many cases there can be no doubt that reduced sales must, as it were, automatically give rise to increased inventories, namely in all cases where the production of raw materials takes place in advance and cannot be interrupted, as in agriculture, sugar-refining, lumber production, and so forth. And the same thing naturally holds true of machine industries insofar as a reduction or temporary shutdown of operations occasions a corresponding loss of interest on the capital that his been sunk into them. If wages and raw material prices have also gone down substantially, as is mostly the case during a depression, and if in addition the interest rate has fallen, then storage of products in inventory even for several years running may become a very profitable speculation. Again, that, as the overproduction theory would have it, manufacturers in general should indulge in such absurd behaviour as to produce for inventory when production costs are high and then sell their inventories at sagging prices, seems a priori not likely to be true. But, as we have said, the decisive proof concerning this can only be given by statistics—by statistics we do not yet possess. It occurs to me that more detailed banking statistics might give us valuable information about this. If the formation of capital assumes essentially different forms during good and bad times, then this ought to reveal itself in the different types of collateral the banks accept during these two periods.
• 22From the pig-iron industry I have, unfortunately, received figures from only one establishment, for the years 1887—1906. Its inventories of fuel, ore, iron and steel during the two years 1887—1888, both characterized as “depressed” years, were worth 3.2 million kronor (according to a report which states the inventories for the entire period in constant prices), and declined during the two following years, one “middling” and one “good” year, to 2.4 million kronor. They rose during the depressed years 1892—1894 to almost 3 million kronor and then sank during the following two years, “middling” and “good” respectively, to 2.65 million kronor. The fluctuations are less pronounced during the subsequent years, but on the whole “depressed” years are again accompanied by an increase and “good” years by a decrease in inventories.