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Felix qui potuit rerum cognoscere causas. 

— Vergil. 


An Analysis of Trends^ Cycles^ and Time Relationships 
in American Economic Activity Since 7700 and 
Their Bearing upon Governmental and 
Business Policy 



Late Professor of Business Research, Graduate School 
of Business, Stanford University; Late President, 
Silberling Research Corporation, Ltd, 

First Edition 
Fol’rih Impression 




Copyright, 1943, by the 
McGraw-Hill. Book Company, Inc. 


All rights reserved. This booky or 
parts thereof, mag not he reproduced 
in any form without permission of 
the publishers. 


In offering “The Dynamics of Business^' to the business and economic 
world the late Dr. Norman J. Silberling presents an analysis of the long- 
term trends of American production, price levels, and income, based upon 
new measurements, followed by a systematic and graphically illustrated 
discussion of cyclical movements in agriculture, building, production, 
trade, finance, and wages, leading to theoretical and practical conclusions 
for both business and governmental policy. 

Economics, according to Dr. Silberling, has been mainly concerned 
during the past century with theorizing rather than measurement. It 
consisted primarily of metaphysics rather than science. Its purpose has 
been to investigate the theoretical laws of price and income distribution 
on the assumption of free competition in a capitalistic system in which 
growth tendencies and institutional changes are considered unimportant. 
Insofar as these artificial assumptions are occasionally approximated in 
the real world this theorizing may have some value, but as a basis for 
governmental or management policy it has been found to be of relatively 
little use. Unfortunately economists have long been captivated by the 
deductive method rather than interested in the observation of actual 
conditions, and as a result their discussion of such actual conditions and 
the practical problems of policy has not until very recently attempted to 
deal with the distortion of “normal’' tendencies and the disturbance of 
booms and depressions and wars. 

The study of business dynamics, as distinct from the foregoing 
approach, stresses the importance of change insofar as this manifests 
itself in measurable growth tendencies and in the rhythmic vibrations 
of the business cycle. It is mainly concerned with the course of general 
progress and the cyclical tendencies in industry and trade, prices, and 
income, as represented in a general way through composite index numbers 
or aggregate experience. Conceived in this way, dynamic measurements 
record historical sequence as a continuous development, and in the course 
of this continuity there is opportunity to observe the interaction of forces 
and the impact of political and other noneconomic tendencies upon 
economic and business processes. In recent years the amount of quanti- 
tative data for the measurement of dynamic tendencies has been rapidly 
increasing and it is now possible to present a fairly clear picture of the 
amount of growth and the extent of distortion in the course of that growth 
resulting from specific events. It has also become possible to distinguish 




to a considerable extent between external and internal forces producing 
economic expansion and depression. 

To the extent that these measurements are possible there is opened 
up the further field of statistical forecasting and the use of dynamic 
measurements by business management in order to protect itself against 
unfavorable external influences. A further and very important field of 
usefulness is in the better planning of public policy in order to avoid 
measures that obstruct progress and growth or produce unnecessary 
cyclical disturbance. Both business managers and politicians have a 
tendency to follow precedent rather than to plan for the future intelli- 
gently. Through long-term measurements there is thus being developed 
a new applied science endowed with perspective and the principle of 
continuity which is capable of throwing a powerful new light on intelligent 

It was Dr. Silberling’s belief that the subject of the business cycle is 
but one aspect of dynamics, but that thus far that phase has been given 
more attention than the study of long-term trends, the interaction of 
dynamic factors for practical policy designed to facilitate future growth 
in wealth and production, and the avoidance of booms and depressions. 
He felt that most books on the subject were merely an extrapolation of 
traditional economic theory rather than an attempt to formulate new 
theoretical principles on the basis of actual measurement. Only in more 
recent years has there been definite progress in combining measurement 
with careful reasoning in the field of business dynamics and particularly 
business cycles. 

The title, ‘‘The Dynamics of Business,^' was selected to emphasize the 
fact that attention is given in this volume to the trends and relationships 
of economic factors as well as business-cycle phenomena as such. The 
book aims to reach effectively the general reader, the business and 
financial executive, the governmental administrator, the legislator, and 
the more advanced students (college juniors and up) in the fields of 
economics, government, history, sociology, law, engineering, and agri- 
culture. The book begins with the subject of long-term trends, first 
dealing with population growth from the very beginning of the American 
people, and then discussing the measurement of the general trend of 
production and trade which is carried back to 1700 or considerably 
further than Snyder or other authors have attempted hitherto. This 
long period of perspective affords an exceptional opportunity to observe 
the rate of growth and it is possible for the first time to reveal the inter- 
mediate trend or long wave of economic progress, as well as the shorter 
fluctuations of the business cycle through a period of nearly two and one- 
half centuries. The long wave of trade and production is shown to be 
closely related to wars and to political events, and the book may be said 



to make a distinct contribution to the knowledge of the economic and 
dynamic effects of major wars. This phase of the subject is then further 
analyzed in terms of price-level changes which are shown to be produced 
mainly by war conditions. New measures of the relation of money and 
credit to price level are discussed, and the work of Carl Snyder on this 
subject is carried back with more refined methods almost to the beginning 
of the nineteenth century. This is followed by a new theoretical pres- 
entation of the relations between money, credit, trade, and prices in 
which an effort is made to correct prevailing misconceptions of the ‘‘equa- 
tion of exchange as originally formulated by Irving Fisher. 

Having demonstrated the statistical and theoretical forces operating 
upon the price level, a foimdation is laid for a discussion of the value of 
trade and production, the national income, and the important component 
of farm income which is highly sympathetic to price movements. The 
political bearings of farm-income fluctuations are particularly empha- 
sized and this is followed by an entire chapter on the short-term cycles 
of agriculture. Attention is then given to the cyclical behavior of the 
building industry and real estate activity. In this connection new and 
important basic indexes are presented extending back to the beginning 
of the nineteenth century and revealing for the first time the true signifi- 
cance of the building cycle as a major factor in business cycles generally. 
This is further amplified by similar long-term indexes of the cycles of 
transportation construction, which represent an entirely new contribution 
to the subject. What is usually regarded as the business cycle is shown 
to have been, in American experience at least, the joint result of several 
types of construction and land-development speculation. 

From the foregoing analysis Dr. Silberling proceeds to draw important 
conclusions with respect to the kind of credit and capital financing which 
produce or accentuate cyclical disturbances. Here, as in other parts 
of the book, the principles are drawn from the facts, reversing the pro- 
cedure so commonly encountered of selecting certain facts to “ prove a 
theory. One of the most important conclusions drawn from American 
economic experience is shown to be the disregard for sound capital use 
through what is known as excessive trading on the equity, and this is 
demonstrated in succeeding chapters to illustrate its pervasive importance 
as a source of economic excesses and breakdowns, including the inter- 
national depression of the 1930^s. 

The Great Depression of the 1930^s created an urgent need for con- 
structive economic policy, but as generally acceptable principles of 
dynamic economics had not yet been formulated so that this could be 
put into practice the New Deal worked out its reconstruction by the use 
of many odds and ends of panaceas and amateur opportunism, thus 
complicating many of the problems encountered. Thus, public policy 



has become in itself unquestionably a source of cyclical instability and 
illustrations of this are given. At the same time recent legislation has 
accomplished many desirable objectives and it has seemed important to 
present these in some detail so that the reader may form a clearer concept 
of the kind of world he will live in after a great world upheaval and its 
aftermath of reform and reconstructive legislation. Throughout this 
discussion attention has been given continually to the basic principles to 
determine the soundness or wisdom of public policy. 

The discussion then reverts to the dynamics of the financial markets 
as they bear upon interest rates, stock prices, and corporate earnings. 
In connection with the interest rate Dr. Silberling has presented some 
new measures of the factors which appear to govern changes in interest 
rates and the high-grade bond market. The factors influencing the stock 
market are illustrated and the subject of stock market forecasting is 
discussed. Attention is then given to the dynamics of corporate earning 
power, internal savings, and expenditures for capital equipment, with 
illustrations drawn from manufacturing and public service corporations. 
Surprising tendencies are revealed regarding the ability of American 
corporations to accumulate savings in recent years and in this connection 
considerable critical analysis of government policy looking toward the 
expropriation of private capital is included. It is then shown that con- 
sumer earnings, savings, and capital investment, both for individuals and 
for families, have tendencies essentially similar to those shown by corpo- 
rations. A novel presentation is developed of the merchandising cycle, 
and important dynamic aspects of retail trade and consumer credit are 

As retail trade is so closely dependent upon wage income Dr. Silberling 
has devoted an entire chapter to the dynamics of wages in relation to 
labor productivity and employment covering a longer period, it is 
believed, than is presented in any other available book. Some important 
conclusions are drawn with respect to the forces which have governed 
the broad changes in industrial wage rates and policies which are thereby 
indicated as desirable. This is followed by a more detailed discussion 
of the means of introducing more stability in wage income through unem- 
ployment compensation or similar devices. This in turn suggests the 
place that business management should occupy in better planning of 
management policies as a means of preventing unemployment crises and 
improving the return on business capital. New methods of business 
forecasting are developed and another whole chapter is devoted to the 
practical application of statistical forecasting to business policy. After a 
further discussion of the merits and defects of rigid and fluctuating prices, 
insofar as these bear upon both business and governmental policy, the 
book concludes with a chapter on the future trend of the American 



economy and the contribution to future capital and income growth which 
might be made by a better system of taxation and by more general 
acceptance of the principle of private property and its protection against 
the encroachments of collectivism. 

In order that the technical reader may understand exactly how the 
basic indexes presented in this book have been developed, a Statistical 
Appendix has been added summarizing the methods used in these 
measurements. One of the most important features of The Dynamics of 
Business^^ is the care which has been used in preparing the charts, of which 
there are 76 in the volume. As many of these exhibits portray the 
dynamic aspects of American business over long periods of time. Dr. 
Silberling believed that the book would be of value indefinitely. No 
other book now available presents anything like the wealth of illustrations 
to which the reader may turn to obtain a clear idea of what has happened 
and how various aspects of the economic system are related to other 
aspects. Most of the exhibits are drawn to ratio scale in order to carr>^ 
through the idea of proportionality, and the underlying principle is 
clearly explained in an early chapter so that every reader can understand 
the meaning of the scales. 

‘^The Dynamics of Business^' breaks new ground in the attempt to 
analyze the causal factors creating business cycles. Dr. Silberling had 
stated on various occasions that no other book known to him analyzes 
causation satisfactorily, and that most books have merely been concerned 
with the manner in which small booms become large booms and small 
depressions become great depressions. Much attention in the past has 
been given to prices as the central fact of business dynamics, but it was 
Dr. Silberling^s opinion this has merely led to a superficial kind of study 
in getting to the root of things. He maintained that it is not until one 
has grasped the significance of dynamic behavior in terms of production, 
prices, income, the divergent tendencies of agriculture and manufacturing, 
the peculiarities of wages, interest, profits, and the outstanding momen- 
turn of construction as a dynamic factor that clear and accurate reasoning 
can proceed. 

This book lays the foundation for various further lines of scientific 
research by revealing the nature of the dynamic behavior of building, 
real estate, agriculture, merchandising, and manufacturing. A basis 
is provided for the development of a new science of industry analysis, the 
need for which is already urgent. In pointing toward certain specific 
factors as the prime movers in booms and depressions, the book may be 
instrumental in furthering the formulation of sound governmental policy 
in the post-war period. And in giving for the first time emphasis to 
systematic procedure in planning management policy a basis is laid for 
the development of a technique of management and a wider use by 



executives of business statistics for internal control. In the last analysis 
the American people are going to move either in the direction of totali- 
tarian dictatorship, which is another form of feudalism, or they will 
reaffirm the value and dignity of business management as a means of pro- 
viding for expansion of real wealth and a higher standard of living. If 
it can be generally understood that capitalism, fortified by a wise use of 
capital and credit, a rational tax system, and a few well selected and 
strategic devices to avert booms and depressions, is by no means obsolete, 
then it will be easier to understand why collectivism of any kind is a sham 
and a delusion. 

It is not easy to conclude this preface. Dr. Silberling had given more 
than a decade of painstaking research and careful analysis to all the 
factors which he believed essential in developing what he termed a '^new 
science of industry analysis.’^ He took nothing for granted. A most 
searching analysis and the most exacting tests were made at every step. 
The manuscript had been completed, the charts and Statistical Appendix 
finished, and the proofs for more than three-quarters of the book returned 
to the publisher. It was Sunday, October eighteenth. That afternoon 
tragedy struck — Dr. Silberling was seized with a heart attack and died 
within a few minutes. Would that he might have lived to see not only 
the completion of ^^The Dynamics of Business,^^ but its reception by the 
thoughtful leaders in education, government, and industry ! It is 
probable that no scholar has ever given more unselfishly of himself to 
complete his magnum opus than Dr. Silberling gave to this study. 

The Preface had not been written. However, from Dr. Silberling’s 
notes, his correspondence, and from years of association with him, I have 
endeavored to present here something of his aims and methods, his point 
of view, and his genuine accomplishment. Any failure to state his true 
point of view must be attributed to one^s inability to speak fully and 
correctly for another. To his assistants who had worked with him and 
to his colleagues and fellow scientists wherever located, I express in Dr. 
Silberling^s behalf sincere appreciation and deep gratitude for all assist- 
ance given in the preparation of this volume. In ‘^The Dynamics of 
Business,^' one may behold the mind of a true scientist, the judgment 
of a mature and practical man, and the soul of a pioneer — one unafraid 
to step out ahead of the procession and point the way to his fellow men 
to richer and fuller living. That was Norman Silberling^s mission on 

J. Hugh Jackson, 

Dearly Graduate School of Business, 
Stanford University. 

Stanford University, Calif., 

December y 1942. 



Preface v 


1. Introduction 1 

2. The Trend of Population Growth 9 

3. The Growth Trend of Production and Trade 30 

4. Business Activity, Prices, and Wars 47 

5. The Dynamics of the Price Level 72 

G. The Interaction of Money, Trade, and Price Level . . . 103 

7. The Value of Trade, National Income, and Farm Income 124 

8. Further Cyclical Aspects of Agriculture 152 

9. The Dynamics of Building and Real Estate 175 

10. Transportation Development as a Cyclical Factor. . . . 208 

11. Commercial Banks AND Capital Financing 239 

12. The Federal Reserve and Credit Control Experiments. . 265 

13. The Gathering International Storm, 1928-1931 291 

14. International Factors in Monetary Policy, 1931-1938 . . 314 

15. Financial Reconstruction 337 

16. Interest Rates and Corporate-bond Issues 364 

17. Stock Prices, Speculation, and Stock Financing 396 

18. Corporate Earnings, Savings, and Capital Investment . . 428 

19. Consumer Income Use and Merchandising Cycles 461 

20. Industrial Labor Productivity, Wage Income, and Employ- 
ment 497 

21. Cyclical Stabilization of Wage Income 535 

22. Business Forecasting 559 

23. Dynamic Business Policy 586 




Chapter Pagr 

24. Price Disparity and Cyclical Instability 614 

25. The Future of Production and Capital 651 


1. Annual Index op American Trade and Production, 1700- 

1940 685 

2. Annual Index Numbers op Wholesale Commodity Prices, 

1700-1940 695 

3. Construction op an Annual Index op Credit Currency, 

1811-1940 696 

4. Construction OF Measures OF National Income 702 

5. Index op Total Agricultural Income, 1800-1940 704 

6. Indexes of Transportation Construction and Building 

Construction, 1800-1940 709 

7. Construction op the Reserve-loan Ratio as an Indicator 

of High-grade Bond Prices 715 

8. Corporate Revenue and Its Disposition, 1922-1938 .... 720 

9. Receipts, Net Revenue, and Capital Outlays of Individu- 
als AND Farmers 722 

10. Indexes of Labor Income and Productivity in Manufac- 
turing Industries 724 

11. Composite Monthly Barometer op Cyclical Movements in 

General Business Activity, 1881-1924 728 

12. Real-estate Foreclosures; Failures in Commerce, Rail- 

road Companies, and Banks; and the General Commodity 
Purchasing Power of the Dollar 732 

13. Note on Unemployment Estimates 734 

Index 737 




A thoughtful businessman, reminiscing upon his progress through 
the years, would undoubtedly be impressed by the pervasive element of 
change. He would be inclined to reflect upon the manner in which his 
enterprise had grown from a modest start; how it had adjusted itself again 
and again to new conditions in the course of that growth; and how its 
structure and organization had been subject to repeated revision. 

Such a survey of the fortunes of a particular business unit — a manu- 
facturing firm, a store, or a farm — might be developed in voluminous 
detail. There might be episodes shaped and colored by the personality 
of a founder or a manager; there would be in the full story many acci- 
dental circumstances of fire or flood or failure or fortunate turns of the 
wheel of chance. To each established enterprise there attaches much 
specialized history, differentiating that unit from the experiences of other 
units. We should not be able to derive from such an individual business 
experience anything in the nature of basic principles capable of general 
application. We might derive inspiration, suggestion, and frequent 
glimpses of the more general changes in the economic or political atmos- 
phere; but these impressions would usually be blurred and vague. 

We might, of course, derive from an intensive study of the history 
of a business some fairly clear evidence of the pattern of its growth — 
the slow, uncertain beginning, the period of assured survival, the more 
rapid acceleration in importance and prestige. And, finally, toward the 
later years, we might note a tendency to lose some of the old momentum 
or even to undergo more or less retrogression. 

The life of the average individual firm, in the broad perspective of 
human affairs, is relatively short. The proportion of failures among 
new enterprises is known to be astonishingly high. If we were to limit 
our attention to those who initiate but soon fall by the wayside, we might 
form an impression of business fortune strongly tinged with the element 




of hazard and difficulty. But even the more successful enterprises rarely 
enjoy long life. Their periods of growth stand in relation to the more 
general economic trend of the nation as the growth of trees stands in 
contrast to the growth of a forest. And the environment of an individual 
business unit is usually more or less localized; to a high degree it contains 
the many peculiarities of geography. It involves changes in the sur- 
rounding forces of competition, both within the industry and without, 
and the influence of these ever-varying environmental factors will by 
no means be comparable among the various establishments. 

Finally, if we limit our observations to a given concern, we are likely 
to restrict attention to phases of accomplishment that are expressed in 
terms of money whereby the individual management largely calculates 
and measures its performance. The actual volume of wealth or service 
created, as distinct from the value of sales, prices, profits, or payrolls, is 
not so readily measurable. It is often exceedingly difficult to discover 
the reasons for changes in these various results, since the nian}^ diverse 
factors affecting the organization from outside tend to be so closely 
intermingled with changes in internal policies reflecting the caliber of 
management or the terms of ownership and control as they exist from 
time to time. Thus, a study of the dynamics of the business in terms of 
an individual enterprise would probably in most instances throw but a 
dim and flickering light upon the broad changes in the business atmos- 
phere, and exact measurement would prove difficult. 

If now we broaden our picture to include an eritire industry by con- 
sidering a composite record of the experience of all the units engaged in a 
given type of business, we find more significant patterns revealed. We 
need, of course, a large enough segment of a given field to enable us to 
ascertain whether among these more or less comparable concerns a certain 
amount of common experience has stood out against the particular dc'tails 
fashioned by locality, personality, sheer accident, and what not. If it 
were possible to hit upon the necessary data whereby we could trace the 
growth and the ups and downs of a group of steel companies, or a group 
of retail stores, or a considerable number of wheat farms, we might expect 
to find that the nature of the product in each case would introduce certain 
elements more or less common to all the individual enterprises making 
up the group. Company structures, matters of personality, localization, 
etc., would continue to color the statistical patterns; but they would 
tend to be subordinated by the influence of the industry characteristics. 
These, in turn, originate mainly from the manner in which the product 
or service sold affects the behavior of prices and costs, the extent and 
intensity of competition, etc. We should thus expect the dynamic 
behavior in each field of business to reveal itself in characteristic patterns 
over periods of time. 



If we were to measure such performance for an entire segment of 
business by collection of information at frequent intervals relating to 
all operating and financial performance, we might form a picture of 
growth and change and adaptation according to various categories of 
observation and measurement. We might measure the results in terms 
of the changing value of the products or what is roughly equivalent to 
the gross revenue derived by an industry group from its aggregate sales. 
Assuming that figures were available, we might determine approximately 
the broad trends and temporary variations over the years in profits or 
disbursement of wages or earned surplus or capital assets utilized. In 
all such composite observations of the changing fortunes of an entire 
industry, it would be desirable to measure the change in terms of physical 
volume as well as price and value. This would serve to isolate the actual 
amounts of variation in units of product or service from mere gyrations 
of prices or the value of money. What contribution has the industry 
made from time to time to the ^^reaP^ income of the community? 

Precisely how the statistician can obtain for some selected industry 
useful dynamic measures of the industry's performance is a matter to be 
considered hereafter. Let us observe here that when we concentrate 
attention upon this broader aspect of observation, not only can we 
derive more significant patterns of change but these patterns will tend 
to be reflected in some degree in the experience of each individual enter- 
prise within the group. In the study of individual firms, we might not 
be wholly aware of the frequent occasions when the industry factors 
were really the significant influences transcending the internal factors. 
Once we see the industry pattern, the distinctive features, tendencies, 
and trends of the group become apparent. It will be found also that the 
element of time takes on a new significance. An industry usually has a 
longer life than most of its constituent units. Its environment relates 
more directly to the structure and development of the nation as a whole 
and, indeed, to the ever-shifting political and economic forces of the 
globe. An industry feels the impact of changes originating in other 
industries, and this great interplay of forces can be usefully observed 
if we have adequate measurements of a series of industry groups in terms 
of production, values, prices, and many other significant dynamic aspects. 

We should not expect to find the production pattern or, indeed, any 
other measure of industry performance exactly duplicating what is found 
in some other industry group. In fact, we shall find, as we go forward, 
that whereas each type of industry has its characteristic time patterns 
in terms of growth, short-term responses to the seasons, or alternating 
fluctuations of prosperity and depression, these features will be distinc- 
tive as we pass from group to group. The individual businessman is 
frequently but partly aware of the characteristics of his own line of 



business; he insists upon infusing the personal element into his observa- 
tions of success or failure. He is inclined to give himself credit for 
his successes and to blame the Government or competition or luck for 
his difficulties. It will be found, however, that the patterns of an indus- 
try remain fairly consistent over long periods, and this holds true for 
those characteristics having a bearing upon the principles of sound 
management. In rather general terms, it can be said that the time 
patterns of manufacturing industries tend to have a good deal in common, 
particularly with respect to the fluctuation in operations from year to 
year. The trends of growth over long periods of years among these 
manufacturing groups, however, differ considerably. The trend in the 
manufacture of locomotives would appear to be definitely downward 
over recent years, while the trend of aircraft production is very sharply 
upward. If we confine our attention to the alternating expansions and 
declines in activity (let us say in terms of units of production or an 
‘4ndex number’’ measuring composite change in production), we still 
find it true that among the manufacturing industries there tends to be a 
remarkable reiteration of pattern. 

When these industry segments are combined in a grand total of all 
manufacturing industry and its broad fluctuating tendencies, apart from 
long-term growth, the resulting over-all pattern is easily identified in 
most of the constituent groups. We could break down the total into 
two broad major groups by segregating, on the one hand, those manu- 
facturing industries that produce durable goods, such as equipment, 
machinery, appliances, and those making nondurable and semidurable 
products which represent the typical merchandise purchased by individual 
consumers. As between these two subgroups, we should find that in 
the former the swings from prosperity to depression, from expansion to 
contraction tend to be relatively violent, and these violent changes are 
transmitted to the patterns of employment, payrolls, income, and well- 
being throughout the group. Among the nondurable goods, on the other 
hand, the fluctuations are usually narrower, and the impact of the 
business cycle, by which we mean the alternating fluctuations (apart 
from merely seasonal changes and apart from the trend of growth) is 
relatively moderate. 

As we examine further the time patterns in production or income of 
the various types of business considered as segments having more or less 
common characteristics, we come upon the segment ordinarily known as 
trade or commerce. This comprises merchandising and all its related 
processes catering to the wants of individual consumers and also the 
operations of wholesaling and marketing that form the bridge between the 
producer or manufacturer and the industries or merchants or the imme- 
diate users of the product. Another subgroup is transportation service 



for the products of industry and for the carriage of passengers. Beyond 
this are large fields of service activity, such as warehousing, insurance, 
and banking, extending to many forms of professional work, some of 
which are represented by individuals or firms of small size. 

To measure many of the aspects of performance of these groups in 
the '^service industries'^ is not easy, particularly if we seek to measure 
changes over the years in physical terms rather than in value terms. 
From the statistical standpoint, this problem is perhaps more dilfficult 
than is the problem of obtaining the corresponding measurements for 
industry. But from a practical standpoint, it is obvious that most of this 
service activity is directly or indirectly involved in moving along the 
products of enterprise toward final consumption. Although measure- 
ments of trade and transportation operations might not agree exactly 
with those found in manufacturing, the degree of correspondence is 
nonetheless significant. It can be at least tentatively assumed that it 
is the industrial or manufacturing operations that form the dynamic 
nucleus of the present-day economic system. In the United States 
and other advanced industrial countries, most of the new wealth created 
and added to the current real income of consumers has passed — at some 
stage, at least — through manufacturing processes. 

Another broad and important segment of our economy includes 
enterprises associated with construction. The erection of buildings is a 
form of business having many peculiar features and dynamic patterns, 
more fully described in later chapters. Indeed, the manner in which the 
various types of building enterprise relate themselves dynamically to the 
general drift or, indeed, influence that general pattern are worthy of 
special consideration, and evidence will be presented that this great 
group of activities probably contributes in a powerful manner to wide 
rhythmic fluctuations in many industries engaged in manufacturing 
and extractive operations. 

Finally, we may refer briefly to the complex processes and peculiar 
patterns associated with agriculture and animal husbandry. When we 
refer casually to ‘‘business conditions^' or business prosperity, we fre- 
quently do so without direct reference to, or consciousness of, the agri- 
cultural phase of business enterprise. Much of our discussion of business 
has a distinctly urban point of view, probably because over the years, 
that segment of our population engaged in the cultivation of the soil and 
the raising of animals has been a consistently declining part. From a 
statistical standpoint, this farm group of industries reveals rather peculiar 
patterns of production and income change. Whereas the production 
patterns of many branches of manufacture, as previously stated, develop 
similar reiterating movements, the changes in agricultural production 
present many dissimilar patterns rather than a repetition of essentially 



similar movements. We should expect this, since each branch of agri- 
culture has its peculiar relation to weather and soil conditions, growth 
processes, and even marketing operations. No two branches of animal 
husbandry are alike in their operations or the patterns of change that 
result therefrom. We shall see later that, whereas the contribution of 
agriculture to the real income or wealth of the entire community may be 
measured in the drift of aggregate farm production, the farmer^s changing 
results from year to year in well-being or buying power, and also those 
of his hired workers and the surrounding rural community, do not depend 
on the volume of product but may actually be inverse to changes in the 
physical volume of output. This is less true of price changes, but it is 
an important characteristic of volume. 

If these dynamic differences which characterize broad segments of 
industry are borne in mind, it would appear that an over-all measurement 
of change, in terms of output, would develop a highly significant picture of 
the course of the entire nation^s flow of ‘^rear^ income from its resources, 
labor, skill, and management. Such an over-all measure of physical 
progress, if compared with the detail, would illuminate at many points 
the influence exerted by the general movement upon the particular 
segments of activity. The general pattern of change and fluctuation is 
thus the immediate controlling force in the flow of income of millions 
of families. And we may also find it useful to look at the matter the 
other way around and endeavor to discover how particular industry 
disturbances transmit themselves to the general pattern; or, to put it in 
other words, to discover whether some particular segments of industry 
or trade or finance tend to develop dynamic trends or a rhythm of 
fluctuation so powerful as to influence the general changes and to reach 
into the far corners of the economic mechanism. 

We must not overlook that part of the business environment which 
is today so potent in its formative and regulating aspects — governmental 
activity. As we trace the performance of the entire productive system 
through time and observe its general trends, fluctuations, and vibrations, 
we should recognize that this system operates in an environment that 
itself is not stable but that is subject to forces of political evolution or 
revolution, political and social experiment, mass hysteria, military policy 
and wartime turbulence and destruction, and all the legal and judicial 
innovations arising from the vast complex of social change. We shall 
have occasion from time to time to discuss political emergencies and 
breakdowns represented by war and the effect that they have upon the 
pattern of change in business. We might, indeed, carry our studies far 
afield into foreign affairs and the occasional impact of political and 
technological and industrial developments in all those parts of the world 
that may be considered capable of affecting in some degree the course 
of our own economy. 



We must keep in mind, too, the fact that the system of business 
operates in the service of people. The population is gradually but 
constantly changing in numbers and conceivably, also, in human type 
and human quality, a fact that suggests fields of study well beyond the 
scope of the business analyst. One of the first problems we shall con- 
sider is the long-term growth of our own population in order to observe 
clearly its pattern of change and its relation to economic development. 

In all these departments of dynamic study the reader will observe 
that the environment within which the business process as a whole 
operates broadens out as we proceed from the individual shop or store 
or farm to the workings of the economy as measured in its aggregate 
production or income value. We shall be dealing mainly in this volume 
with the dynamic characteristics of the economy as a whole rather than 
with individual industries or particular businesses. We shall have some- 
thing to say, however, about the dynamic peculiarities of construction, 
transportation, agriculture, and a few other segments having special 
importance from one angle or another. 

We are dealing with the American business system, which, from its 
inception, has embodied the elements of private property, a considerable 
degree of unrestrained competition, an increasingly elaborate mechanism 
of exchange and division of labor, and the use of vast amounts of credit 
to facilitate the operations of exchange. We shall therefore examine the 
dynamic patterns of prices, including subgroups of price movements as 
well as the general drift. There are particular groups of prices in the 
service markets that have special interest and importance, such as farm 
prices, the price of capital, the price of bank credit, and the behavior 
of wages. This analysis of the pattern of prices may enable us to under- 
stand still more clearly the changes in money income or business receipts 
accruing to the nation as a whole or to important segments of it. We 
shall find that in some instances the economic welfare of a group depends 
primarily upon the volume of its output but in other cases upon the 
changes in value or the product of output and price. Much popular 
generalization on these matters overlooks these basic contrasts. But 
after all, it is the substantive, tangible product — the actual physical 
units of service that we can use and enjoy — that ultimately justify the 
efforts and sacrifices of business enterprise. For one reason or another, 
the prices of those products and services do not remain constant, even 
over short periods; and over longer periods the variations in the fabric 
of prices may become so marked and complex that measurements only 
in terms of value would become distorting elements in the effort to meas- 
ure and interpret the more basic aspects of real income and actual wealth, 
which make up the moving standard of human living. 

As we proceed with this study, we shall have occasion to analyze the 
methods whereby capital and credit have been used and misused in 



financing building, speculation, agriculture, wars, and other activities. 
Factual evidence will be presented to show how booms and depressions 
have been generated by wars and by specific factors in the land-using 
industries involving speculative use of capital and bank credit. It is 
remarkable how much of our current economic thought regarding the 
business cycle, unemployment, finance, and political policy has been 
evolved out of monetary and credit theories, which, in turn, have been 
translated into income and capital theories, without much regard for 
the facts of actual economic life. The Great Depression of the 1930’s 
afforded an extraordinary opportunity to experiment with various 
political “income-creating” schemes evolved from observation of money 
circulation rather than production processes. The results, although in 
some measure helpful, have raised many new and complex questions. 

During the 1920’s, dynamic policy was being enthusiastically expressed 
in terms of stability of the price level, via central-bank manipulation of 
the money market. In the 1930's, gold was supposed to have become 
“scarce” and, amidst international currency troubles, we were pushed 
into a gold-hoarding, cheap-money program. Well before the 1940's, 
this had gravitated to a philosophy, cherished by many economic theo- 
rizers and political leaders who accepted their counsel, that regards 
capital as having become “excessive” as population tapers off, so that 
saving must now be discouraged rather than encouraged. As much 
private capital as possible, we are being told, must be expropriated by 
Government, which alone is supposed to be able to use it wisely and thus 
to sustain employment. Truly economic theories and the political 
policies embodying them run in cycles, like fashions and styles, with 
exaggerated emphasis upon some one idea or assumption which may be 
far removed from reality. 

What is most needed now, in a world at war and amidst turmoil that 
perils the very survival of economic democracy, is much more adequate 
measurement of the dynamics of the business process and a broader 
perspective of the manner in which its moving parts interact. We must 
clearly understand why depressions continually have interrupted progress 
toward a wider distribution of income and capital before we can formulate 
sound political and business policy, directed toward preserving progress 
in hving standards and eliminating needless cyclical vibration, and 
capable of more widely diffusing economic opportunity and security. 
An industrial society that can achieve steady growth in wealth creation 
can also achieve an equitable distribution of that wealth without resort- 
ing to political dictatorship or collectivism. 



We have sketched in a preliminary way some of the aspects of business 
and economic activity upon which our attention will be focused. Our 
fundamental problem concerns time and change. Let us now distinguish 
between change that occurs gradually, over extended periods of time, 
and change that is in the nature of vibration or short-term fluctuation, 
which, in many aspects of production, distribution, and prices, serves, to 
make the course of economic progress undulating and irregular. The' 
vibration at times becomes so pronounced that far-reaching social 
reverberations result. But to measure and distinguish these undulating 
cycles,^’ we must first study the underlying trend. 

We have seen that the long-term development of an economic system, 
such as that of the United States, has occurred in a social, political, 
geographical, and international environment. The environmental fac- 
tors have conditioned to a large degree the pattern of historical develop- 
ment. The expansion of population over a vast continental area, 
endowed with exceptionally rich resources and a generally satisfactory 
climate, has served to create a partem of long-term change in the Ameri- 
can economy that distinguishes it from the experience of other nations. 
Our expansion in industry and wealth since the seventeenth century 
proceeded upon the basis of land, forest, and minerals capable of exploita- 
tion for widely diversified production. Natural growth was augmented 
by heavy migration to our shores from Europe. To a large degree, these 
continuing additions to our people represented relatively advanced 
cultures, with backgrounds of industrial skill and economic initiative, 
traditions of opposition to restrictive forms of government, and aptitudes 
favoring a pioneering spirit. The spreading of such people over a rich 
new area and their ability to create one of the world’s greatest industrial 
economies within an astonishingly brief period were facilitated by another 
important factor, the insulating effect of great oceans that minimized 
the dangers of international friction. In contrast to the developments 
of the crowded checkerboard of Europe, our people were long able to 
develop a coordinated, unified system of economic life with virtually a 
free flow of trade, population movement, and capital investment, little 
hampered by nationalistic jealousies, historic antipathies, and the 
paralyzing influence of armaments, standing armies, huge military debts, 
and the constant threat of destructive warfare. 




In introducing our analysis of the economic trend by some discussion 
of the growth of American population, it is not intended to suggest that 
expansion in numbers must necessarily have a fixed relationship to growth 
in wealth or income or living standards. In the early settlement and, 
indeed, throughout the Colonial period and for some time thereafter, 
business expansion appears to have proceeded at a rate closely paralleling 
that of the estimated annual increase in population. In any simple and 
largely agricultural community, a large proportion of the economic 
effort is called upon to provide the basic essentials of food, clothing, and 
shelter. With production mainly the result of manual labor, assisted 
by tools and animal power not subject to rapid changes in design or 
efficiency, total productivity per capita could not vary from one decade 
to the next over a very wide range. The introduction of labor-saving 
devices and expansion in variety of products and services during the 
nineteenth century has brought about, as we shall presently indicate 
in more detail, an important change in the relationship between total 
population and total production and trade. One of the features of this 
change has been the declining portion of human effort engaged in the 
simpler pursuits of agriculture and the rapid expansion of urban and 
industrial population. During the course of these changes, improvement 
in technology and the application of power and improved mechanism 
have extended not only to the industries of the cities but to those of the 
farms and forests as well. But there have been more recently changes 
in the population growth itself that have further widened the divergence 
between population and production in the aggregate, and it is of con- 
siderable importance to study the dynamics of the human environment 
as a factor capable of independently influencing the development of the 
economic system in various aspects in the future. 

The first Census of the people of the United States was taken in 1790, 
and the population has been enumerated every ten years since that time. 
During our Colonial period, there were no thorough or uniform attempts 
to obtain an actual count of the people. There are in existence, however, 
various estimates that have been carefully fitted together and adjusted 
by statistical authorities, and from these figures we can derive at least an 
approximate pattern of growth as far back as the early years of the 
seventeenth century. 

If the reader will refer to Chart 1, he will find the data of the American 
population depicted in two different ways. Corresponding to the 
arithmetic vertical scale shown at the right, the total population at decade 
intervals is represented by the middle line. It is impossible to show on 
this scale the exceedingly small numbers (less than half a million) during 
the seventeenth century. From the early part of the eighteenth century 
the curve rises gradually and then describes a rapidly accelerating and 



rather smoothly advancing course. This continues until the moderate 
slackening of increase develops in the last decade, ending at 1940. The 
lower line on this chart (plotted to the same arithmetic scale) indicates 
the amount of net increase in total population during each decade. 

Chart 1. — American population growth. The upper curve shows total population 
drawn to a ratio scale so that changes in the direction of the curve indicate changes in the 
rate of growth. For the Colonial period estimates only are available. The lower curves 
are drawn to an arithmetic scale which gives effect to the actual increment per decade. 

It should be noted that these are shown as amounts of increase. Although 
the curve describes the growth, it does not necessarily indicate changing 
rates of growth or percentage variation. The upper line in Chart 1 is 
drawn to what is known as a ratio scale, the vertical divisions being 
logarithmically determined. It is the property of this kind of scale 
graduation to show a given percentage change, increasing or decreasing, 
by a designated vertical distance. Thus, if figures plotted in this fashion 



result in a straight line, inclined steadily upward, it signifies that during 
each interval of time there is an equal distance gained and hence a con- 
stant rate of increase. The converse would hold if such a curve formed a 
straight line steadily declining.^ Hence this type of graphic illustration, 
once the principle is understood, shows by the slope of the resulting 
curve the rate of change and any tendency for alterations in this rate 
of change. 

It appears from the upper curve of Chart 1 that in the early part 
of the seventeenth century the rate of population growth was very rapid. 
On the lower portion of the chart, it is virtually impossible to show the 
very small numbers of people in the early Colonies or the rate of expan- 
sion. Not until the close of the eighteenth century does this arithmetic 
presentation clearly picture the expansion. But strangely enough, just 
as the arithmetic curve appears to accelerate most rapidly during the 
first half of the nineteenth century, we find that the logarithmic or ratio 
curve is beginning to show evidence of some tapering off! In a sense, 
the two ways of plotting the same data seem here to become contradic- 
tory. The point is that although there was a continuing increment in 
numbers until about 1910 (as shown by the lowest curve on the chart), 
these additions had for a considerable time failed to produce a constant 
proportionate expansion. It is a striking fact that for two centuries, 
from about 1660 to about 1860, our total population grew at a rate that 
was so nearly constant from decade to decade that the small variations 
from this constant rate are barely discernible, even on the ratio curve. 
The lower arithmetic curve does not reveal the fact at all, nor does it 
show clearly that soon after 1860 the rate of increase per decade was 
already beginning to decline. This rate averages about 34.5 per cent 
per decade over a period of about two hundred years, but after 1860 it 
drops to 26 per cent, then to 21, then to 15, and in the last Census decade 
1930-1940, the rate of increase proved to be only a little above 7 per cent 
per decade. This relatively sharp decrease in the rate of increase is, of 
course, clearly reflected in the lowest curve, indicating the actual amount 
of per decade gain. The arithmetic curve of population also begins 
finally to show the tapering tendency. 

1 According to the logarithmic principle, equal vertical distances may correspond 
to logarithms of the actual data, or the actual data may be graduated through a range 
from 1 to 10 (or any multiples thereof) in such fashion that the distances separating 
the units correspond to the differences between the successive logarithms. As a 
result, arithmetic progression by equal vertical distances per unit of time is equivalent 
to progression by equal multiples of the actual data. Similarly, equal declines indicate 
equal ratios of decrease. Hence the degree of slope of the curve drawn to ratio scale 
is immediately indicative of the rate of change, and if the scale is known, it is possible 
to read off approximately the percentical change from any point to any other point on 
the plotted curve. 



It is important to understand the two ways of illustrating these long- 
term changes and to distinguish carefully between rates of change and 
amounts of change. There are occasions when the rate of change is 
important and other occasions in which the amount of change is more 
significant. In following chapters, much use will be made of the ratio 
scale in displaying changes in various aspects of business dynamics, 
particularly when it is desired to compare the movements of several series 
of data. 

If we return now to some further analysis of the dynamics of American 
population growth, it is interesting to observe that during the past 
century and a half of our existence as an independent nation, our growth 
in numbers has been much more rapid than that of any important part 
of Europe (except Russia). From about the middle of the nineteenth 
century, the countries of Europe contributed each year hundreds of 
thousands of their people to the growth of the United States. We can 
trace the magnitude of this flow of immigration only since 1820; and 
unfortunately, there are no complete statistics until recent years of the 
number of permanent emigrants. The net figures, down to fairly recent 
years, are merely estimates. But the numbers who came into this 
country formed occasional mass movements or major waves in the general 
tide. In 1854, about 400,000 immigrants arrived, a number equal to 
about 1.5 per cent of the existing population. In the early 1870^s, there 
occurred another wave. Again in 1882 a high peak of nearly 800,000 
was reached, again about 1.5 per cent of the total population. There- 
after, the incoming flow was reduced to an average of about 400,000 per 
year, but a number of exceptional waves occurred from 1905 to 1907, 
around 1910, and, finally, just before the outbreak of World War I. 
From that time the flow of immigration has been greatly reduced as the 
result of legislation first passed in 1921, followed by still more restrictive 
laws in 1924. Since 1923, when about three-quarters of a million of net 
immigration occurred, there has been a rapid reduction in net additions 
from foreign countries, and during the last decade there were several 
years of net loss as the result of these movements. 

If we refer again to Chart 1, it will be seen that the lowest line, showing 
actual numbers added to the population each decade, proceeds with 
occasional fluctuations, while the total population line still rises smoothly. 
This illustrates the general principle that the changes from time to time 
in a total magnitude or a stock or inventory tend usually to be of a much 
more fluctuating pattern than that of the aggregate itself. The latter 
is an accumulative series; the former reflects net differences. This, 
again, is a useful elementary principle that should be kept in mind in the 
dynamic analysis of economic variables. In terms of population, we 
do not, of course, have records of the actual population based on actual 



enumeration at annual intervals; the Census count is made only at 10- 
year intervals. But from estimates that can be worked out on the basis 
of birth rates, death rates, net immigration, etc., it appears that the 
minor fluctuations in the amount of net population increase from year to 
year have been accounted for primarily by the fluctuations in migration 
from and to foreign countries. It will be seen in Chart 1 that the curve 
of additions to the population reached its highest point in the decade 
ending at 1910. The additions in the following decade, ending in 1920, 
were somewhat less because of the intervening years of World War I, 
which directly affected migration, and also a rise in the average death 
rate attributable directly or indirectly to the War. But in the decade 
ending at 1930, the net increase changed little, in the absence of the 
previously unrestricted flow of immigration; in the last decade, ending 
at 1940, some portion of the sharp decline in the amount of increase in 
numbers resulted from the existence during much of that decade of a net 
deficit in immigration. 


More fundamentally, of course, the rate of growth in the population 
must be traced to the three basic factors: the area comprising the national 
domain and its qualitative characteristics, the birth rate and the death 
rate. So far as the physical expanse of the nation is concerned, it can 
be said that during our entire history, the land available for development 
and production has represented a high ratio to numbers in comparison 
with the ratio in all other important civilized countries. Beginning with 
a domain comprising close to 900,000 square miles at the beginning of our 
national existence, there were but three important continental additions 
in the subsequent period. The Louisiana Purchase in 1803 brought the 
territory up to about 1,700,000 square miles; some rather minor additions 
were made in 1819; the addition of the Texas and Oregon areas in 1845 
and 1846 combined to bring the area to nearly 2,500,000 square miles. 
Shortly thereafter, in 1848, the territory acquired from Mexico brought 
the total close to 3 million square miles. Since 1853, when the Gadsden 
Purchase brought the total slightly over that figure, there has been no 
significant addition to the national domain so far as continental United 
States is concerned, and we shall confine our attention to this part of our 
territory. So far ahead of the growth of population has been this vast 
expanse that the various additions have not reflected themselves clearly 
in the growth of population. Significant, however, is the fact that unless 
the United States acquires outlying possessions in addition to the approxi- 
mately 700,000 square miles now administered outside the continental 
boundaries, any further growth in numbers will occur under conditions 
of more intensive use of the resources comprised in the existing domain. 



To examine thoroughly the various factors entering into the relation- 
ship of natural resources to number of people would carry us rather far 
afield; but it is obvious that the problem is one not merely of area and 
numbers but rather of the kind of people and the kind of technology that 
motivate the productive processes. This country has never been faced 
with the kind of problem envisaged by Malthus, the British social 
philosopher, and his followers in the early years of the last century — the 
problem of declining sustenance and productivity that might result 
from exhaustion of resources and particularly of food supply. Part of 
the reason for this long-continued freedom from any such imagined 
deficiencies is found in the rapid strides that have been made in applying 
mechanical devices and improved methods to the land, the forests, and 
the mineral resources at our disposal and to the transporting of their 
products. At the same time, it must be remembered that there is under 
way a counterforce in the nature of deterioration of agricultural land 
through erosion, improper drainage, and exhaustion of important chemical 
properties; meanwhile, new mineral and even petroleum output is being 
obtained from resource discoveries made at longer and longer intervals 
of time. The physical frontiers have been pushed practically to our 
geographic boundaries. Henceforth the quality of our technology, pro- 
ductive organization, and utilization of resources must replace the hap- 
hazard rough and ready wasteful pioneering of an earlier day if per capita 
real-income progress is to continue in the future. The possibility of add- 
ing to readily available natural resources by appropriation of outlying 
territory is becoming remote, although trade relations with Latin America 
may ultimately provide some addition to supplies of various basic mate- 
rials or advantageous items. 

We now come to the human factors — the birth-rate and death-rate 
trends, the age grouping within the population, and migration tendencies 
occurring within our boundaries. The slowing down of the rate of popula- 
tion expansion, beginning as early as the decade following the Civil War, 
is attributable mainly to the fact that the average birth rate per thousand 
of total population has declined somewhat more rapidly than the average 
death rate. In 1800, it is roughly estimated, the birth rate might have 
been as high as 45 or even 50 per thousand of total population. By 1880, 
the rate appears to have declined to the neighborhood of 35 per thousand; 
and further gradual decline had brought the figure down to about 24 by 
1920. We cannot be entirely sure of these figures, since the official 
registration'' of births, although undertaken in a few states early in the 
last century, was not accomplished on a nation-wide basis until 1915, 
since which year the statistics have become increasingly reliable. This 
substantial progressive decline in the birth rate has, of course, been a 
world-wide phenomenon. In many other countries, such statistics have 



been more carefully recorded, and they leave no doubt that changing 
ways of life, improving standards of living, and, particularly in recent 
years, the exercise of voluntary control of family size have been important 









factors in all advanced countries. Since 1920, the decline in the American 
birth rate appears to have accelerated, and this particular change appears 
clearly to have been due to a spreading knowledge of means of contracep- 
tion, facilitated by the increasing concentration of population in urban 
and metropolitan areas. 



The birth rate has always been higher in areas having a high propor- 
tion of foreign-born persons and in most of the rural areas of the country. 
The normal trend has been for the cities to absorb the rural surplus. 
In Chart 2, it will be seen that the population growth in the urban areas 
for more than a century has been relatively faster than the total growth, 
whereas the expansion in the rural and farming population has tended to 
slacken — to such an extent, in fact, that it may be considered now 
virtually stationary. The rural reservoir of population is thus no longer 
being steadily increased, and it is quite possible that hereafter the 
deliberate control of numbers may spread to all sections, along with 
other evidences of more advanced living standards and the displacement 
of labor by machines in farming. 

Turning now to the essential data of death rates, we again are con- 
fronted with the necessity of making rough estimates for earlier years, 
since the progress of systematic recording for this, as for many other 
aspects of economic and social change, has been slow. It appears, how- 
ever, that from a rate probably in the neighborhood of 20 per thousand 
at the beginning of the last century, there followed a declining tendency 
sufficient to offset the parallel decline in the birth rate. Hence the excess 
of births over deaths, along with immigration, sufficed to maintain a fairly 
steady expansion at the rate of over 34 per cent per decade as far as 1860 
or thereabouts. Since then, and particularly since about 1920, the aver- 
age death rate has not fallen so rapidly. Continuing sharp decline in 
the death rate of infants has been offset by a less favorable showing in the 
higher age brackets. To this should be added the fact that the popula- 
tion is gradually growing older. This alone will, of course, contribute 
to a probable stabilizing of the death rate during the next generation, 
and beyond that there may even be some rise in this rate. The latest 
available figures point to a crude birth rate averaging about 17.5 per 
thousand of total population and a crude death rate of about 10.5 per 
thousand. Since 1933, both the birth and death rates appear to have 
increased slightly; the death rate, in fact, appears close to a level that, 
on the basis of the experience of other countries having relatively low 
death rates, appears close to the optimum figure not likely to be lowered 
appreciably in the future. The birth rate may perhaps be expected to 
decline further, although perhaps not so rapidly as it fell in the decade 
ending at 1930. There will be a pinching out in future decades of the 
excess of births over deaths, and the point of equilibrium will mark the 
time at which further increases in population, apart from migration or, 
conceivably, enlargement of the national domain or easily available new 
resources, will be at an end. Although it is so commonly assumed by 
those who have not examined these facts and tendencies that growth 
always goes on and on and the trend of population is always pointing 



upward, there seems no escape from the conclusion that this growth will 
henceforth taper off rapidly. 

If we examine for a moment the internal structure of our population 
in terms of age groups, as illustrated in Chart 3, it is interesting to see 
that there has already occurred a slight decline in the number of persons 
under 20 years of age. There has also been some increase in the number 
of people aged 65 and over. In fact, the proportion of total population 
coming within the age group under 20 has been steadily declining for more 
than a century, and the upper age group, 65 and over, has been relatively 
gaining. It is the belief of close students of this subject that in the future 
the proportion of population above the age that roughly limits the most 
productive period of human life will increase rapidly, while the number 
of young persons, below the productive age group, will diminish. The 
middle group, aged 20 to 44, has for a long time remained relatively 
constant; in fact, in the past forty or fifty years, it has slightly increased 
proportionally. It is expected that this group will continue without much 
change for another forty or fifty years. 

From what has been said, it might be concluded that, since the middle 
age group is the productive, or perhaps we should say reproductive, 
group, its contribution to numbers through natural fertility, apart from 
other factors, would remain relatively constant. Such, however, is not 
necessarily the case, since within this segment the ^‘modaT^ or most 
typical age will be gradually rising so that a gradually contracting part 
of that middle group will be capable of making population contributions 
paralleling those that were made in previous decades. This intragroup 
change has not been altogether clear to many people. The probably 
gradual shifting in age composition or in the weighting of the average 
within the middle age group will have its own distinct effect upon the 
future net fertility rate. The changes already taking place in the age 
composition and those that will certainly occur in the future have, of 
course, some important implications with respect to economic and busi- 
ness affairs. These matters, along with the significance of the general 
population trend as it may be projected into the future, will be discussed 
in later chapters in the light of many other dynamic features and char- 
acteristics of our economic system and its political environment. 


The shifting of population from the rural areas to the cities is a phase 
of this subject in which we can observe economic factors and population 
conditions interacting one upon the other. As farms become mechanized 
and as moderate-sized industrial communities establish themselves some- 
what apart from the metropolitan concentrations (partly as the result of 
lessened dependence upon steam motive power), we can expect more 



of the rural people to be brought within the influences of an essentially 
urban type of life. This tendency is generally also an influence in the 
direction of further reducing the natural birth rate. At present there 
is still a relatively high rate of reproduction in the Southern States. But 
even in this section the net fertility is already being reduced more rapidly 
than heretofore by the development of new Southern industries and the 
decay or transformation of the older forms of Southern plantation agricul- 
ture. An excess of births over deaths per thousand of population ranging 
from 10 to 15 in the Carolinas, Mississippi, Georgia, and Kentucky is not 
likely to persist indefinitely. In other words, the great reservoir of 
human resources and labor supply that for so long contributed to metro- 
politan growth will presently cease to be a source of population for urban 

The movement from farms to cities and from cities back to farms is 
one upon which fairly good recent statistical estimates exist, at least for 
the past twenty years or so. From 1920 to 1930, there was a net move- 
ment from the farms to cities, but from year to year there was considerable 
fluctuation in this movement. In 1932, the cityward movement was 
actually reversed, and although since then there seems to have been a net 
movement from farm to city, it has been upon a scale much reduced 
from that which previously prevailed. The Great Depression of the 
1930^8 kept more people on the farms where governmental efforts to 
restore income achieved a measure of success sooner than was apparent 
in the industrial urban centers. The urgent call of the national-defense 
industries for workers, beginning in 1941, however, will again produce 
.some additional rural exodus, possibly of permanent character. 

We have noted two ‘‘reservoirs'' of population from which American 
industry, and more particularly the urban centers, have recruited popula- 
tion — an alternating and variable flow of people from abroad and a flow 
from farms to cities. But neither of these is longer capable of contribut- 
ing to urban growth on the scale witnessed in the past. In fact, some 
of our largest metropolitan areas have already been shown by the Census 
of 1940 to be no longer growing or actually to be losing population, 
probably to the immediate surburban periphery.^ It does not seem 
necessary to avssume radical future changes in existing immigration 
restrictions or any such back-to-the-land social movement as is pictured 
by some observers who believe that our Federal Government policies 
are pointing the way toward resumption of a rustic static civilization 

1 If prevailing birth and death rates at each age level continue unchanged and if 
no net migration from country to city should occur, the Bureau of the Census esti- 
mates that urban population will decline about 24 per cent per generation, whereas 
farm areas will increase about 36 per cent and rural nonfarm areas will increase about 
16 per cent. This is on the basis of preliminary analysis of the 1940 Census data. 



comparable to that of the Middle Ages. Hence the rate of natural 
increase and the death-rate outlook is important. Within our large 
cities it should not be overlooked that the death rate has not been brought 
under control to an extent compatible with what we may expect of the 
progress of medical science. We have successfully lowered the rate of 
deaths from some diseases, particularly the fevers and tuberculosis; but 
heart disease, cancer, and deaths from automobile accidents, all of which 
appear to flourish in crowded cities or to develop from the strain of 
metropolitan existence, are claiming larger percentages than twenty years 
ago. On the other hand, infant mortality, which has been cut drastically 
in the last quarter century, is still twice as high in the United States as in 
New Zealand. Possibly the further survival gains that can be expected 
will for a period of time counterbalance the shrinkage in the birth rate 
itself. One of the important economic factors bearing upon this expecta- 
tion is, of course, the growing public concern and expanding governmental 
effort to enlarge the share of national income accruing to the lower income 
and wage-earner groups. Although we cannot be sure that these meas- 
ures will be as effective as some have hoped, they will doubtless contribute 
in some measure to that raising of living standards that appears invariably 
to result in better medical care of infants and young children, but at the 
same time the raising of standards of living seems to contribute directly 
to fewer births per family. To estimate the net revsults requires, as we 
shall presently see, careful statistical technique. 

There are several additional factors capable of introducing year-to- 
year changes in population increment in the nature of variations in family 
status. One of these is the marriage rate. Through the years this rate 
varies in close response to observed changes in economic prosperity and 
employment opportunities. Although here again our statistical data 
are not wholly satisfactory or complete, we can piece together enough 
of the picture on the basis of selected industrial areas to verify this belief. 
During a period of depression marriages are deferred until times improve. 
The number of new families initiated is thus a minor variable and one 
that is capable of producing some degree of acceleration of the prosperity 
phase of the business cycle, just as the postponement of marriage tends 
to contribute to the decline in certain types of business and construction 
activity. A somewhat similar factor is found in the manner in which 
“families^’ live together in larger or smaller groups. During severe 
depressions there is a greater tendency for both single and married sons 
and daughters to live with parents or other relatives as a measure of 
economy. This forms an influence unfavorable to building activity, the 
furniture industries, and even the sale of automobiles. As the unscram- 
bling process develops with improvement in business conditions, the 
number of family units increases. The constituent groups separate out 



into individual places of abode. The reader must therefore observe that 
what is said about the broad trend of the total population may not be 
true of the number of family units. According to the most recent data, 
there seems to have been an increase in the number of occupied dwelling 
units (which may be taken as more or less representative of family units) 
of over 16 per cent since 1930. This is more than twice the rate of increase 
in total population. Presumably this increase in family units occurred 
mainly as a result of the improvement in general conditions following 
1933. Since the building of homes, as we shall presently see, is an 
extremely important and basic segment of American industry, the 
dependence of this industry upon number of families rather than number 
of people is a significant economic fact. 

Still another aspect of the dynamics of population deserves a brief 
word. The migration of people in considerable numbers is not, of course, 
restricted merely to the farm-city movements. Industry today is 
decidedly in a state of flux, and there are many potent influences that 
attract workers and their families now to this section, now to that. 
More than twenty-five million individuals now reside in states other 
than those in which they were born. The war program of the nation 
that is being initiated as this is written has already produced significant 
migrations to new industrial areas and rapid enlargement of some existing 
centers, especially the smaller communities. The population trend, 
therefore, in a given area may be widely at variance with the general 
trend. For a localized area, it may therefore be diflScult to project the 
growth into the future with any degree of accuracy. The most effective 
approach to this problem probably lies in the careful analysis of the 
various occupational incentives that are attracting population to the 
locality and the conditions in other parts of the country that may motivate 
people to leave those sections. 

These problems are of considerable importance to particular states, 
such as California, where the natural rate of population reproduction is 
extremely low and where virtually all the increase in population in recent 
decades has been due to migration into the state. In tracing the origin 
of these mass movements, there is to be considered, on the one hand, the 
rise of a succession of major industries on the Pacific Coast — petroleum, 
fruits, motion pictures, textiles, and, lately, aircraft production. On the 
other hand, there has been for several decades a substantial westward 
movement from the Mississippi Valley and, more recently, the Southwest, 
partly motivated by the desire of the retired farmer to find a pleasant 
climate for his declining years and, more recently, representing destitute 
refugees from wind-swept and depleted soil and the swift encroachments 
of mechanized cotton culture upon helpless workers in the cotton belt. 
We find evidence also of other recent shifts within the national borders. 



There is a tendency toward less than average growth of urban population 
in the Northeastern and Middle Atlantic sections and a relatively higher 
rate in the Southern Atlantic and Southwest areas, where industrial 
development has been accelerating. A solid block of states, North 
Dakota, South Dakota, Nebraska, Kansas, and Oklahoma, lost population 
from 1930 to 1940.^ In connection with the growth of individual cities, 
it is interesting that not only economic conditions but also political factors 
are potent factors in migration. The Census of 1940 disclosed that rather 
generally the capital cities of the country revealed considerably faster 
growth during the decade than cities that did not contain governmental 
vseats. Washington, D.C., and its environs represent a conspicuous 
example, with the highest rate of growth of any large American city in 
that period. 


Let us return now to the problem of projecting estimates of the total 
population into the future. This problem might appear to be relatively 
simple, because the historical trend of population exhibits so consistent 
a pattern of change, and the variation occurs so gradually. From the 
curves in Chart 1, the statistician might be tempted to project extensions 
ten, or twenty, or fifty years in advance merely by the graphic device of 
sketching out a curve in a direction such as to complete the pattern down 
to the present. Such a purely graphic method, carefully used, would 
probably prove superior to an assumption of constant amounts of increase 

^ For local areas, it is of some assistance in gauging the population drift and plan- 
ning adequate regional facilities to be able to estimate the size of the population at 
annual intervals. It is possible to approximate the population of a county or city by 
using data of the number of children enrolled in the public schools. This information 
is collected in many states. From it estimates of the local population can be derived 
by observing the long-term trend of the ratio of school enrollment to total numbers 
and converting enrollment into population with a correction for this trend. The 
Tax Digest^ a periodical published by the California Taxpayers* Association, presents 
interesting estimates developed by Paul V. Lane and his associates for the county 
population figures in California and based upon this method. These project the 
official Census data to the current year, and some short-range forecasts are also 
published. Caution must be used, of course, in view of the fact that there is a gradu- 
ally changing ratio of children to total population in most areas, and allowance for 
this trend is necessary. But the method is superior to that frequently employed, 
which averages the results of changes in utility meters, directory counts, and similar 
correlates of population that individually are less satisfactory than school enrollment. 
A formula long used by the Bureau of the Census for current population estimates, 
beyond enumeration years, involved merely short projections of previously observed 
increments or ratios of change. The results proved to be increasingly inaccurate 
beyond a few years from the Census count, and the method has therefore been 



per decade. This certainly is no longer realistic. Extensions from the 
present time forward would prove accurate if we happened to hit upon 
just the right amount of decrescent advance followed by stability and 
in the proper time period. 

It might also be assumed that the per decade amount of future popula- 
tion growth would gradually step down in a manner substantially revers- 
ing the earlier positive increments, as seen in the lowest curve in Chart 1. 
Such an assumption is, in fact, made by some statisticians who argue 
that the increments during a long period tend to develop a certain 
symmetry. They employ for projection purposes curves developed from 
mathematical formulas of the so-called ‘^logistic” type. These permit a 
curve to be fitted to the historically observed data and continued forward 
in progressively smaller increments of increase that essentially duplicate 
the decreasing declines toward zero if the observer traces the earlier 
record backward to the beginning. The curve thus undergoes a sym- 
metrical inversion of pattern, approaching a more or less assumed upper 
limit and with the general form of an elongated Mathematically 

these curves are equivalent to an integration of the ordinates of a ^‘normal 
distribution” of growth increments in a symmetrically bell-shaped design, 
with the highest growth increment at the middle and progressively smaller 
increments tapering off on either side. This function has been used as a 
device to express the pattern of multiplication of numbers in any limited 
environment, by the noted biologists Lowell J. Reed and the late Raymond 
Pearl. ^ 

In their use of this mathematically determined extrapolation, Reed 
and Pearl have relied very heavily upon evidence drawn from populations 
of fruit flies raised in bottles and other similarly restricted populations 
of a very simple biological order. In such instances it is readily assumed 
that expansion beyond a certain limit becomes impossible in view of the 
established limitation of space and nutrition. Observations from such 
cases may be misleading when applied to far more complex human popula- 
tions living in environments capable of a high degree of voluntary control 
and even expansion through the exercise of even rudimentary intelligence. 
Many statisticians who are skeptical of this mechanical principle believe 
that the equations may be beautifully symmetrical and the future points 
on the curve of population may issue from a function conforming exactly 
to the pattern of past history; but oddly enough, it is entirely possible to 
devise for a given population record more than one plausible equation or 
logistic curve, with many alternative extrapolations! Whether the 

1 Another statistical form of the logistic type of equation for the fitting and extra- 
polating curves of growth assumes that the increments are distributed logarithmically 
rather than arithmetically. 



observer accepts as valid his highest or lowest future estimate then 
becomes a matter of judgment rather than of mathematical objectivity. 
Most extrapolations arrived at by this method seem to have reached 
much higher future estimates than have been either reasonable in the light 
of other evidence or verified by subsequent experience. The Reed-Pearl 
forecast of the United States population made for the year 1940 was 
136 million, but the actual count was less than 132 million. They reached 
a figure of 175 million for 1980 and an ultimate maximum of 197 million. 
These figures may be contrasted with the results of other methods that 
will be outlined below. We need not, however, go quite so far in con- 
demning this general approach as A. B. Wolfe, who has referred to it as “ a 
sort of fatalistic law somehow distilled by the alchemy of mathematics.^^ ^ 
The curve-fitting method does provide a formal pattern that population 
movements over centuries of time seem to follow in a general way, and if 
utilized with discretion in projecting the subgroups of a total so that the 
total estimate for future years may be derived by summing up the seg- 
ments in terms of logistic or similar formulas, the results can be at least 
a useful auxiliary check upon other calculations and a way of setting 
limits of probable range for very distant future periods. 

In contrast to the foregoing more or less mechanical projection of 
population, another type of method has been developed to which we may 
apply the term “analytical.^' This is the method that has been skillfully 
used by the Scripps Foundation for Research in Population Problems, 
directed by T. K. Whelpton and W. S. Thompson. The essential feature 
of this analytical approach is the breaking down of the problem into 
fundamental elements and the making of various detailed estimates that 
are finally assembled into the aggregate forecast. The population process 
is visualized as essentially biological, and such aspects as birth rate, 
death rate, age composition, racial characteristics, and distinction of 
foreign born from native born are followed out in considerable detail 
and upon several alternative assumptions covering the less easily predicta- 
ble conditions, such as net immigration. In extrapolating the course 
of the birth rate for a given segment of the people, we are, of course, 
dealing with psychological elements, changing customs, and complex 
economic and regional shifts affecting living standards and the importance 
of having or not having children. Death rates, on the other hand, are 
variables representing primarily the progress of medical science and other 
surrounding social conditions that may be independent of the decisions 
or standards of individuals. But if changes in these major elements 
in the problem are found to be progressing according to definite trends 
and can each be projected ahead, with recognition given to gradual 
changes in the age composition for various major groups and types of 
^ Quarterly J ournal of Economics ^ August, 1927. 



people and reasonable assumptions with respect to future net immigra- 
tion, the final results are likely to be fairly reliable.^ 

In thus breaking down the problem, it is best to deal, not with the 
crude birth rates and death rates in terms of the total population but 
with reference to specific rates, such as births to various groups of women 
at various ages. Deaths can likewise be analyzed, age group by age 
group, to throw light on specific past trends. In so doing, it becomes 
apparent that as a population becomes gradually older this fact in itself 
will have an effect upon the crude death rate, regardless of changes in the 
specific death rate for each particular age group. Since the annual figures 
for births and deaths are now available (and have been available since 
1933) for every state, it is possible to obtain detailed survival rates and 
fertility rates by areas as well as by nativity and racial groups. The 
Whelpton-Thompson estimates are made up by five-year continuations 
of the experience observed during 1930-1934. The tendencies of that 
period were then carried forward in the detailed table by reference to 
trends found in larger groups of population, extending further back, and, 
of course, by the use of general observation of current developments and 
some reference to the conditions obtaining in various foreign countries, 
the latter to establish extreme limits. These authorities acknowledge 
that the future estimation of birth rates, either general or specific, involves 
many difficulties and assumptions requiring judgment. It is not a 
purely statistical problem. All the more is this true of assumptions 
regarding future immigration. 

As a result of this analytical step-by-step, group-by-group integration 
of detailed projections, Whelpton and Thompson were able to obtain a 
variety of future estimates as far ahead as 1980. These are available 
for the entire country, for each state, and for various age groupings. The 
results were worked out between 1934 and 1936 and were published in a 
series of monographs by the National Resources Committee during 1937 
and 1938.^ If we refer again to Chart 1, we shall find several of these 
estimates drawn to both ratio and arithmetic scales. The projections all 
extend to the year 1980. The highest estimate at that year represents 
assumptions of medium birth rate and mortality rate and a net annual 
immigration of 100,000 persons. The probable 1980 population on these 
assumptions is 158,967,000. If we estimate in the same manner but 
allow for no net immigration, the total population of 1980 would probably 
be no more than 153,628,000. If low average fertility is assumed, with 

^ For a description of the calculations made by Whelpton and Thompson, see the 
Journal of the American Statistical Association^ September, 1936, pp. 459^. 

2 See Problems of a Changing Population,^^ National Resources Committee, 
Washington, D.C., May, 1938; also, “Population Statistics,” by the same Committee, 
October, 1937. 



medium estimates for mortality and no net immigration, the maximum 
number would be expected about 1960, with a population of approxi- 
mately 140 million. An intermediate estimate, if relatively low average 
fertility and also low mortality are assumed but if an allowance for net 
immigration of 100,000 a year is included, would date the maximum 
growth at about 1970, with a population of 146 million. 

The Scripps Foundation projections, therefore, as they now stand, 
based upon assumptions and calculations made about 1935, previous to 
the actual Census figures of 1940, point definitely to a more rapid tapering 
tendency for continental United States. The four estimates that appear 
to represent the most probable of the various assumptions and expecta- 
tions range from a low figure of about 134 million to a high figure close 
to 160 million at 1980. Estimate 3, resulting in the lowest of these four, 
as of 1980, is found to coincide almost exactly with the actual Census 
result for 1940, namely, 131.9 million.^ If this particular estimate is 
carried forward, it indicates that well within a generation the country 
will reach its maximum population. It is well within the range of 
probability that there may be some net immigration during the next 
twenty to forty years, for the results from 1930 to 1940, during which 
period there was a net deficit of 200,000, may conceivably have repre- 
sented exceptionally unfavorable conditions with respect to migration 
to this country.^ But the medium estimate 2, indicating a population 
of 153,628,000 at 1980, with no allowance for immigration, seems on the 
whole a fairly safe figure to use for practical projection purposes. 

Various other estimates could be cited, some of them reaching a figure 
close to 200 million of population at 1980 and maximum numbers beyond 
that date; others result in the expectation of less than 120 million in 
1980. Perhaps the most extreme lower assumption would be arrived at 
by the crude graphic device of extending through another decade the 
curve of increments shown in Chart 1. This is seen to decline sharply 
at 1940; extending it in a straight line to 1950 would bring us practically 
to zero. This would mean that national growth might be already close 
to its maximum. It must be remembered that such simple graphic 
extrapolations may lead us into error, inasmuch as the increment or net 
addition to the total population each decade has previously pursued a 

^ The actual Census figure is 131.6 million, as of Apr. 1, 1940; but all the data that 
we have been summarizing express the population as of July 1. The Bureau of 
the Census estimates that as of July 1, 1940, the population amounted to 131.9 million. 

* In addition to the four estimates that were selected for special attention here, 
there are available twelve other Scripps Foundation estimates, representing various 
combinations of fertility, mortality, and immigration assumptions. Some of these 
are based on an expectation of high fertility and high mortality or other assumptions 
that do not appear entirely reasonable and, indeed, are not considered by Whelpton 
and Thompson as sufficiently realistic to deserve much emphasis. 



somewhat fluctuating course, and a similar extension of the results in any 
particular decade would not have produced an accurate fiigure for the 
succeeding decade. 

As the official Census data of 1940 are analyzed, it is indeed already 
becoming apparent from samplings that we should expect the future 
course of our population (barring territorial alterations) to veer toward 
the more conservative estimates. If present birth and death rates con- 
tinue, it is the preliminary expectation of Director W. L. Austin^ that 
the white population will actually decline within a generation by as much 
as 5 per cent, whereas the nonwhites may increase by 7 per cent. The net 
result would be a failure of the whole population to maintain its numbers 
to the extent of about 4 per cent per generation. Since 1930, the net 
reproduction rate declined from 111 to 96, approximately. This would 
roughly exemplify the Scripps estimates for 1960-1970 maxima between 
110 and 146 million. 

Before concluding this discussion, it is of interest to notice the forecasts 
of population by age groupings as they were prepared by the Scripps 
Foundation for the National Resources Committee. If we refer to 
Chart 3, these projections will be found condensed into three age classes: 
persons under 20 years, those aged 20 to 44, and those 45 and over. The 
{)rojcctions are shown for assumptions as to natural increase and immigra- 
tion as already included in Chart 1 and represent the upper and lower 
range of the assumptions therein included. It will be seen that the group 
aged under 20, in accordance with the lower of these two sets of assump- 
tions, namely, low fertility, medium mortality, and no net immigration, 
would steadily decline until by 1980 their numbers would be somewhat 
less than in 1890. According to the upper estimate, if medium factors of 
natural increase and net immigration of 100,000 per annum are assumed, 
the decline in this younger group would be distinctly less rapid, but there 
would be no tendency to resume the increase that appears definitely to 
have ceased somewhere between 1920 and 1940. The middle-aged group 
would be expected to hold its own until about 1950, and in accordance 
with the lower forecast assumptions, it would then decline almost as 
rapidly as the numbers of the youngest group. This is shown a little 
more clearly in the upper section of Chart 3, where the various series 
have been plotted on ratio scales in two separate sets of curves corre- 
sponding with higher and lower assumptions. According to the higher 
set of assumptions, the middle-aged group would almost hold its own as 
far as 1980 and in this respect would be expected to describe a rate of 
change corresponding closely to the actual numbers in the lower group. 

1 Census Bureau release, January 31, 1941. See also in this connection the 
Presidential Address by Raymond Pearl on The Aging of Populations, Journal of the 
American Statistical Association^ Centenary Celebration Proceedings, March, 1940. 



The numbers in the oldest group would not be expected to reach their 
peak even by 1980 on either of the assumptions. 

The lower section of Chart 3, in which the three classes of the popula- 
tion have been shown superimposed, one upon the other, on an arithmetic 
scale, vividly demonstrates the relative total size of the oldest age group 

Chart 3. — United States population by ago groupings. The upper curves show the 
growth and projections for each of the age groups relative to 1850. The lower curves, on 
arithmetic scale, show the age groups superimposed. The medium and low projections 
correspond to forecast estimates 2 and 3, respectively, as shown in Chart 1. 

as it expands through the coming decade and the extraordinary contrast 
with its numbers as they stood at the middle of the last century. We are 
truly becoming an older country. There is little question that prob- 
lems relating to the adequate support and care of these large numbers of 
old persons in our population will bulk large in economic and political 
afiFairs in the future. Another interesting and important point that is 
illustrated in Chart 3 is that the most productive group of the population, 



aged 20 to 44, will continue to enlarge the numbers seeking employ- 
ment probably for at least another decade, and the youngest group, which 
also includes many who are entering industry and seeking employment, 
will also continue to be increasing for another decade, anticipating further 
expansion in the jobs available to the extent of four or five million during 
the decade. Obviously it is enormously important that industry and 
trade be in a position to furnish to this still growing segment of our most 
productive people the full opportunities for work that they have a right 
to expect. 

All the foregoing figures and estimates pertain to the population of 
continental United States, excluding the people living in the various 
possessions, such as Alaska, the Philippines, Hawaii, Puerto Rico. As 
this is written, the world is in a state of unprecedented flux and revolu- 
tionary militarism, the results of which during the coming generation 
are difficult to appraise. From this stupendous turmoil there may well 
be shifts of peoples and even changes in many political boundaries, which 
a few years back might have been considered beyond the realm of possi- 
bility. Perhaps we have in this global warfare still another reason to 
lean toward the conservative in estimating population.^ 

1 See in this connection P. M. Hauser, The Effects of War on Population and 
Vital Phenomena, American Journal of Sociology y November, 1942. 



The discussion of population trends has developed several significant 
points. The growth of numbers within the boundaries of the United 
States has revealed a high degree of continuity, describing a smoothly 
flowing curve. If the entire record and the most reasonable available 
estimates of future trend are taken into consideration, the over-all 
pattern seems more or less typical of the general organic growth process — 
relatively small increments at first, then rapidly increasing increments to a 
certain stage, and, finally, increments that begin again to slacken and then 
decline to zero or to negative values. 

During the course of national expansion over the centuries, the size 
of the population and the momentum of its increase have interacted with 
factors in the economic environment. The progress of science and 
applied technology have in some measure accounted for the population 
growth. On the other hand, the number of available workers has 
contributed to the various incentives bringing about the expansion of 
productive capacity, industrial diversification, and trade activity. Our 
fabricating capacity (as distinct from purely extractive production) has 
tended to be concentrated in urban communities, and these enjoyed a 
much more rapid rate of increase than the rural areas during the nine- 
teenth century and a portion of the twentieth. In one sense, however, 
this tendency has met opposing factors with respect to future growth in 
number of people. Although urban life has contributed to a lower death 
rate as well as the enhanced productivity capable of supporting a larger 
population, the birth rate in the cities, almost the world over, has tended 
to decline, principally as the result of voluntary control of family size. 
As we turn our attention to an examination of the material and economic 
phases of national growth, we shall become conscious of continuing 
developments in the processes of production, sources of motive power, 
and the facilities for transport, which may tend to modify or even reverse 
the long-standing social urge toward city life and escape from the open 
countryside. We shall have occasion to refer to several important aspects 
of this interrelationship between technology, on the one hand, and 
population on the other. We shall require some basis for expressing the 
significance of the broad results of our magnificent technical progress 
over the years upon productivity per capita. What has the average 




American gained from secular progress? Has growth in total output of 
useful wealth kept more or less in step with the growth of population, 
or to what extent has it been falling behind or advancing more rapidly? 
These are questions of fundamental importance, and we shall now give 
our attention to further measurements, again covering the broad aspects 
of our economy as a whole, to provide factual background for analysis 
and conclusions. 


To measure the long-term development of the nation^s productive 
power, or, rather, the aggregate creation of useful goods and services, is 
much more difficult than to depict from Census records the smoothly 
flowing course of total population. One reason for beginning with the 
discussion of population trends was to familiarize the reader with the 
general concept of trend as shown by data not expressed in terms of money, 
extending over an exceptionally long period. We found a high degree of 
continuity, but in no economic elements do we find such an equally 
smooth progression within either short or long periods. From year to 
year the sequence is usually disturbed by abrupt inclines or declines; 
(wen over periods of ten or twenty years we find from our best available 
measures of the volume of aggregate business that there have been periods 
of rapid acceleration presently followed by intervals during which little 
or no net progress occurred. If we happen to confine our attention to 
particular phases or segments of industry and trade rather than attempt 
to deal with comprehensive composites of performance, we are confronted 
by the random play of adventitious variability referred to in Chapter 1. 
We could be led to erroneous conceptions of the aggregate experience 
if we sought to study only particular and localized facts. The life of 
one firm tends to be shorter and more subject to disturbing accidents 
than the industry, and the life of an industry emerges, accelerates, 
reaches maturity or undergoes decay with more tendency to erratic 
vibration and frequent interruption than the economic development of 
the nation. 

Recent studies have demonstrated clearly the typical life experience 
or growth pattern of individual industries.^ In some branches of manu- 
facturing, mining, forestry, and agriculture, a tendency toward retardation 
or decline appears already to have set in, following years of growth and 
maximum output. But meanwhile, new industries and new forms of 
commerce and of service have been developed. Some of these are in the 
early stages of what may hereafter be a long and highly creative course of 

^ See, for example, Arthur F. Burns, “Production Trends in the United States 
since 1870,^^ National Bureau of Economic* Research, New York, 1934; also, S. Kuz- 
nets, “Secular Movements in Production and Prices,” Boston, 1930. 



evolution; others are already in the stage of acceleration that eventually 
will be followed by retardation as they approach full maturity. But 
for the moment we are less interested in the trees than in the growth 
tendencies of the entire forest. We must gather together all the seg- 
ments — or, in a more practical and hmited sense — as complete and 
representative a sampling of them as we can muster, so that the trees 
already fallen will not obstruct our view of the saplings that presage 
future growth. Whatever data we use as the basis for measuring the 
over-all trend of development must therefore not exclude the new, or 
prematurely discard the old, forms of activity. 

Another important feature of our problem is how to secure an aggrega- 
tion or composite from the numerous individual segments of economic 
activity. We may happen to have available data for a period of time 
expressed in money as values and reflecting the convenient manner in 
which money serves as a common denominator of values in permitting 
homogeneous summation into totals. For some purposes, as wc shall 
later see, such value is in itself significant and important as an economic 
measure, but it is obvious that time movements thus expressed will 
give effect not only to the course of the physical volume embodied in the 
various production or commercial processes but to prices as well. And 
prices may move widely and erratically and thus distort the pattern 
considerably from what might be expected in terms of quantity alone. 

There are several possible solutions of this difficulty, none capable 
in this finite world of perfectly accurate results but deserving of careful 
statement to set forth a guiding principle. We may have sufficient 
pertinent data (even though incomplete) to permit a statement of the 
relation of the value of production (or trade or service) transactions in, 
let us say, a given year, to what those same activities were worth in 
money at some previous time. Suppose that in so doing, we make the 
numerator of the ratio not the actual current values but what this same 
output or trade would be worth if prices since the earlier period had not 
changed. We can, in other words, manipulate our data in such fashion as 
to show changes in values at constant prices, which, of course, means the 
net over-all changes from one period to another in the volume element, 
each component being given its due weight in terms of its constant value. 
If the data should relate to manufacturing output, we could thus trace 
the course of an index made up by summing each yearns output valued 
over and over again at the unit prices of some previous period serving 
as the origin or base and dividing each of these sums by an amount equal 
to what the goods produced in the base year were worth at those same 
original prices. Of course, there are periods of time in which we must 
be content with but a meager sample of the data, and all we can attempt 
is indirect measurement of the whole performance. 



A second method of arriving at a volume index of change would start 
from actual values at actual prices, such as we might find available in 
records of our foreign trade or some phase of domestic commercial turn- 
over. These data could be deflated ” or divorced from the price element, 
so to speak, by dividing the items by a separate index of prices (or, rather, 
of average price change) during the period. This method would assume 
that the prices used in this deflating index matched the prices involved 
in the actual business figures reasonably well and that in preparing the 
price index care was used to preserve throughout a fairly representative 
system of weighting to give each segment its proper degree of importance 
in the averaging process. Such deflating of actual values would be highly 
accurate so far as basic principle is concerned if a particular form of 
price index were uscd.^ It is found in actual experience that although 
different kinds of price indexes built up for the same problem by different 
formulas may give somewhat divergent results, the degree of correspond- 
ence is often sufficiently close to justify the use of much more elementary 
price deflators if we use the final results merely to piece out difficult 
periods where more perfect data do not exist and if we do not rest too 
heavily in our long-term measurements upon data thus computed by 

There is thus some hope of arriving at the determination of the 
long-term trend of wealth creation in terms of the probably significant, 
rather than the meticulously accurate, as we move forward to the present 
time*. But we must pause a moment longer in our brief outline of 
procedure to point out that we have left rather indefinite just what it is 
that we consider the primary object of measurement. Is it production? 
Is it trade? Is it both? Here again we must keep historical perspective 
in mind. In the early Colonial days farming was the principal enter- 
prise; commercial activity was less pervasive than it is now. A great deal 
of production did not involve sale and purchase; it was self-sufficient. 
Today farming is a steadily dwindhng enterprise, compared to total 
enterprise, and manufacturing operations have become dominant in their 
utilizing of resources, human effort, and the facilities of trade and service. 
If we may rtffer to the flow of us(fful goods and services to final users as 
the national real incoine (as distinct from the flow of money), we can 
accept the statement of Edmund P]. Day that 

^ That is, an index formed by ratios of values for the various time intervals in 
which numerators were sums of the expression, current price times current quantity, 
and denominators were sums of the expression, base period prices times current quan- 
tities. If the actual values, which would be summations of the expression, current 
prices times current quantities, were divided by the corresponding price indexes in 
this form, the results would be expressions of the total of current quantities at base 
prices or a measure of trade capable of being compared, at any point in the period of 
time covered, with the base-period trade aggregate. 



The most important single barometer of changes in the size of the income is 
the physical volume of output in manufacture. This follows from the fact that 
the great bulk of modern articles of consumption pass at one stage or another 
through factory processes. Even our foodstuffs — our flour, meat, sugar, coffee, — 
emerge in finished form from industrial plants. Only a few commodi- 
ties, — fresh vegetables and fruits, milk, household coal, — are not regarded 
as in any way manufactured. , . . The physical volume of factory output bears 
a definite relation to the national real income.^ 

What Day says concerning manufacture is more or less true today 
of most of the other fabricating and service industries, not necessarily 
because physical materials ^^flow through’^ their plants but because the 
services are rendered so closely in relation to the production and fabricat- 
ing operations. The engineering, financial, legal, architectural, and 
numerous other services rendered to and for business reveal an expanding 
tendency when the production processes themselves are expanding, and 
vice versa. When industrial production is exceptionally active, the pur- 
chasing power of that large segment of the consuming public receiving 
income in wages, profits, and fees speeds up not only the flow of service 
facilities and the merchandising and transportation activities but also 
the personal services of doctors, dentists, cosmeticians, singers, and 
dancers. In fact, some of this service now utilizes apparatus of considera- 
ble complexity, calling for special industrial facilities. Hence it can be 
stated that if at present the operations of manufacturing so well reveal 
and represent the dynamic phases of productive enterprise and national 
real income, then the total amount of service rendered can be expected 
to vary more or less proportionately with those changes. Each line of 
industry is, in fact, so related to others that there is a response throughout 
the system to stimulating or depressing influences; the degree of sympa- 
thetic response is indeed remarkable and affords us the opportunity to 
make statistical measurement on the basis of well-selected samples and 
representative partial data, even though we cannot make complete 
enumerations. The accompanying diagram further illustrates the heavy 
overlapping of production, trade, and service. 

We can thus formulate our objective more clearly by saying that the 
problem is to measure at long range the progress of composite production, 
considering that in recent years it carries the service and commercial 
operations along with it and fairly well represents their drift as well, 
whereas in earlier years, it may be not only necessary but quite representa- 
tive of the facts to express economic activity by such physical trade 

^ The Measurement of Variations in the National Real Income, Journal of the 
American Statistical Association^ March, 1921, p. 554. Dr. Day, now president of 
Cornell University, made important statistical contribution to the technique of 
production measurement. 



measures as appear to be fairly representative of the underlying produc- 
tive efforts of the nation. The details will be discussed later. 

We have had occasion to refer to the flow of production and, more 
particularly, manufacturing output as a representative measure of the 
flow of real income. It should be pointed out that several qualifying 
terms must be added to make this a wholly justifiable statement. It may 
not be precisely true from month to month or even from year to year 
that the change in productive operations is proportionate to the flow of 
goods and services to consumers^ hands. Production in industrial plants 
may rise or decline in greater degree than actual use or final purchase 
of the products. This would be true if part of the product were being 
added to inventory and stored or if it were contributing to the expansion 
of productive apparatus and was thus not in a form directly available 
to consumers. This implies that the income concept is associated 
with what comes into the hands of individuals for their use and enjoyment. 

In this sense, we may also limit the term ‘^national income^' in the 
form of money payments to what is received by individuals in their varied 
capacities of wage earners, capitalists, business managers, or landowners. 
We might conceive as a special form of national income what business 
firms add to their surpluses (or subtract as negative income) after allowing 
all necessary expenses; this might be called total ‘‘national income’^ as 
distinct from “income payments to individuals.^’^ But we do not ordi- 
narily speak of either national money income or real income as having 
anything to do with the payments to business units for their materials or 
semifabricated products. In other words, in computing national income, 
we eliminate the duplications involved in the passage of materials through 
several steps in the process from raw extractive product to finished 
product. That term refers to the value of all raw material plus what is 
added in subsequent processes by way of service effort to bring it to the 
final stage of usable product. With the original raw-material values, we 

^ A usage adopted by the U.S. Department of Commerce in its income-statistics 



combine the ^ Values added” in the process of fabrication.^ To this we 
may add, of course, further detail to make up the complete income picture, 
such as the value of transportation service, power service, merchandising 
service apart from inventory values, and a host of other components, for 
each of which duplications of material values are eliminated. But if 
we are tracing over a long period of time the aggregate of such net values 
added to raw-material values, the rate of change will probably be found 
to be much the same as if we have weighted the items by gross values. 
The discrepancy, if any, would be due to the fact that articles that passed 
through many stages, each involving a business transaction, might be 
somewhat overweighted in the final result. What has been said on this 
point also indicates that if we wish to secure high accuracy, it is best 
to use in the weighting of a production index not market prices but, 
rather, the average “unit values added” in each stage of operations. 
This is done in some of our modern indexes, but as we go farther back 
historically in our quest for materials, we must rely on much less precise 
results. Finally, it is probably correct to say that the long-term trend 
of real income will agree vdth that of industrial output, properly weighted, 
but to the extent that there are components of service activity or some 
of the basic extractive industries that have peculiar trend gradients, 
there will be a modification of the purely industrial over-all trend in the 
most significant final result.^ 

By the use of the device of an “aggregative” index measure previously 
mentioned (it matters little for practical purposes whether we use the 
resulting current totals or ratios to base period totals) or occasionally the 
deflating of trade values, various types of production or trade*, data can 
be translated into a continuous long-term measure of business. Since 
we are about to present results extending over a very extendc'd iuiei val 
of American history, there are naturally limitations in the aA^ailable data, 
and we must recognize also the fact that the structure of the* (*eonomie 
system itself has been changing through the years. In Colonial days, 
over 80 per cent of the population engaged in some form of agriculture 
or forestry. The colonists, however, enjoyed fairly active foreign trade, 
mainly with Great Britain, the West Indies, and some Mediterranean 

^ This is done by the Census of Manufactures in computing every two years the 
sum total of manufacturing net value. 

* One of the conspicuous cases in which physical volume does not appear to vary 
consistently with the general average or total of production would be the case of 
agriculture and animal husband^>^ As will be pointed out in a later cha})ter, there 
are special weather factors and other conditions in these fields of industry that cause 
the annual output in physical units to vary more or less inversely to the money income 
obtained by the producer. In most kinds of industrj', the reverse is true; the money 
value of income of the particular group, under conditions of fairly stable prices, will 
vary directly with the volume of material or service output. 



countries. Some of the agriculture of the American colonies represented 
highly specialized export production, such as tobacco, rice, hemp, and 
various products of the forest. In such a simple economy, in which the 
total of all production, largely agricultural in nature, and manufacturing 
was hampered by the simple technology and by restrictive British laws, 
we should expect the aggregate ‘^real income” of the people to consist 
largely of food, clothing, and dwelling space, supplemented by those 
foreign manufactures, luxuries, and semiluxuries, paid for mainly by the 
great Southern export staples. 

As we pass to the nineteenth century, agricultural export as a means 
of acquiring diversified manufactured products persisted as the predomi- 
nant pattern of our economy. If we had the complete data of domestic 
manufacturing output, internal transportation ser\dce, etc., these would 
still not reveal movements as typical of variation in the real income as 
they would be today. It is apparent, then, that we cannot obtain an 
entirely homogeneous measure of total production of trade or national 
real income during a period of time long enough to establish a really 
long-term trend of aggregate business or income growth. If, however, we 
can utilize such data for each stage of our national experience as are most 
representative of enterprise at that period, we shall have a tolerably 
reliable means of extending back even into the eighteenth century the 
much more complete business measures of the twentieth. 


The details of statistical procedure used in the construction of a long- 
term index of American production and trade will be found in Appendix 1. 
The most important feature of this index to be noted here, in carrying 
forward the summary of procedure and terminology just presented, is 
that it has been possible to make use of trade figures during the earlier 
years of national growth and industrial production figures during the later 
years. If we were to measure the activity of business in the earlier period 
by using data for production (which unfortunately do not exist), our result 
would probably be heavily weighted by agricultural output, but since 
this paid for so much of the manufactures and the services therewith 
associated, the resulting trend would be in fair agreement with the trend 
of trade, and both trends would approximate that of population growth. 
The limited scope of markets and transportation facilities made total 
farming output the net result of many localized influences, which tended, 
however, to offset one another, except at times of major disorganization. 
Standing in contrast to this gradual expansion in extractive output were 
the occasional abrupt changes in the income accniing of townspeople, 
merchants, and craftsmen who were directly affected by developments 
peculiar to foreign-trade conditions. The foreign import trade was paid 



for by exporting the surpluses of extractive industry, but the flow of 
trade, particularly the extremely significant inflow of manufactured 
products from the British Isles, was also subject to the vagaries of specula- 
tion, financing, warfare, and the changing laws applying to such com- 
merce. On the one hand was the mavSS of extractive producers whose 
variable individual fortunes merged into a gradually changing aggregate, 
dominated by farm production, and on the other hand were the much less 
numerous townsmen, with their merchants, financiers, artisans, and other 
professional groups deriving income from shipbuilding, construction, 
foreign commerce, or the rendering of personal services to those whose 
incomes, in turn, were largely governed by these simple commercial 

Through the years this latter group increased rapidly as manufactur- 
ing, transportation, and the growth of cities developed. We may con- 
sider that these groups of merchants, artisans, and manufacturers 
constituted essentially the business group, very minor relative to the 
total population in Colonial days, distributed along the Atlantic seaboard 
in the villages and towns but destined to grow into a much more represen- 
tative group, experiencing simultaneous ups and downs in income through 
trade booms and depressions. Apart from the variability and fluctuation 
in the money and real income of those deriving their living from business 
operations, there was, of course, a long-term underlying trend of develop- 
ment, the pattern of which we desire to translate into figures. In 
establishing this long-term trend, the reader should understand that its 
course would be determined not only by the more or less fluctuating 
activity or real income of the urban business groups but also by the 
volume of production by the farmer. As explained in more detail in 
Appendix 1, the long-term trend of production and trade shown in Chart 4 
involves two component parts: an index of changes in agricultural pro- 
duction, which is represented by population growth during the eighteenth 
century, and is given a gradually diminishing weight through the years 
as the estimated value of agricultural production tends to decline relative 
to total national income and, second, a trade or business index consisting 
of several segments. This index refers in earlier years to the estimated 
changes in physical volume of the most significant part of American 
import trade and in later years to estimated changes in the physical 
volume of total industrial output and domestic trade. 

Fortunately, we have available excellent foreign-trade statistics 
extending back to the beginning of the eighteenth century, limited, 
however, to commerce with Great Britain. Throughout that century, 
Britain was the world center of manufacturing, and our imports of 
British products, paid for with surplus agricultural and forest products, 
may be assumed to represent faithfully the variations that occurred from 



1700 1720 1740 1760 <730 1800 1820 1840 1860 1880 1900 1920 1940 

Chart 4. — American business trends and cyclical movements, 1700-1940. The cyclical movements in total produc- 
tion and trade are shown in the upper portion of the chart as they fluctuate above and below the intermediate trend. In 
the lower section the intermediate trend is shown as itself a wave-like variation about the secular or long-term trend. 



year to year in export surpluses, in speculative commitments, and in use 
of credit in anticipation of commercial prospects, such as would affect 
the ability of the colonists to acquire the fabricated goods whose posses- 
sion marked the rising trend in living standards above the level of isolated 
production and the bare subsistence of frontier husbandry. It happens, 
fortunately, that the movement of British goods across the Atlantic to 
Colonial America was carefully recorded in London. These records 
extend back to the beginning of the eighteenth century and, in fact, 
several years beyond that. More important still, they were maintained 
in a form exactly comparable to what we have previously referred to as 
the very useful aggregative index of change, involving fixed prices and 
variable quantities. Just as today we usually compute average changes 
in physical production by this device, so the British authorities happened 
to hit upon a way of measuring changes in trade volume by using the 
prices of 1697 (with minor changes when necessary) in order to total up 
the magnitude of their commerce. The variations in these totals are 
essentially the measures of physical change. There is probably nothing 
comparable to tins extraordinary series of data in the commercial records 
of the world. The use of these figures allows us to obtain a consistent 
indicator of the physical magnitude of the merchandise brought ov('r 
from Britain, not only during the eighteenth century but during th(i 
early decades of the nineteenth as well. As our own official statistics 
became available to record our total import trade (of course, in value) 
and as the significance of imports from the British Isles began to diminish, 
it was found necessary to use deflated import values until the period was 
reached at which physical production data became available. 

If we have commercial or industrial totals expressed in actual money 
value, therefore involving variable prices, the process of converting these 
totals into a measure of the physical volume of changes can never be 
perfectly satisfactory. This problem appears in various forms in studies 
of business conditions. The best approximation is found in the deflation 
of the value data by an independent measurement of average price 
fluctuations. Such an index number of prices may itself be prepared on 
the ^^aggregative principle,^^ in which the prices vary but the quantity 
weights for each of the individual items remain fixed and the price vari- 
ations are essentially those of the weighted prices. Roughly comparable 
price indexes may be obtained by other methods, and in many cases it is 
necessary, in the absence of complete data, to use simple, unweighted 
indexes of price change. It happens that during the major part of the 
nineteenth century we have just about enough information concerning 
commodity prices to be able to deflate United States import statistics 
with tolerably good results, in order to continue the measure of the 
physical volume of imported merchandise. This device has been 



adopted to obtain that portion of the long-term index that is '^spliced’' 
onto the British data early in the nineteenth century and spliced again 
toward the end of that century to the more completely representative 
data measuring the changing volume of our industrial production. In 
referring in this connection to industrial production, the reader should 
bear in mind that we use the data to gauge not only factory operations 
but also a wide variety of service activities whose patterns are believed to 
be essentially similar to those of industrial output. 

By a series of splicings of appropriate statistical data, therefore, we 
obtain a preliminary series that is not, however, the final index of treiid. 
The series that we obtain is first smoothed out by means of long-term 
moving averages, and it appears in Chart 4 as the intermediate trend. 
Not all the data used to determine this intermediate trend are also the 
best measures of fluctuations in activity from year to year. During most 
of the period of time covered, special series of data, selected as probably 
the most indicative of the short-term rhythm of movement, have there- 
fore been superimposed upon the smoother and more gradual undulations 
of the intermediate trend. In other words, the intermediate trend is the 
^‘spinal cord^^ or central tendency of the index, and the year-to-year 
index, shown as the upper curve in Chart 4, reveals the degree of minor 
vibration in general economic activity. This we may refer to as the 
^^cyclicaT^ vibration of boom and depression about the underlying 


It will be noticed in Chart 4 that there are long-term movements, like 
tidal swells, as well as short-term fluctuations. The existence of these 
long-term waves has for some time been suspected by economists, and we 
are now able to carry the necessary observations much further back than 
they have previously been carried and to express the indexes in terms of 
physical volume rather than merely in terms of price g 3 Tations, as has 
usually been the case in attempting to illustrate the phenomenon. In 
the succeeding chapter, further attention will be given to the nature of 
this tidal action and the apparent reason for its occurrence. For the 
present, we are concerned with determining a further result. What is 
the over-all rate of growth underlying these wavelike undulations of the 
intermediate trend? 

By methods that need not be described in detail at this point, it is 
possible to average out these long wavelike movements so that the 
still longer range pattern of secular trend can be observed. Such a secular 
trend of growth (the word “secular” referring to change “over the cen- 
turies,” that is, over very long periods) is so fitted mathematically to the 
wave index as to equalize the deviations above and below the line through- 



out the entire period of time covered, 1700-1940. In this sense, it is the 
average growth slope or gradient, balancing out the extended wavelike 
tendencies that, in turn, balance out the choppy year-to-year fluctuations. 

It should not be thought that this secular growth trend represents 
anything in the nature of an ideal or normal^' or inevitable tendency to 
which the actual performance of our economic activity necessarily must 
adjust itself over the decades. The trend is statistically derived from the 
more or less vibrating pulsations of actual economic life, and it merely 
expresses the net result of the give and take. Nor is the trend, as shown 
in Chart 4, to be regarded as meticulously accurate, for there are obviously 
many minor deficiencies in the data, and it is therefore presented as a 
tentative and preliminary result. But a careful study of the chart will 
clearly demonstrate that the long-term secular trend, as it has been 
computed, is a more accurate expression of the long-term average slope 
than any given segment of the intermediate trend from which it has been 
derived. The intermediate trend smooths out the annual fluctuations, 
but from time to time it alters its own gradient enough to convey a mis- 
leading impression for decades at a time of the rate of underlying secular 
drift. Had we endeavored, for example, to express the rapidity of 
growth in the physical volume of business from 1880 to 1920 on the basis 
of the intermediate trend, the result would have been to establish an 
excessively high average rate of progress, as tested by later history. 
For that particular period, the progress, on the whole, was more rapid 
than could be indefinitely maintained. On the other hand, from about 
1850 to 1870 or from 1800 to 1820, the intermediate index of production 
and trade would have created an impression of a slower rate of progress 
than was later found to be attainable. Thus an approximation to the 
true rate of national economic progress, in terms of physical creation of 
wealth or flow of real income, requires a longer continuity of pertinent 
data. This is why particular pains have been taken to extend the 
indexes in Chart 4 as far as the eighteenth century. 

There is one important precaution to be noted in interpreting the 
long-term trend of economic growth. The basic data are obviously drawn 
from the history of the past. We do not know what the pattern of the 
distant future will turn out to be. Therefore, when these trends, how- 
ever carefully fitted to conform to the average slope of the data, are 
extended down to the present time, their position or level is not yet 
influenced by those unknown future movements that will later form a continu- 
ation of the component data. If those future wave movements respond to 
conditions so that the give and take continues to vibrate around a central 
tendency of about the same gradient as in the past, we shall assume that 
the trend position as now shown is tolerably correct. But if the future 
brings about a marked and persistent acceleration of the rate of general 



productive progress or, on the other hand, a continuing tendency toward 
a faltering of the rising drift, we shall be entirely wrong in assuming that 
the current position of the secular trend index affords a valid expression 
of the ultimate level, the ultimately confirmed gradient. If, in the 
future, declining movements tend to outweigh the effects of periods of 
temporary business expansion, it will become necessary to introduce more 
or less curvature into the secular trend, and this will require a relocation 
of the trend as previously estimated, possibly far back into the earlier 
years. For this reason the secular trend of growth as shown in Chart 4 
has been indicated in a broken line since 1910; the position as shown as of 
1940 is entirely provisional and subject to further change in the light of 
what the future will bring forth. All such trends are, of course, heavily 
weighted by past experience; and the records of nearly two and one-half 
centuries may cause the over-all gradient to be a tolerably accurate 
representation for most of that period. But we should not place too 
much reliance upon the gradient as shown in the last few decades in view 
of the unknown future events that will necessarily influence the slope of 
the trend when it is recalculated in 1980 or 2000. 

One of the remarkable features of our economic growth from 1700 to 
1940, as indicated in the index of secular trend fitted to trade and produc- 
tion data, is the modest amount of variation in the rate of advance per 
decade. Since a ratio scale has been used in Chart 4, it is apparent to the 
eye that the secular trend, being almost a straight line throughout the 
period, reveals an almost constant rate of growth. This rate approxi- 
mates an annual rise of less than 3 per cent prior to 1750; there is a slowly 
advancing rate thereafter to about 3.8 per cent per annum in the decades 
following the Civil War; and since about 1890, we observe a slight 
tendency toward decline to about a 3.6 or 3.5 per cent rate in recent 
decades. Even though these surprisingly consistent rates of expansion 
reflect no inevitable or ^‘normaE^ law of material progress conforming to 
the popular notion firmly rooted in human nature that growth is part of 
the natural order, one may legitimately draw from this record of the past 
at least one element of assurance and perhaps inspiration. The nation 
has encountered many intervals of difficulty, crisis, and chaos, but energy, 
courage, and coordinated effort have overcome them all. Perhaps even 
in the recent troubled years, during which our complex productive 
system has been exposed to the shocks of an exceptional depression, 
followed by unprecedented changes in political structure and adminis- 
tration and, finally, a war of gigantic scope — perhaps even in these days 
there are constructive influences at work somewhere capable of extending 
the measures of productivity presently in a direction continuing still 
upward rather than declining. If such influences are in the making, 
they are as much concealed from our present view as they were in previous 



periods of temporary stagnation and crisis. We shall return to this phase 
of the subject in Chapter 25. 

It has been stated that the indexes in Chart 4 are probably not a 
perfectly accurate portrayal of the economic progress of the United 
States. That progress in all its detail and the psychological aspects of 
human well-being can probably never be wholly accurately determined or 
expressed. Even though we have sought to obtain a reasonably homo- 
geneous index of physical productivity, not distorted by the occasionally 
wide gyrations in commodity prices, many of the intangibles and the 
qualitative aspects entirely escape our yardstick. If the data at our 
disposal were more complete, making it possible to allow, for instance, 
for the many changes in the quality of goods and the efficiency of service 
or transportation activities or the circumstances of health, safety, and 
comfort in the processes of production, even so there would still be a host 
of minor intangibles defying measurement. We should find ourselves 
ultimately confronted by the necessity of estimating the purely psycho- 
logical utilities, as distinct from the physical commodity output or the 
tangible evidences of services performed. We should be confronted by 
the subtle gradations of psychic income, enjoyment, sacrifice, personal 
satisfaction, dissatisfaction. There are many aspects of human experi- 
ence and our ways of organizing human life that a prosaic statistical 
index of business progress fails to record. But nonetheless, it does 
record a very substantial portion of those material contributions to 
physical well-being that, in turn, condition so much of what may be 
termed individual well-being and cultural amenity. 

In order to bring together a measure of change in production and trade 
with population changes on a reasonably comparable basis, there are 
shown on Chart 5 (lower section) the decade-to-decade population 
increments and the 10-year increments of the actual measure of busi- 
ness. In this manner the short fluctuations are smoothed out, and we 
can compare the behavior of the productive effort at those times when 
population change introduced variations of increment. The two lines 
in Chart 5 have both been drawn on a ratio scale, but the scale for the 
increase in population per decade represents a range of calibration twice 
as wide as the scale for the business-index increment. That is to say, 
the latter series is shown with one-half the range of variation that it 
would naturally show, and this is done in order to bring the two curves 
more closely together for comparison from decade to decade. It will be 
noticed that in the decade from 1810 to 1820 a definite retarding tendency 
appears in both curves. Then the increases are continued very rapidly 
until the decade of the Civil War, 1860-1870, when another decided 
hesitation in both measures of increment is observable. In the decade 
1890-1900, the population increment was again dampened down, but 



there was in this case less of a corresponding reduction in the momentum 
of business activity. Further evidence of sympathetic movement there- 
after appears in the decade including the great depression, 1930-1940, 
during which the population increment sharply declines and the per 
decade net expansion in the volume of business shows a hesitating tend- 
ency similar to that in 1860-1870. There appears, therefore, to be some 
degree of functional relationship between the amount of growth in 
population and the net accumulated progress from decade to decade in 
general business volume or the real income of the people of the country. 

The causes involved in this interesting relationship might be con- 
sidered as operating primarily from changes in increment of population to 
the business increments or, on the other hand, from the state of business 
conditions to the factors giving rise to retarding or accelerating tendencies 
in population. The truth here is not wholly clear. It will be noticed, 
however, that three instances of temporarily interrupted increase in the 
population and business increments occurred during periods of unusual 
wartime disturbance and postwar readjustment. In the following 
chapter, we shall examine in greater detail the behavior of the general 
business index during and following periods of major war disturbances. 
In the course of this discussion evidence will be presented for the con- 



elusion that in all probability the more or less similar movements of the 
factors that we have been referring to above may be attributable to a 
common underlying causal factor. It is highly significant that whatever 
relation exists between the business and population increment measures 
is revealed from decade to decade but not in the long-term drift. There 
is little agreement in the general patterns. 



We have seen that the concept of trend as applied to business growth 
admits of several interpretations. The measurements of such trends 
that have been presented are of two types, one more flexible than the 
other. The intermediate trend traces what might be regarded as a 
moving center of gravity; the secular trend is in a sense a mathematical 
abstraction or idealization of what the long-term average gradient might 
have been had there been no alternations of momentum of a wavelike 
kind. We recognize, then, that there is an apparent tendency over a 
very long period of time for the volume of general business to expand; but 
this actual performance proceeds by fits and starts rather than in an even, 
uninterrupted flow. In this fact there is some degree of analogy to the 
growth of living organisms. The life process reveals periods of more and 
less rapid acceleration during the course of growth. But these analogies 
must not be carried to the point of insisting that there is in economic 
affairs any necessary or inevitable wavelike tendency, undulating around 
the secular trend of expansion, or even cyclical oscillation about the 
wavelike intermediate trend. 

Although possibly not intentionally, the impression has been created 
by some writers who have referred to evidence of these long-term tend- 
encies that there is an inherent instability and recurring wave movement 
involved. In point of fact, however, a study of historical events will dis- 
close that most of the long-term waveUke undulation shown by the 
intermediate trend seems to have resulted from specific factors in the 
nature of exceptionally serious breakdowns in business activity and inter- 
ruption of trade relations. Invariably such unusual interruptions in the 
progress of economic development have occurred following major wars, 
that is, wars that have created drastic and far-reaching dislocations not 
only of the prevailing economic system but of political and social affairs. 
It is important to consider in more detail the relations between business 
activity, wars, the course of commodity prices, and the state of the 
political atmosphere in this country, beginning with the eighteenth 

Since we now have available an annual index of trade and production 
reaching back to the beginning of the eighteenth century, it is possible to 
examine the relationships between political disturbance and economic 
disturbance and to draw some conclusions such as cannot be derived from 




a study of relatively short periods in recent history. The important wars 
that have affected the economic conditions of the American Colonies and 
the United States have been so spaced in time that we must view the 
course of events in broad perspective and with long-term data. This is 

1700 1710 1720 1730 1740 1750 1760 

Chart 6a. — Business, prices, and wars, 1700-1760. The war periods are as follows: 
(1) Spanish Succession; (2) Queen Anne’s War; (3) War between Great Britain and Spain, 
and War of the Austrian Succession; (4) King George’s War in America; (5) French and 
Indian War and (1756-1763) Seven Years’ War in Europe and India. 

important, too, because the periods of exceptional business breakdown or 
prolonged stagnation following great wars have some distinctive char- 
acteristics with each successive experience. We would not expect to 
find precise repetition of pattern. Of one thing we can be reasonably 
certain — major war disturbances are associated with, or followed by, 



such relatively violent readjustments in the productive and commercial 
processes and especially in the prices of commodities, property, and 
services that even when the year-to-year fluctuations are smoothed out by 
an intermediate trend (as shown in Chart 4), the course of that trend may 

Chart 66. — Business, prices, wars, and politics, 1760-1820. War periods: (6) Con- 
tinuation of Seven Years War; (7) War of the American Revolution; (8) First phase of the 
French and Napoleonic Wars; (9) Continuation of Napoleonic Wars; (10) United States 
War of 1812 with Great Britain. 

be perceptibly diverted temporarily from the generally rising secular 
continuity. At these times hesitation develops. If we study closely 
these alternating long waves of intermediate trend, it is convenient to 
express them in terms of their ratios to the underlying estimates of 
secular growth. The results appear in this form in Charts 6 and 7. 



Through these charts there is drawn a horizontal band with lightly 
shaded or solid black sections. These mark the approximate duration of 
wars capable of having some bearing upon American economic life. The 
shaded portions represent wars in which the American people were not 

Chart 7a. — Continuation of Chart 6, 1820-1880. War periods: (11) United States 
War with Mexico; (12) Crimean War; (13) United States Civil War; (14) Franco-German 
War. The general price level shown here includes wages, security prices, rents, etc., as 
well as commodities. 

directly involved, and the solid black portions refer to war periods that 
called into action American man power and equipment. The length of 
these segments naturally does not express the relative importance of 
these war intervals or the demands upon man power oi' materials or the 
general amount of financial sacrifice involved. If, however, we glance at 



the index of wholesale commodity prices and, after 1820 , the general 
price level directly above the war intervals, we gain a better impression of 
the impact of these military emergencies upon an important phase of the 

Chart 7b . — Continuation of Chart 6, 1880-1940. War periods: (16) Chinese-Japanese 
War; (16) United States War with Spain; (17) Boer War; (18) Russo-Japanese War and 
German-Moroccan War scare; (19) Agadir Incident and Balkan Wars; (20 and (21) World 
War I; (22) Italian War in Ethoipia, Chinese-Japanese War (1937 ff.), Spanish Ci'^ War, 
and beginning of World War II. 

economic system. It will be noticed that every war that has directly 
involved American participation has been marked by a more or less 
violent general rise in prices.^ 

^ For a description of the data used in the indexes of prices see Appendixes 2 and 3. 




Our wars during the first half of the eighteenth century were some- 
what desultory, in the nature of intermittent skirmishes in the wilderness. 
The American Revolutionary War was the first example in our history of 
a concentrated military effort, involving armies and financial outlay that 
placed a heavy burden upon the pioneer civilization of that time. In 
terms of the price movement, the violent inflation shown in Chart 66 
tells the story of the financial vulnerability of the Colonies and their 
desperate attempts to procure for military forces essential materials 
that could be produced and assembled only under the greatest difficulties. 
The dilution of currency by issues of emergency paper money served to 
produce our first notable price inflation. After the reestablishment of 
peace and initiation of the independent government, the return to a sound 
currency basis involved the abrupt writing down of prices all along the 

During the wars that followed the French Revolution, culminating in 
the momentous conflict between the British groups of Allies and the 
French groups, there occurred another marked elevation of the American 
price level to a high, irregular plateau. These wars were marked by 
interruption of trade and intermittent periods of intense demand for 
American ships and raw materials. Finally, the European contest 
reached the United States in the short War of 1812-1814, and it will be 
noticed that during that period of direct participation, the commodity 
price level rose above the preceding high plateau to a still higher peak. 
Following this peak, there was an extended period of deflation, very rapid 
at first, then continuing at a slower pace until the early 1830^s and intro- 
ducing, as it proceeded, all the painful consequences of such a process. 

Passing over the brief and relatively unimportant War with Mexico, 
1846-1847, we find the next important period of price inflation during the 
American Civil War. In this case again, the Northern States (to which 
the measurements particularly pertain) found it necessary, as did also 
the Confederacy, to mobilize the war effort by urgent material purchases, 
financed in large measure by the printing of new paper currency. Again 
we find the postwar collapse of prices violent at first and then long- 
continued, the pattern somewhat repeating that following the War of 
1812-1814. Deflation of commodity prices was rapid until about 1879; 
after a brief interruption, it was resumed at a slower pace until about 1897, 
and in the more comprehensive ‘‘generaP’ price-level index, still more 
gradually. At that point there occurred a significant reversing tendency, 
probably accelerated in some measure by the Spanish-American War 
emergency, which was shortly followed by the Boer War in Africa, and 
later the Russo-Japanese War of 1904. These wars, however, did not 



produce a movement of basic prices that we could describe as really 
inflationary, and the gradual rise during the early 1900’s probably reflects 
several special factors. Next we have the period of World War I, which 
produced a decided rise in prices prior to the entry of the United States 
into the conflict. After the conclusion of the War, prices continued to 
soar to another historic peak. This period illustrates characteristic 
aspects of postwar scarcity of primary commodities, particularly in 
Europe. The price movement of World War I was accomplished, so far 
as the United States was concerned, through the medium of credit 
expansion rather than the issue of inconvertible paper money as such. 
From the peak of 1920, the first stage of deflation was rapid and brief in 
this instance, followed by a fairly long table of relatively steady prices 
that again collapsed during the general depression of the 1930's. The 
general’^ index, however, remained on a much higher level than com- 
modities alone. The rising drift of prices in the latter 1930^s, although 
attributable partly to internal political policies, became part of the 
momentum created by world-wide preparations for World War II. 

If the reader will now again review this remarkable correlation of 
commodity price inflations and deflations with major war intervals, it 
will be observed that the business-activity index (shown in Charts 6 and 7 
below the war periods) fails to reflect the same pattern of movements. 
The degree of response of business conditions to wars can be observed 
in terms not only of the intermediate trend but also in the year-to-year 
fluctuations. The earliest war period shown at the beginning of the 
eighteenth century failed to produce any pronounced price inflation, and 
there is no evidence of a sustained and unusual rise in business (trade) 
activity. The War of 1745 (King George^s War) produced a moderate 
rise in the price level, but business activity appears to have improved 
after the War rather than during the conflict, when there was evidence of 
a rather marked depression. The experience in the French and Indian 
War is rather different; prices rose somewhat and there was a rather 
pronounced business boom culminating at the close of the War. The 
fighting was done principally on land and did not involve the obstructions 
to foreign commerce that have in many cases characterized major wars. 
The period of the American Revolution marks a striking instance of 
directly inverse movements in commodity prices and trade activity. 
Following a short and violent boom in trade in 1771, there developed a 
creeping paralysis of all business as the colonists organized opposition to 
British trade. During the War itself, trade conditions reached an 
extremely low level of depression, which was sufficient to deflect the 
intermediate trend into a pronounced trough. Thereafter trade 
conditions improved and continued a rising drift, even during the first 
period of the ensuing conflict between the British and the French. 



Following a brief respite from 1800 to 1802, the great Napoleonic 
conflict involved the extension of commercial embargoes, severely 
restricting the market for American exports and the distribution of the 
usual imported products. Again we notice an abrupt business depression 
during the War of 1812, coinciding with the most rapid rise in commodity 
prices. The intermediate trend of business activity reaches its peak 
about 1800 and declines until 1819, despite the sharp rise in commodity 
prices between 1811 and 1814. We see that the great waves of price 
inflation are by no means positively correlated with the underlying 
cyclical undulations of business activity itself (expressed throughout in 
terms of volume). The American Civil War was preceded by a period of 
unusually active business and much reckless capital promotion. From 
the depression, which began as early as 1853, the Civil War itself did not 
bring about any significant recovery, and the intermediate trend con- 
tinued to drift lower until 1869. Business recovery from the Civil War 
was particularly slow in the Southern States, where industry and trade 
were demoralized to a far greater degree than in most Northern States. 
But the recovery that followed the War, although marked by occasional 
sharp depressions and financial panics, developed a gradual rise in the 
intermediate trend that persisted into the early part of the twentieth 
century. As in the previous cases, World War I failed to produce more 
than a brief interval of productive expansion, prior to the actual involve- 
ment of the United States in 1917. Following this, the volume of busi- 
ness activity irregularly deteriorated until after the first collapse in 
prices in 1921. From what has already happened in World War II, 
beginning as a gigantic conflict and involving our direct participation as 
this is written, it appears that another rise in prices is under way, but 
general production, despite drastic limitations upon many civilian-goods 
industries, may for a brief period rise to very high levels, since it is 
destined to be a war of machines, 


There seems little room for doubt in the light of this historical evidence 
that major wars have contributed to our most important instances of 
price inflation; but they have not produced during their occurrence more 
than fitful and ill-balanced increases in the volume of business activity. 
Including the war and postwar periods, the intermediate business trend 
does not form a pattern correlating directly with similar long waves in 
prices. The wars have a powerful effect on the price level, but in the 
postwar periods the volume of production and trade is apparently 
motivated by mixed forces, of which price-level deflation is one. This 
last point is important because several writers, apparently basing their 
views on inadequate statistical evidence, have created the impression that 



long waves in business operations have about the same dynamic pattern 
as those found in the movement of prices. Thus far the predominant 
references to these longer waves of activity or major oscillations in the 
price level have been by European observers. Most important among 
these, and one of the first to develop the idea, is N. D. Kondratieff, director 
of the Conjuncture Institute of Moscow.^ He observed that when 
various basic production series or price data were smoothed out to 
eliminate the shorter cyclical fluctuations (including those having 
periods of as long as nine years), there were observable very long waves 
that he thought pointed toward a regularly recurring cyclical undulation, 
with peaks and valleys between forty and sixty years apart. He applied 
smoothings to a variety of data, most of which, however, consisted of 
prices or value measurements, but a few fairly long series for coal and 

1 Kondratieff important article, published as Die langen Wellen der Konjunktur 
(Archiv fiir Sozialwissenschaft und Sozialpolitik^ December, 1926), was translated in 
summarized form as The Long Waves in Economic Life, Review of Economic Statistics^ 
November, 1935. The studies that gave rise to Kondratieff ’s use of the concept of 
long waves were undertaken about 1920. Kondratieff was probably preceded in this 
regard by the Dutch writer Van Gelderen (Springvloed Beschouwingen over Indus- 
trielle Ontwikkeling en Prijsbeweging, in De Nieuwe Tijd, 1913); cf. also S. de Wolff, 
Prosperitats- und Depressionsperioden, in Festschrift flir Karl Kautsky'’, Jena, 
1924; W. Woytinsky, Das Ratsel der langen Wellen, Schmoller^s Jahrbuch, 55th year, 
1931; F. Kuczynski, ‘‘Das Problem der langen Wellen und die Entwicklung der 
Industriewiirenpreise, 1820-1933,^^ Bale, 1934; F. Simiand, “Les Fluctuations econo- 
miques h longues p6riodcs et la crise mondiale,'^ Paris, 1932. 

Among American writers there is an interesting discussion, accompanied bj^ 
statistical measurements relating to the United States and several other countries, 
in C. A. R. Wardwcll, “Investigation of Economic Data for Major Cycles,’^ University 
of Pennsylvania, 1927. Wardwell used the term “intermediate trend. Another 
more specialized use of the idea of wavelike movements longer than the usual alterna- 
tions of the business cycle may be found in the flexible trends fitted by Dr. Simon 
Kuznets to various price and production series in his book “Secular Movements in 
Production and Prices,’^ 1930. Professor Schumpeter (“Business Cycles,” 1940) 
appears to accept Kondratieff^s evidence that there are long waves in the movements 
of economic factors, but Schumpeter apparently docs not accept Kondratieff^s insist- 
ence that these waves are necessarily internally generated within the capitalistic 
system or that they must be considered as periodic. 

In a review of Schumpeter^s “Business Cycles” (American Economic Review, June, 
1940, p. 267), Simon Kuznets calls attention to the probability that Kondratieff ’s 
conclusions as to the patterns of the long waves in economic data relating principally 
to European countries were largely dominated by evidence associated with price 
and value series. Such data would necessarily have been influenced to a marked 
degree by great movements in prices throughout the world, and the tendency of these 
price movements to be probably more nearly the same in pattern from one countrv 
to another than would be the movements of production and trade. Kuznets partic- 
ularly questions the idea that the long waves must be considered necessarily as having 
periods of fifty years or that they represent any regularly recurring tendency generated 
within the mechanism of the prevailing economic system. 



iron production were also examined. Most of his data related to England, 
France, and Germany and little attention was given to statistics for the 
United States. In spite of the fact that the various extended waves or 
cycles that emerged from these series failed to show much agreement in 
pattern, and without clearly differentiating between prices on the one 
hand and volume data on the other, Kondratieff summarized his long-wave 
patterns as follows: 

Wave 1, rising from the late 1780’s to about 1810-1817 and declining thereafter 
to about 1844-1851. Such a wave does describe more or less the major pattern 
that can be read into the behavior of commodity prices during that period, but it 
fails to correspond with the intermediate trend that has been shown on the Chart 
above for the physical volume of trade in the United States. According to that 
index, the business wave extended from about 1782 to 1800 in the rise phase, 
and the decline extended to about 1819. 

Wave 2, indicating a rising tendency from 1844-1851 to roughly 1870-1875, 
thereafter declining to about 1890-1896. Again this pattern is much more 
descriptive of long-term price movements than of the physical volume of business 
in this country. Our results show a rising intermediate trend phase from 1820 
to about 1852 and thereafter a decline to about 1868. 

Wave 3 is incomplete in Kondratieff 's scheme, but he conceives it as extending 
upward to 1914-1920 or thereabouts, and he remarks that probably it would 
decline to about 1914-1920, an unfortunate error due to the fact that he wrote 
before this important long wave of decline had actually reached its bottom. 
According to the writer ^s measurement, the intermediate trend rose to a peak in 
the neighborhood of 1910 and has declined until the late 1930’s, with a provision- 
ally indicated tendency toward initial upturn about 1939 or 1940. 

Kondratieff added a number of other observations concerning the 
long waves that are interesting and worthy of note. He called attention 
to the fact that during the long periods of stagnation marking the receding 
waves, large numbers of important discoveries and inventions in the 
technique of production and communication seem to be forthcoming — a 
surmise that is not yet capable of thorough verification but that deserves 
further study. One of the most remarkable features of Kondratieff^s 
views is the contention that all the wavelike action in business activity 
arises from within the economic system, meaning in this connection the 
capitalistic system of enterprise. The long waves, he claimed, are 
“inherent in the essence’^ of such a system. According to this remark- 
able view, wars are not an “external,” politically motivated factor 
impinging upon trade and production from without; instead, wars are 
believed to arise from the economic conditions associated with periods 
of exceptionally long-continued acceleration and expansion. “Wars 
originate in the acceleration of the pace and the increased tension of 



economic Even the opening of new productive or consuming 

areas in the world was considered by Kondratieff to be a resultant of the 
long-continued upswings of production that generate friction, pressures, 
and the exploitation of new sources of raw materials and establishing of 

Finally, this Russian writer considered that the production of gold, 
instead of being possibly one of the fundamental factors operating upon 
the world level of prices and thus having something to do with the long 
waves of national price movements, is a resultant rather than a causal 
force. We have here, then, an interpretation of this wave phenomena 
that is very probably associated with a Russian view of the mechanics 
of capitalism and that attributes to the dynamics of capitalism most of 
the things that happen in the world, including the making of tears and 
revolutions and the promotion of new colonial areas. We have here a 
view that insists that these long waves are true periodic cycles, having 
a tendency to repeat themselves with a fair degree of regularity through 
the centuries, so that there are about two to each century. It is the 
view of the present writer, however, in the light of the fairly definite 
evidence now available for American experience covering nc^arly two 
and a half centuries, that the undulations of the intermediate business 
trend are probably much more responsive to the play of political dis- 
turbances and ambitions and major innovations in the ways of production 
than are the shorter business-cycle’^ vibrations. There is no a})parent 
reason of a conclusive nature, however, why either of these types of 
business fluctuation should be any more inherent in the capitalist eco- 
nomic or social system than are vibrations necessarily inherent in a piece 
of machinery. A high degree of stability in the price level and the 
absence of important deviations in either direction along the course 
of the growth trend in production and trade do not seem to be theoret- 
ically or basically inconsistent with an essentially capitalist society; 
and there is certainly no evidence thus far that they would be absent 
in thoroughly collectivist society. 

To eliminate unnecessary and harmful business vibrations requires 
diagnosis — careful study and measurement of all the possible factors 
that may contribute to imperfect coordination of a vastly complicated 
series of parts in motion. There is no conclusive proof that the removal 
of such sources of disturbance in (or impinging upon) our economic 
system would necessarily be either destructive of long-term progress or 
incompatible with the maintenance of a high degree of individual 
initiative and a legal framework of private property. But we have yet 
to advance a long way in our measurements of these dynamic economic 
forces and their interrelationships and a long way, too, in the art of 
^ Kondratieff, op, ciL, p. 115, 



political administration before the patterns of disequilibrium and friction 
give way to the smoothly continuous progress — a continually rising 
secular trend. 


Holding to the view that wars have a most important bearing upon 
distinctive patterns of long waves in prices and in business activity, we 
may now examine more closely the process whereby a major war brings 
about inflation of the price level and of money values generally, whereas, 
on the other hand, it introduces disturbance of varying patterns and 
proportions in the business system. It is already clear that periods of 
intense warfare — accelerating some lines of production and trade and 
discouraging or even destroying others — produce effects upon business 
that cannot be expressed in a simply defined pattern, repeating itself 
upon each occasion. What we are now primarily interested in is the 
question why wars are capable of apparently producing such marked 
aberrations and deviations from the general drift of progress or growth. 
Before we undertake a study of the minor or year-to-year fluctuations in 
business, usually referred to today as ‘^business cycles,’’ it is desirable to 
formulate more definitely some conclusions as to the nature of the forces 
producing the long-term tidal movements. We shall turn first to the 
major cycles, because they seem to be associated with political policy 
under conditions of acute emergency. In fact, it may prove to be essen- 
tial to divide our study of business dynamics into two distinct phases: 
wartime conditions and peacetime conditions. This distinction has been 
inadequately observed in studies of business conditions, doubtless because 
of the absence of reliable statistics and measurements of trade conditions 
over periods long enough to reveal the full perspective of relationships. 

Probably the most fundamental economic characteristic of a major 
war emergency is the existence of a sudden, extremely intense, and power- 
fully mobilized demand on the part of the Government for the materials 
and equipment needed for the fighting forces (or for actual or potential 
allies). In our own national experience, this public demand has expressed 
itself primarily in money payments flowing through commercial channels. 
The Government has entered the markets as an urgent purchaser, 
not as an authority exercising the power to commandeer or to operate 
directly all machinery of production. This aspect of war supply has 
indeed been changing to a significant degree in recent years; some govern- 
ments have assumed such sweeping control over production, trade, and 
finance that the war experience means merely a stepping up and altered 
character of a regimented production, no important buying of what is 
needed, and no need for huge issues of new money or credit. But to take 
the wars that have involved the American people since the beginning of 



the eighteenth century, the transitions from a peacetime basis to wartime 
basis, and the diversion of productive activity called for by the emergenc}^ 
have been marked by serious dislocation and extraordinary strain upon 
the normal mechanism of commerce, finance, and exchange. In none 
of these wars was there any extended period of previous preparation, 
gradual and deliberate mobilization of resources or capital or man power. 
The relatively sudden recognition of an inescapable emergency crashed 
upon an economic system normally functioning with relatively little 
governmental control over productive, commercial, and financial proc- 
esses. Under war conditions the fighting personnel is commandeered; 
but the specialized material requirements, in amounts virtually without 
limit, are obtained under conditions that very soon cause competition 
between the Government and civilian consumers for possession of essential 
goods. The Government enters the markets supplied with virtually 
unlimited funds and bids against the private consumer or business firm; 
the result is naturally a swift and more or less cumulative spiral of price 

Contrasting with this sweeping intensification of demand and the 
prospect of enormous spendings of new money, obtained by borrowing or 
paper issues, to supplement inadequate tax revenue, actual production 
of the many materials needed can seldom be expanded fast enough. The 
drafting of men for war service removes labor from farms, factories, mines, 
and transportation. Women take their places only gradually. The 
direct allocation of allowable supplies to civilians, although today accepted 
as a necessary step by all governments, was not so much relied upon in 
(^arlier wars. There comes about a substitution of less well-trained, less 
skillful and efficient workers; a faster depreciation of machinery and 
transportation equipment and inadequate replacement occur. There 
may be, depending upon circumstances, an abrupt curtailment of raw 
materials from foreign countries. This quickly develops into bottlenecks 
of supply, creating the possibility of further swift advances in prices, in 
part speculative; at the same time inability to secure strategic materials 
hampers production of equipment in which those materials are 

In the case of most agricultural production, expansion of output to 
serve war needs is a relatively slow process. It requires a year or more 
to obtain even a modest increase, weather conditions permitting, in the 
output of field crops, and expansion in production of animal products 
requires considerably longer periods and tree crops still longer. A similar 
“inelasticity of supply characterizes many of the important industrial 
metals and minerals. Mining operations can be speeded up somewhat 
if it is essential, but the discovery of new sources that can be economically 
developed even under the stimulus of intense demand is by no means a 



simple routine matter. Foodstuffs and mineral products invariably arc 
in urgent demand under wartime conditions, for the fighting forces con- 
sume more food per capita than the same number of persons would 
require under normal conditions. Certain metals and minerals, such as 
steel, iron ore, copper, lead, tin, zinc, and, more recently, aluminum, 
manganese, and nickel, are absolutely indispensable raw materials, 
without which a war cannot be effectively carried on. Likewise, among 
chemical products, some are capable of rapid supply expansion, but others 
are subject to limitations in technique or to curtailment of imported 
ingredients, and the prices of all such things can rise perpendicularly 
during a war emergency unless political control is exercised promptly. 
As some strategically important articles are observed to rise several 
hundred per cent in price, there is an acute psychological effect. Specu- 
lators and individual consumers accumulate supplies in all directions, 
and a forward buying and more or less speculative hoarding movement 
occur in business firms. This adds fuel to the inflation flame, and as the 
prices mount higher, the Government, in order to continue its purchases 
and ensure adequate supplies in the shortest possible time, must either 
devise new ways of enlarging its monetary resources, even to the point 
of abandoning the principles of sane finance, or impose stringent dicta- 
torial controls over prices and uses.^ 

1 In January , 1940, for example, the Army and Navy Munitions Board announced 
a list of commodities that were considered ^‘strategically important,’^ that is, goods 
essential to national defense, for the supply of which, during war conditions, depend- 
ence must be placed in whole or in substantial part on sources outside the continental 
limits of the United States and for which strict conservation and distribution control 
measures were thought necessary. The following list of these strategic materials is 
presented as an illustration of the things that in this particular emergency were in this 
classification: ahacd (Manila fiber), antimony, activated carbon, chrome ore, ferro- 
manganese, manganese ore, mercury, mica, nickel, quartz crystals, quinine sulfate, 
rubber, silk, tin, tungsten ore. In addition to these materials, still another list was 
announced and designated as containing “critical’^ materials, those considered essen- 
tial to defense, involving less difficult procurement problems than the foregoing but 
nevertheless some degree of necessity for conservation and distribution control. 
These include aluminum, asbestos, cork, graphite, hides and skins, iodine, kapok, 
opium, phenol, platinum, tanning extracts, toluol, vanadium ore, and wool. 

It is of interest to note that the prices of the strategic commodities rose, on the 
average about 25 per cent from the end of August to the’end of September, 1939, after 
the outbreak of World War II. In present-day warfare, in all major countries, a 
much more alert attitude on the part of even nondictator governments than ever 
before is directed toward accumulation of supplies of scarce materials and the applica- 
tion of equitable rationing or even prohibition of civilian use. The importance of 
exercising drastic control over normal consumption, over prices that are advancing 
too fast or under speculative or hoarding pressure, is much better recognized today 
by our Federal Government than in past wars. See the further discussion of this 
subject in Chapter 24. 



In a simple economy, such as prevailed in eighteenth- and early 
nineteenth-century America, it was far less easy than today to develop 
substitute materials to replace those urgently needed for production of 
arms, explosives, ships, and clothing for the fighting forces. Today the 
drain upon the strategic commodities is somewhat reduced, although by 
no means eliminated, through the remarkable developments in the 
chemical and metallurgical industries capable of providing within a rela- 
tively short time alternative or supplementary materials, thus making it 
less difficult to sustain distribution of consumer goods and preventing 
skyrocketing prices. Rapid inflation has proved in the past so disastrous 
in its ultimate results that there is almost universally in a world at war 
a grim determination to control or avert it, even at the cost of despotic 
methods. It is by no means beyond question that if ways and means of 
avoiding the kind of universal conflict now existing are not found and 
made effective, these elaborate political devices for authoritarian control 
of war operations will project themselves rather generally into a future 
pattern of regimented society in which the difference between wartime 
and peacetime may be rendered permanently inconsequential. 

Enough has been said of the economic effect of war to show the diffi- 
culty of formulating precise principles capable of application to any and 
every war period. Generalization is dangerous. But as we look back 
over the historical record of price behavior and general business changes, 
not only are the dislocating effects of war clearly evident but the effects 
appear to follow long after the event. Let us pursue the subject some- 
what further. Why does it seem to be true that despite a temporary 
stimulating effect of war upon some industries, wars are generally asso- 
ciated with a long-term retarding of business growth, as was apparently 
true following the World War I, which did not fully reveal its distorting 
effects on the economic system of the world and of the United States until 
the 1930^8? 

An adequate answer to such a question cannot be attempted until 
some further aspects of business dynamics have been more fully analyzed 
in later chapters. We can, however, supplement the preceding sketch 
of the fundamental forces of war disturbance by noticing the impact of 
war demands upon extractive industries, particularly agriculture and 
mineral production. Again we must emphasize the pronounced inelas- 
ticity of supply characteristic of these industries, dramatized by the 
fierce pressures of military necessity and the accelerated tempo of 
demand. As prices of the products rise, an enlargement of output does 
somehow come about. If a war lasts for several years and if it involves 
the transportation of food, fuel, and metal goods to other countries, 
there is certain to be a substantial expansion in farm acreage and in the 
working of mineral deposits. This is usually true also of transportation 



facilities; there is emergency demand for ships, railroad equipment, and, 
in recent times, for a tremendous variety of military apparatus moving 
on wheels or through the air. 

This expansion of effort involves the use of capital, which under war 
conditions has usually been provided under considerable difficulty. The 
heavy war borrowing by governments, owing to the impracticability of 
quickly increasing taxes or the reluctance of political leaders to resort 
to ruthless taxation, depletes the capital market until the Government 
itself has taken steps to liberalize credit creation by setting aside the 
usual reserve requirements recognized by sound banking practice or 
statutory law. Although the issue of private-capital securities is rarely 
easy under intense war conditions, banking systems come to the rescue 
of hard-pressed producers and offer loans at longer than usual terms and 
for essentially capital purposes. In the Civil War period, for example, 
the commercial banks greatly increased their loans secured by the obliga- 
tions of manufacturers and farmers. In World War I, with the banking 
system fortified by the recently established Federal Reserve System, 
such loans were forthcoming in very substantial sums. 

The case of the farmer under these conditions is of special interest 
and importance because of the temptation to borrow and expand that 
rapidly ascending prices create in the mind of the average grower of 
crops or breeder of livestock. It has been consistently true that farm 
indebtedness tends to multiply fast in periods of wartime inflation, and 
this means, in turn, that the elevated fixed charges on intermediate and 
long-term debt remain long after the war is over and the prices of the 
farmers' products have probably collapsed to much lower levels. Most 
farmers operate without the refinements of accounting or the principles 
of sound business judgment. The sudden windfall of high prices and 
corresponding larger earnings is not seen as the fleeting experience that 
it is. Land hunger and the speculative urge to secure profit from the 
appreciation in land values open up the road to financial ruin during the 
long years of price deflation.^ When a large productive group is thus 
caught in the toils of inflation, the ultimate effects upon the total buying 
power and prosperity of the country should not escape the notice of those 
who would understand the dynamics of business. The effects have 
frequently been exaggerated, but there is no denying the fact that such 
abrupt rise and fall of farm income does serve as one of the many impor- 

1 At the beginning of World War II, well-organized farm groups, through powerful 
representation in Congress, for a time effectively opposed efforts by the Federal 
Administration to set maximum or ceiling” levels for basic agricultural prices, even 
at levels higher (in terms of relative purchasing power) than those prevailing prior 
to World War I. The ^‘parity-price ” philosophy, and other aspects of deliberate price 
control are further discussed in Chapter 24. 



tant distorting influences upon the flow of trade and industry following 
periods of war. 

In the case of mineral products, there are somewhat similar results. 
Some mineral deposits are controlled by fairly substantial business organi- 
zations or interests controlling extensive capital. Expansion in holdings 
and the working of new or previously uneconomic deposits tend to be a 
concomitant of war conditions. The effects are broadly similar to those 
in agriculture, although impinging on a smaller social group. The prices 
of metals in wartime have been very volatile; demand is insistent, and 
supply is inelastic over short periods of time. But by the time the 
emergency is over we face a situation of expanded and excessive mineral 
production capacity. With war demand ended, huge amounts of scrap 
metal, war surpluses, or supplies from new foreign sources must be 
disposed of, and they cannot be fitted into the normal operations of 
industry fast enough to avert an acute surplus problem and hence a 
deep, sharp decline in prices. This may also leave behind it, as in agri- 
culture and animal raising, inflated capital structures and fixed charges 
capable of impairing for a considerable time the solvency of the less con- 
servative units in the industry. This, in turn, restricts their own 
demand for labor and the products of equipment industries. These 
are illustrations of but a few of the outstanding sources of price disloca- 
tion under wartime conditions and the tendency to expand the scale 
of extractive operations. These cases serve to depict, in a broad and 
general way, the manner in which great wars generate not only temporary 
economic or financial dislocation but disturbance of such magnitude 
that the broad course of industrial progress may be appreciably modified 
for several decades. It will be important to keep this in mind throughout 
the remainder of our analysis of business dynamics. 


We have not yet considered the experience of the industrial population 
and the large urban groups whose income is derived from service or 
finance and is not readily adjustable to the wide swings in the cost of 
food, clothing, and other essentials that characterize war periods. These 
groups have become an increasingly large proportion of the total popula- 
tion, and the distortions and strains of war and postwar readjustments 
have therefore tended to shift their emphasis toward these segments. 
In a general way, however, it can be said that wage earners in industry 
seem to have been able to adjust their money earnings to the inflationary 
price movement created by war conditions. This adjustment has not 
always been prompt or complete, but the available data on wage rates 
and prices establish the tendency. When industrial wage rates have 
been adjusted to the wartime level, they have remained far less sensitive 



to subsequent deflation than wholesale commodity prices or the retail 
cost of family essentials. Hence during the postwar period, a dislocating 
factor introduces itself throughout the field of manufacturing, trade, 
and transportation. Even before the productive system has completed 
the transition to normal operating conditions, the higher wage rates 
in industry have stimulated the demand for goods and houses among 
wage earners and also the demand among employers for labor-saving 
equipment as a means of reducing per unit labor costs. Meanwhile,^ 
supplies of essential foodstuffs and clothing materials become more 
abundant and prices decline rapidly. Hence in those industries that 
are able to continue operations or resume normal production promptly, 
the working population has the advantage of a higher purchasing power 
than might have prevailed in the absence of war. The farmers' deflation 
loss is translated into the industrial workers' gain.^ Wars are thus a 
means whereby a pronounced shift in the distribution of real income is 
brought about, and such far-reaching change in the relative position of 
important economic groups appears to continue for years after the 
war emergency itself has passed. Thus the forces created by major 
wars are of an explosive nature, but the aftermath involves even more 
basic changes capable of affecting business conditions either directly or 
indirectly for decades. And as we shall presently see, there are political 
and social aspects of this aftermath that the student of dynamic processes 
cannot overlook. 

One of the important factors contributing to the recovery of produc- 
tion and trade after the immediate postwar deflationary readjustment 
is over is found in the necessity of making up for a period of curtailed 
or wholly suspended production of goods and equipment for civilian 
use. While prices are rising faster than wages, real income is reduced 
in many directions. Those living upon incomes that are relatively 
fixed find their actual purchasing power abruptly curtailed. Govern- 
ment requisitions, the possible shutting off of imported goods, prohibi- 
tions upon civilian use of certain articles and services, and the rise in 
financial payments to Government out of current income and even 
savings — all these involve the deferring of purchases by individual 
consumers whose incomes are drawn from industry, service, and finance. 

^ Excluding cases in which the war has directly demoralized productive capacity, 
as in the Southern States following the Civil War. 

* The general price-level index in Charts 7a and 76, which includes urban wage 
rates and retail prices, showed little tendency to deviate from the movement of whole- 
sale commodity prices from 1820 to 1880, but thereafter an increasingly wide spread 
develops. The general price-level index after World War I notably resists deflation 
and shows a remarkable instance of the effect of maintaining industrial money wages 
geared to rising war prices after commodities suffer a tremendous deflation. This 
phenomenon is discussed in more detail in Chapter 20» 



This deferment accumulates a potential demand, not only for routine 
requirements of the family budget but for consumer capital goods, 
represented by houses, furniture, and other household equipment, and, 
in recent years, automobiles. We shall further examine in a later 
chapter the dynamics of durable consumer-goods activity in relation 
to war periods, but to summarize the principle in a few words here, we 
can say that a more urgent and effective demand for consumer durable 
goods, particularly in industrial areas, favored by the revised relation 
of wage rates to cost of living in the postwar period, tends to revive 
important branches of industry despite continuing difficulties in extractive 

The recuperation in urban industry and incomes, partly responding 
to the accumulated demand for consumer durable goods, can be expected 
eventually to encounter limiting forces arising from the existence of a 
continuing unbalance within the economy as a whole. Postwar recovery 
movements appear to be destined to give way presently to a secondary 
depression, particularly if the postwar reconstruction is carried on with a 
reckless and more or less speculative momentum and is amplified by the 
continued expansion of credit facilities and the ease of capital financing 
that major wars appear always to have provided as one of their important 
consequences.^ Having this train of events in mind, Leonard P. Ayres 
has formulated it into the generalized observation that after a major 
war there are two depressions: a primary depression and a secondary 
depression, the latter following the postwar reconstruction excesses, 
speculative financing, and overbuilding. This secondary reaction may 
indeed prove to be more severe and extended than that immediately 
following cessation of hostilities. ^ Ayres summarizes his conclusions 
as follows: Great wars appear to produce regular sequences of economic 
results which we may identify as (1) commodity price inflation, (2) farm 
prosperity and farm land speculation, (3) price deflation and short 
primary post-war depression, (4) a period of city prosperity and wide- 
spread speculation, (5) secondary price deflation and a long secondary 
post-war depression.^^3 

The Great Depression of the 1930’s, according to this interpretation, 
was a delayed secondary depression following World War I, complicated 
not only by the domestic forces of disequilibrium among income and 

^ Disposal by individuals of governmental obligations previously purchased to 
assist war financing may be a factor contributing to postwar purchasing power and 
also to the usual tendency for high-grade bond prices to decline sharply in such periods. 

* This view is developed and illustrated in an interesting way by Ayres' pamphlet, 
published by the Cleveland Trust Company in 1935, entitled *‘The Chief Cause of 
This and Other Depressions.'' See also his ** Economics of Recovery," New York, 
1933, especially Chapter 2. 

* ‘‘Chief Causes," p. 50. 



industry groups but by the demoralization of international markets and 
finance traceable to the war. It is doubtful whether Ayres^ view is 
capable of being translated into a hard-and-fast principle, describing a 
necessary sequence of events in every case; but it provides a working 
hypothesis that is most helpful in interpreting postwar readjustments 
in the United States after several of our important conflicts. It is rather 
difficult to discover any substantial verification of Ayres' secondary 
depression following the American Revolution, since the revival in busi- 
ness activity following the general demoralization attending that conflict 
was rapid and continuous until the Napoleonic wars again introduced 
severe disturbance. Nor do we find much evidence of the principle 
following the War of 1812; there was a brief recession in 1819 and 1820, 
but the forward sweep of industrial expansion carried the business index 
upward with but minor variations until the middle 'thirties. Following 
the Civil War, however, there is some evidence that the delayed read- 
justments following initial postwar recovery were unusually marked and 
long-continued. The difficult years of the 'seventies and 'eighties 
illustrate the final blow suffered by the extractive producers, whose 
incomes had been particularly deflated by raw-material price collapse. 
Acute rural distress colored political and social movements and kept 
alive a spirit of unrest and resentment toward urban industry, capital 
institutions, and the railroads for many years. The 1930's witnessed a 
repetition of much the same friction between country and metropolis 
that strongly colored the reform measures of the New Deal. 


The impact of postwar economic depressions upon social attitudes 
and political temper has not escaped the attention of historians and 
political scientists. One historian who has made notable contributions 
to the study of economic and political forces during the evolution of the 
United States is A. M. Schlesinger, who has recently provided a most 
interesting summarization of political attitudes during nearly two 
centuries of our history.^ He finds that there are long-term, alternating, 
wavelike movements in the general political atmosphere. He is not 
here concerned with the mere alternation of political parties or formal 
platforms but rather with the general characteristics of conservatism 
as distinct from liberalism, or rightism as distinct from leftism, that are 
revealed in the political policy and expressions of ideas. Beginning 
at 1765, Schlesinger characterizes each period, as shown in the lower 
portion of Charts 6 and 7, by the narrow band indicating shifts between 
leftist and rightist political temper. The first period, 1765-1787, he 

^ Tides of American Politics, Yale Review y Winter Issue, 1940. 



characterizes as one of dissatisfaction and revolutionary and leftist 
sentiment directed against the British. It was this feeling, doubtless 
accentuated by the heavy taxes and debts carried over from the wars 
against the French, that so rapidly welded the colonists into a unified 
body of revolutionists. This period was followed by one of contrasting 
temper, lasting until 1801. There was a conservative backwash during 
which the new leaders of the successful but still struggling Republic 
brought to bear upon national policy the talents of business leaders and 
propertied men of considerable ability as well as public spirit. It will 
be noted in the chart how well these periods, as designated by Schlesinger, 
correspond with the phases of the long-term wavelike intermediate 
business trends, the leftist and liberal intervals more or less coinciding 
with periods of stagnation and failure to keep pace with the underlying 
secular growth. Periods of political rightism and conservatism coincide 
with a contrary pattern. 

During the disturbed years of the Napoleonic campaigns there were 
intervals of war and peace but continuing economic instability, and the 
broad drift of the business trend again failed to keep pace with the secular 
growth tendency. This was the period of Thomas Jefferson and the 
growing influence of the farm groups in national policies, lasting until 
about 1816. Then followed another rightist movement from 1816 to 
1829. This was a period when demands for tariff protection became 
insistent and large amounts of Federal funds were allocated to the con- 
struction of roads and canals and experiments with national banking. 
The period of the 1830^s, until about 1841, was dominated by the spirit 
of Jacksonian democracy when, as Schlesinger puts it, ‘Hhe plain people 
romped into power — with consequences that will be noted further in 
later chapters. The party in power abruptly reversed the tendency 
toward Federal assistance to business and capital promotions all along 
the line. It cultivated the sentiment that it was “small business^' 
rather than “large business^' that should carry the American economy 
forward. Bankers, in particular, were often denounced in Washington. 
Although these were years of very rapid national growth, this political 
temper, especially after 1836, served to incite the popular mind against 
the financial system and against speculators in land and real property. 
A period of general economic retrogression lasted until the late ’forties. 
Between 1841 and 1861, there was again a period characterized as 
generally conservative and marked about midway by one of the greatest 
business booms of our history. There was widespread resumption of 
trading in land values, tolerated by a political temper exemplified by 
Tyler and not unfriendly to the promoter and speculator. There was 
even some rather general toleration of the system of slavery until the 
great crisis of the Civil War broke. 



During and following the Civil War, until about 1869, and particularly 
during the years of collapsing prices, the bitter cries of the farmer were 
again heard. It was this rural distress that motivated demands for free 
land for more settlers and a drastic modification of the Federal Govern- 
ment's policy of land distribution. With the doctrine of human freedom 
and abolishment of servitude, there was a general popular emphasis on 
the elimination of restrictions upon the access by even the humblest 
citizen to agricultural acreage. This interval was followed by a long 
period of relatively conservative political temper, which Schlesinger 
closes at 1901. With the administration of President Grant, we have a 
succession of friendly gestures on the part of the Federal Government 
toward railroads, manipulators, and promotional finance generally. 
Import tariffs were stepped up, and industry enjoyed one of the greatest 
periods of stimulation and acceleration that any nation has ever seen. 
This was our Golden Age of industrial growth, relatively untrammeled 
by regulation and subsidized in many indirect ways by a sympathetic 
political attitude. At just what point this attitude, so friendly to 
enterprise and business promotion, actually gave way to another reformist 
interval is not wholly clear. Schlesinger puts it at 1901, with the coming 
of Theodore Roosevelt’s regime of the Big Stick over corporations and 
the philosophy of more power to the people. Actually, however, this 
attitude, although dramatic and full of portents of reform, did not produce 
many far-reaching reforms until after the sharp and sudden business 
collapse of 1908. This immediately ushered in a wave of insistent and 
determined reformism, expressed in the adoption of a Federal income 
tax, various banking and insurance reforms, and particularly the great 
crusades against the ‘trusts,” resulting in the ^‘dissolution” of the 
Standard Oil and American Tobacco monopolies amidst a tremendous 
flourish of animosity toward big business in general. Sometime between 
1900 and 1911, there occurred the transition from the remarkably long 
period of conservatism and political indifference to the modus operandi 
of finance and industry, to an equally extended period of reformism, 
which the writer is inclined to believe has almost continuously tinged 
our political atmosphere to the present day. Schlesinger, however, con- 
siders the reformist period as lasting from 1901 to 1918, when Woodrow 
Wilson, according to his view, lost control of his reformist movement and 
gave way to the opposition forces for more than a decade. And this 
period of the 1920’s was a period of postwar boom, dominated by the 
activity in construction and the bringing to maturity of great new 
industries built upon the internal-combustion engine and its material 

These booming years of the 1920’s were not of a consistent and uni- 
form political and social temper. All through this period, financial 



reform was busy, as was also a steady encroachment of paternalistic 
aid to chronically unprosperous farmers. This was a period of liquor 
prohibition; the period when political minds were uneasily conscious of 
the troubles of postwar Europe and when much was heard of ways and 
means of resolving a mountain of postwar debts and reviving the eco- 
nomic life of conquered nations. It was, therefore, not difficult for 
American sentiment and political policy to become imbued with an 
essentially reformist temper as soon as the great secondary depression 
came after 1929. What has happened in the past decade in the way of 
reformism is the political counterpart not only of an exceptional economic 
depression were but of one that was felt the world over. There is thus 
deep social meaning in the long-term convolutions of the business-activity 
measurements. In the words of Schlesinger, the rhythmic pattern of 
our history seems to be ^'a period of concern for the rights of the few, 
followed by one of concern for the wrongs of the many.” 


Before leaving this subject of the long intermediate waves of economic 
progress and stagnation in our history, let us hazard a few observations 
upon some aspects of the technological environment that seem to have a 
bearing on recuperation following the severe breakdowns. It would, of 
course, be trite to say that through new discoveries and inventions and 
the application of new ideas to the acts of production, we are able to 
progress in an economic sense and can restore prosperity, following even 
the most demoralizing crises. But we can be somewhat more specific 
in the matter of the strategically effective innovations and their influence 
upon reconstruction. 

It seems reasonably certain that during the latter half of the eight- 
eenth century the effect of the wars fought in North America was com- 
pensated by impelling forces of technological change. As long as the 
American Colonies were closely dependent upon trade with Britain, the 
dramatic strides of invention and industrial mechanization occurring in 
Great Britain formed for us also an economic bulwark against any con- 
tinued stagnation. The latter half of the eighteenth century was a 
period of remarkable economic progress in all directions, agriculture, 
transportation, the introduction of the steam engine as a prime mover, 
and a long series of inventions revolutionizing the textile industry and 
creating enormous demands for materials. After the Revolutionary 
War, this continuing technological and industrial tidal wave continued 
to provide basic ideas and principles for our own industrial revolution. 
Among the most potent industrial forces that cushioned the readjust- 
ments following our early wars was the vastly improved application of 
motive power to transportation and manufacturing. The application 



of steam power to navigation was a means of developing the resources 
of the cotton states to feed an insatiable mill demand for raw material. 
The application of steam power in the 1830^s to rail transport provided 
the foundation for thousands of new industries and productive com- 
munities. The application of electrical energy in the 1890^s served to 
continue and reinforce that remarkable epoch of industrial expansion. 
By the time the World War I readjustments were being felt, the applica- 
tion of the internal-combustion motor to individual transportation, as 
well as to agriculture, formed, certainly, one of the outstanding forces 
capable of counterbalancing deflationary influences, until unfortunately 
the economic system of the United States was called upon to bear extra- 
ordinary financial shocks emanating from abroad. Even the potency of 
industrial innovation could not for the time being maintain the pace set 
by the assembly lines of a motor age. 

As this is written, the profound international stresses carried over 
from World War I have created a still more ominous period of global war 
with the portent of unprecedented economic, political, and social con- 
sequences. But the broad sweep of history strongly suggests that when 
the readjustments are at length made, we can expect that new ways of 
applying power to production and transportation will again be the most 
significant contribution of technology to renewed business progress. 
Although not making a formal prediction, the writer hazards the opinion 
that regardless of possible heavy destruction and the interrruption of 
progress in living standards immediately in store and regardless also of 
any political aftermath of regimented planning or fatuous panacea, the 
really dependable sources from which we can expect long-term powers of 
recuperation to be derived will be found to be these major innovations 
in terms of power utilization that have been so important in the past. 
We may not be able for some time to visualize the form or detail or the 
exact principles of physics or chemistry or astronomy they may involve 
in their purely scientific aspects. But let no one expect that the mere 
introduction of gadgets or the inception of particular useful products will 
suffice to provide the sustaining stimulus and the new jobs that the next 
generation of our people will surely need to continue a progressing civili- 
zation. We can be tolerably sure that those nations will survive that 
can achieve the organizing and functioning of their productive resources 
most efficiently and apply controlled power most effectively to aid the 
human hand. Continued progress in the general standard of living is 
not derived from ^'buying power fed by doles but from producing power 
fed by science. 

It is conceivable that in the next long cycle of political developments 
we may see throughout the world another major shift toward placing the 
dynamics of production ahead of the statics of distribution and toward 



recognizing that all progress requires provision for future growth. This 
means that the perennial need for capital cannot be overlooked nor can 
the vast importance of a vigorous flow of capital be minimized. Carl 
Snyder has presented cogent statistical proof that our long-term progress 
and an increasing use of productive capital have been very closely 
correlated : 

The reason for the growth in output over a century and more must be found 
in the improvements in the methods of production, the provision of new types of 
machinery, power, and in the increase in capital available per worker. The 
evidence for this is remarkably clear. The increase in primary power employed 
in industry (measured in horsepower) has gone on at practically the same rate 
as the growth in physical products. The amount of goods produced per horse- 
power in industry has not materially changed in any decennium of the last 
century or more.^ 

^ Carl Snyder, ^ ^Capitalism the Creator/' p. 48, New York, 1940. 



We have seen that the intermediate trend of the volume of business 
describes long-term, wavelike undulations about the secular trend of 
growth. With the aid of statistical measurement, we can designate the 
approximate points when these long-term wave movements reach their 
tops and their bottoms. When we compare this pattern with the corre- 
sponding major tops and bottoms in the long-term movements of com- 
modity prices, we find that the patterns do not agree, even though 
political disturbances and particularly wars seem to have been effective 
in producing both these types of variation from the respective secular 
trends. In the case of commodity prices, the secular trend, over several 
hundred years, approaches the horizontal; for the growth in the volume 
of production and trade the secular trend has continued over a long period 
to rise at an almost constant rate of change approximating 3.6 to 3.8 per 
cent per annum, although for recent decades we cannot definitively con- 
firm the persistence of this rate until many years have elapsed. 

Since the long-term movements in price level have these peculiarities 
of pattern when considered from the standpoint of intermediate trend or 
drift, we shall devote this chapter to an examination of some of the most 
fundamental factors involved in forming these patterns. We must first, 
however, give some attention to the more precise definition of what is 
meant by the level of prices or, more exactly, by measures of average 
change in prices. We have already illustrated the movements of whole- 
sale commodity prices from 1700 to 1940, based on index numbers of 
several types spliced together to form a continuous record. Without 
entering into the technicalities involved in the construction of price index 
numbers,^ it will be helpful for the purpose of clarifying the subsequent 

1 On this subject see Irving Fisher, ‘‘The Making of Index Numbers,” Boston, 
1922; W. C. Mitchell, Index Numbers of Wholesale Prices in the United States and 
Foreign Countries, U.S. Bureau of Labor Statistics Bulletin 284, 1921 ; W. M. Persons, 
“The Construction of Index Numbers,” Boston, 1928; C. M. Walsh, “The Problem of 
Estimation,” London, 1921; The Making and Using of Index Numbers, U.S. Bureau 
of Labor Statistics Bulletin 656, 1938; Carl Snyder, The Measure of the General Price 
Level, Review of Economic Statistics y February, 1928; W. I. King, “Index Numbers 
Elucidated,” New York, 1930; G. F. Warren and F. A. Pearson, A Monthly Index 
Number of Wholesale Prices in the United States for 135 Years, Cornell University 
Agricultural Experiment Stationj Memoir 142, Part 1, 1932; Croxton and Cowden, 
-‘Applied General Statistics,” Chapters 20 and 21, New York, 1940. 



discussion to explain briefly the kind of procedure involved in this typ% 
of dynamic measurement. 


Perhaps the simplest form of an index number of price change is 
obtained by averaging the percentage changes for a considerable number 
of prices, each referring to a previous year or period as its base. The 
base average will, of course, be 100 per cent. Such an average might 
be accomplished arithmetically or by geometric or median methods. 
The resulting average of change might involve no deliberate weighting '' 
of the various articles and hence the relatives expressing their price varia- 
tions, although an accidental or haphazard form of weighting of the 
different components in the index can easily result from careless selection. 
It is considered preferable, if statistics are available, to introduce delib- 
erately into the construction of a price-index number a weighting or 
multiple counting to give some of the components more effect on the 
result in proportion to the commercial significance of the articles and 
others, less effect. Naturally, in the very early years, we lack sufficient 
data to establish such weights, and even the price data are incomplete, 
so that the results are not to be considered of high accuracy. There are 
difficulties too in interpreting the currency units in which Colonial prices 
were expressed. Where weights can be assigned the various commodities 
on an optional basis, either they can be introduced as modifying the 
relative numbers or they can be used to obtain for each commodity at 
the base period a value (price times quantity) with which subsequent 
similar values, preserving the same quantities throughout, may be com^ 
pared. ^ This is known as an aggregative index of prices. It is of course 
obvious that if it is desired to measure the course of price changes over a 
very long period, the selection of weights in an aggregative index number 
representing quantities produced or sold in a period long past might not 
accurately represent the relative weights of the different items at present. 
Hence there is necessary a certain amount of change in the weights from 
time to time, as well as introduction of new articles as they become impor- 
tant and the dropping of old ones as they become extinct. In the whole- 
sale-price index, which has already been illustrated in Charts 6 and 7, 
we cannot say that there has been a consistent system of weighting 
throughout the entire history, but the index is the best picture of whole- 
sale commodity prices that we can present by splicing together a number 
^ An aggregative index number of price changes, in which the values throughout 
are weighted by quantities relating to the base year, is mathematically equivalent to 
a weighted average of individual ratios of price change, each of which is weighted 
according to the value as existing in the base period. For a production index the 
weights become constant prices or unit values in the aggregative form, and the volume 
element varies. 



of representative series, notwithstanding the fact that these segments 
are based on somewhat different methods. The curve shown in Charts 
6 and 7 represents a weighted form of index beginning at 1849; for the 
previous years the computations are based on carefully compiled price 
data, and the absence of weighting is believed not to impair materially 
the value of the results for the present purpose of broad comparative 

There are, of course, a variety of ways in which subgroups of com- 
modities may be formed to observe average changes in their prices. Over 
long periods it is possible to obtain significant index numbers for compar- 
ing domestic commodities and imported commodities, raw materials 
and finished goods or even semifinished goods, farm prices and nonfarm 
prices, manufactured goods and extractive products. When we come 
to retail prices the material is much less complete, at least for the United 
States, and measurements of such price changes prior to 1914 must be 
arrived at by approximation based on other materials. The index 
numbers of the Bureau of Labor Statistics afford a reliable means of 
measuring changes in the retail prices of food, clothing, fuel and light, 
house-furnishing goods, house rent, and certain miscellaneous goods and 
services. Combination of these groups makes up what is known as the 
index of the cost of living or, more specifically, the retail cost of a list 
of items considered essential to an industrial worker^s family.^ 

The cost-of-living index number, it will be noted, carries us beyond 
the range of strictly commodity prices, since it contains such items as 
house rent, electric power, etc. As we move from raw materials to 
finished manufacturers and then again to the goods on the shelves of 
merchants ready for purchase by consumers, we find at each stage that 
there are embodied in the prices a series of labor, capital, and other 
service costs involved in the processes of production and distribution. 
As will be shown later, the price behavior of various kinds of services, 
broadly speaking, differs from that of commodities in the raw state, 
valued at the farm or mine or at some elementary stage of fabrication. 
The difference in behavior is in part due to the fact that in many of the 
fabricating and processing operations it is within the power of producers, 
within limits, to keep prices under a certain amount of control. In 
some instances, this control extends to the power of preventing fluctuation 
over extended periods of time. Such prices are considered in present-day 
terminology to be “fully administered'' prices, but these represent a 
relatively small part of the value of the finished commodities of commerce. 

^ Carl Snyder has computed an annual index of the cost of living as far back as 
1860. R. S. Tucker has shown that Snyder^s index can be approximated fairly well 
by combining an index of wholesale prices and an index of industrial wage rates. 
See Review of Economic Statistics^ Jan. 15, 1934, p. 8. 



The most important single factor, however, that introduces into retail 
prices the familiar tendency to move more slowly and to drift with an 
upward bias, as compared with wholesale prices, is the peculiar pattern 
of industrial wage rates. Because of the influence of labor organization 
and for other reasons too, it has long been characteristic of industrial 
wage rates that they rise without marked delay with important advances 
in commodities, but when commodity prices decline they do not usually 
decline appreciably. Whereas the long-term pattern of commodity 
prices shows wide advances followed by violent declines, in a kind of 
exaggerated saw-tooth pattern, the design of wage rates is rather that of a 
long stairway, with occasional landings. It is not surprising, therefore, 
to find that when we average together changes in wholesale prices and 
wage rates, as in the general^' price-level index, these contrasting 
patterns merge into a composite having in remarkable degree the pattern 
of retail prices. It must also be added that other kinds of service charges, 
such as taxes, interest rates, transportation charges, and all those prices 
that represent direct payment for service, especially personal service, 
tend to be less flexible in the major declines than in the wide advances, 
and these price elements become increasingly important in a complex 
economy in price measures that are of the cost-of-living type. 


We can now proceed to broaden considerably further the concept of 
price level. Let us conceive our problem to be one of estimating changes 
in the prices of all the goods and all the services that enter into commercial 
transactions in terms of money or credit instruments. It might seem 
at first that such a heroically comprehensive price index would be hope- 
lessly inaccurate and might have no definite meaning. It might be indeed 
a statistical curiosity. Nevertheless, such a concept does have much 
theoretical interest and even practical usefulness, even though much of 
its content would be based on sampling and estimation. What we have 
in mind in such a comprehensive index of price-level changes is an attempt 
to separate into two distinct measures the complex aggregate of transac- 
tions. Their value must, of course, equal the expenditure of all the 
money and credit circulated during a given period of time. If such a 
separation of the two factors — (1) the general price-level factor and (2) 
the trade-volume factor — can be even approximately accomplished, we 
have a scientific basis for investigating the relation between changes 
in the money and credit used for making payments and changes in the 
volume of production and trade in all markets. The purpose of this 
becomes a little clearer if we consider that the broad changes in money 
and credit circulation are measurable to a fair degree, and the volume of 
production and trade also is measurable in its essential movements. 



The general price level would be a resultant of the simultaneous changes 
in these two magnitudes. By analyzing such measurements we can 
hope to discover how much our general structure of prices is affected 
by monetary factors and how much by trade factors. 

For the United States, the pioneer effort to construct at least an 
approximation to an index of changes in the general or over-all price 
level was made by Carl Snyder, who for many years headed the economic 
research work at the Federal Reserve Bank of New York and who is 
widely known as a pioneer in many important statistical studies.^ In 
constructing his index (c/. Chart 7), Snyder found it naturally impossible 
to include more than a sampling of the exceedingly voluminous data. 
He found that price data for many kinds of transactions and markets are 
unavailable. Nonetheless, a comprehensive index was prepared by 
averaging separate price series relating to 12 phases of the price system, 
each of these being regarded as significant of its group and each being 
assigned a weight. The list is as follows: farm prices at the farm, indas- 
trial commodities at wholesale, retail food prices, equipment and machin- 
ery prices, hardware prices, automobile prices, urban rentals, other 
cost-of-living items, transportation rates, realty values, security prices, 
and several series of wage rates. Snyder carried his computations back 
to 1860. The resulting index of general price-level changes resembles to 
some extent the dynamic pattern of the cost-of-living index so far as that 
is directly measurable. By using this index as a deflating^’ series, 
Snyder was able to express data of bank check transactions, considered 
as an approximate measure of changes in the value of all trade, into a 
derived index of the physical volume of trade, eliminating price change. In 
other words, the component items and weights were sufficiently well 
selected that this derived index of physical^ ’ trade movements agrees 
fairly well with other measures of the physical volume of trade and 
production independently developed. ^ 

1 For the best description of the index of general price level, see Carl Snyder, 
Review of Economic Statistics, February, 1928, p. 40. 

* R. S. Tucker, in the reference previously cited, has shown that by carefully 
selecting the weights in combining index numbers of wholesale prices and wage rates, 
a composite closely approximating the pattern of the Snyder general price-level index 
is obtainable. This may be conveniently used to carry back the Snyder index as far 
as 1791, as Dr. Tucker has done. In the references in the present chapter to the 
general price level (and in Chart 8), our data have been derived in part from the use of 
Tucker^s series and in part by the use of Snyder’s series. 

It should be noted that the measure of the general price level in Snyder’s sense is 
associated with a concept of aggregate trade values of the broadest possible sort, in 
which, of course, there is duplication of raw-material items through the stages of 
production, processing, and transportation. There is also the presence of a certain 
volume of speculative turnover. In this sense, the value of trade is to be distinguished 
sharply from the value of national income (discussed in Chapter 3), a more specialized 



It is obvious and has long been accepted as true in principle that the 
total volume of money and credit mediums that a community is employ- 
ing to transact its business in any given period must have a definite 
relation to the total trade and to the prices prevailing. If it were theo- 
retically possible to obtain a statistically perfect index of the changes 
in the entire price level, such an index, when multiplied by an appropriate 
and equally comprehensive index measuring changes in the physical 
volume of all transactions accomplished by monetary means, would be 
mathematically equal to an index of change in the aggregate value of all 
transactions. In other words, the total expenditure expressed in dollars 
must equal the sum of all individual transactions, each of which involves 
a price element and a volume element. At any given moment there is 
no way to secure a static snapshot encompassing all prices or including 
the total trade volume. But we can select a starting point in time and 
thereafter observe and record the amount of change occurring in total 
trade activity (expressed in prices held constant); and by a separate 
l)nce index of change we can thus measure change of level. If we use 
constant prices (, those prevailing at the origin) in measuring changes 
in business, there will be a resulting discrepancy between the change in 
calculated volume and the actual change in value of transactions. Our 
g('neral price-level index, however, will measure the extent and direction 
of this discrepancy. By multiplying the index of average price change 
l)y the index of trade volume we remove the discrepancy. We shall later' 
return to this formal statement of these relationships, after some observa- 
tions on the American data over a long period relating to money, credit, 
price level, and business volume. 

In order to obtain a reasonably satisfactory series of dynamic measure- 
ments of these basic and interrelated factors, we should have data in 
fairly continuous form extending over a period of years. Historical 
information regarding the prices of commodities is by far the most readily 
available, and the money and credit measurement is much more difficult. 
Since each of the American Colonies had its own currency system, the 
actual course of prices expressed in local currency differed as between 
one section and another. After the Revolutionary War and the estab- 
lishment of a national currency system the behavior of prices tended to 
be much more uniform throughout the country. In fact, this was also 
true of prices during the Revolutionary War, when currency matters 
were largely under the management of the Continental Congress. Dur- 
ing the eighteenth century and until the Revolutionary War, there were 

concept. In casting up the value of national income, the object is not to count all 
the transactions into which money or credit may have entered but to estimate the net 
value of each operation in the creation of useful wealth or service. 

^ See Chapter 6. 



persistent difficulties in obtaining capital, and, there being very little 
domestic production of precious metals, the actual money supply was a 
conglomerate of foreign coins, obtained through export trade, and various 
kinds of paper money circulated by the Colonial governments (occasion- 
ally to considerable excess). There was also a circulation of bank notes, 
some of them counterfeit and many of them resting upon the ultimate 
security of land, merchandise, or perhaps nothing at all. 

A full discussion of the monetary and banking experiences of the 
early Colonial pioneers would carry us far afield into analysis of details. 
That period can perhaps be best summarized by saying that the colonists 
tended to follow the lead of Massachusetts in the issue of Colonial bills 
of credit. That Colony and also New Jersey, the Carolinas, Rhode 
Island, New Hampshire, and Virginia encountered increasing difficulties 
during the eighteenth century as the result of their public issues of cir- 
culating paper. ‘‘Sooner or later,^^ says Bullock, “all the plantations 
were deeply involved in the mazes of a fluctuating currency, for the 
burdens attending the various wars of the eighteenth century were so 
great as to induce even the most conservative Colonies to resort to this 
easy method of meeting public obligations.^'^ Even when Great Britain 
extended to the Colonies in 1741 her own earlier legislation against 
unrestricted credit issues, she failed to accomplish much control. The 
movement of wholesale prices, as shown in Chart 6a, fails to disclose the 
whole story of these reckless experiences with Colonial paper money and 
land-bank credit, since these prices were taken during that period from 
the records of Philadelphia markets and the currency of Pennsylvania 
happens to have been one of the more stable and better regulated systems. 
The chart does show, however, that as a result of the wars, even the 
price level in the important Philadelphia market registered the existence 
of inflation. 

To finance the American Revolution, vast amounts of paper money 
were issued, not only by the individual Colonial authorities but also by 
the Continental Congress. The latter issues alone, under stress of th(^ 
War, rose from 6 million dollars^ in 1775 to 140 millions in 1779. With 
trade conditions demoralized and no possibility of maintaining con- 
vertibility of the paper into coin, the result was an enormous rise in 
prices. In Chart 66, the rise in the index of wholesale prices is shown 
only approximately as far as 1781 by the use of New York prices, sub- 
stituted during part of the period for Philadelphia prices. During the 
years 1782 and 1783, there are no available quotations because of the 
utter confusion and virtually complete loss of value of this currency. 
In 1781 the outstanding notes were repudiated as practically worthless, 

1 Monetary History of the United States,” p. 33, New York, 1900. 

* Technically, in terms of Spanish dollars. 



but by that time, fortunately, some foreign hard money was again becom- 
ing available for use. When the war ended, there was another short 
period of paper-money excitement in 1785 and 1786 that, as Bullock 
says, “was most distinctly an agitation carried on by and for the debtor 
classes of the country, and thoroughly typical of the struggles of the 
inflationists of the Colonial period.^^^ Finally, with the establishment 
of a new currency system in 1792, clearly defining a uniform metallic 
standard for the nation, we entered upon a period during which the actual 
measurement of the elements of money and credit, volume of trade, and 
general price level becomes increasingly subject to measurement, so that 
we can study the relationships to advantage. 


Before further discussing the statistical evidence, let us summarize 
some of the fundamental characteristics of money and the ways in which 
various kinds of mediums may be expected to contribute to the total of 
effective money in use. It will then be easier to understand the influences 
capable of bringing about changes in the monetary supply and its effective 
commercial circulation. 

Within the jurisdiction of any government are two principal ele- 
ments composing the total of the monetary mediums used for commercial 
purposes. First there is the money legally defined as “standard,^^ in 
terms of which payments and obligations may be finally discharged 
without qualification. In modern times, such standards have usually 
been expressed in terms of specific quantities of gold or of silver or of 
gold and silver indifferently. Whether the standard money actually 
circulates in trade or not, the law defines the standard as a certain weight 
(and fineness) of the metal or metals selected. Second, we have the 
various types of paper money. Such paper may at all times be con- 
vertible, upon request of the holder, into the standard metalUc unit 
without qualification; or it may be so convertible but with qualifications; 
or in still other instances, particularly during wars, it may be incon- 
vertible and circulating by legal fiat. 

Under the so-called “bimetallic monetary standard,'^ the law specifies 
a weight, let us say, of gold and of silver, as the monetary standard; 
theoretically, the money of the one kind is convertible upon demand 
into the other. But unlike the case of paper money, gold and silver both 
have exchange or “market*’ values arising from their uses as bullion 
in industry and the arts. If the coinage ratio set by the law differs 
materially from the market ratio of value, one or the other of the metals 
as coin will have a higher value outside the money system than inside 
the system, and it will tend to be withdrawn from circulation. This is 

^ Bullock, op, cit.j p. 73. 



important from the standpoint of the possible changes in the amount of 
available money for the use of the public under a bimetallic standard. 
If, on the other hand, a single metal is selected for the standard, coins of 
other metals may be kept in circulation by making their metallic content 
so limited and the amount in circulation so restricted that there is no 
tendency for these subsidiary coins to seek higher exchange return in the 
arts. The subsidiary coins then resemble to some extent issues of 
government paper, since they supplement the relatively limited quantity 
of standard coin or bullion and yet are kept convertible into definite 
quantities of the standard. 

The quantity of total circulating currency resulting from govern- 
mental policies will thus be determined by the amount of the standard 
metal produced for use in the world, the part of it absorbed by the arts 
and industry, the part of it entirely withdrawn for hoarding, and the 
part lost entirely by accident. Of the remainder, a certain amount will 
be brought into a particular country as the result of international com- 
mercial and financial dealings and relationships. To these amounts will 
be added paper money and subsidiary money, and these will supplement 
the standard money as long as they are readily convertible into it. If, 
however, convertibility ceases, the paper money in circulation can 
theoretically be increased almost without limit; the control exercised by 
the standard money no longer exists. Under these conditions, two sets 
of prices may result, one expressed in paper and the other in terms of 
money metal. If issues of paper become very large within a limited time, 
prices so expressed will rise, and among these prices will be the price 
of gold and silver as metal. This creates a situation in which both the 
gold and silver may become more valuable as metal than as money, and 
the paper money will force the metals possibly entirely out of circulation. 

During a period of war emergency, a government usually decides to 
limit or discontinue convertibility of its paper into specie in order to 
prevent the exhaustion of its standard reserves, or their capture by enemy 
governments. If large payments must be made during a war to foreign 
countries and large balances of actual cash must be shipped abroad, there 
will be a further rise in the price of gold and silver expressed in the foreign 
exchange rates, and the cost of foreign goods will therefore tend to 
advance even more than domestic products unless proportionate changes 
occur abroad. The extent of depreciation of the paper money, once it 
becomes inconvertible, may then be expressed either in terms of the 
general level of domestic prices, which is perhaps the best means of 
measuring it, or in terms of exchange rates against foreign moneys (if 
it is assumed that these remain on a metallic standard) or the prices of 
the precious metals quoted by bullion dealers (if it is assumed that such 
dealings are permitted). 



During periods when inconvertible government paper money must 
be used, the units in which commercial transactions are expressed tend to 
be extrapolated by public usage and the need for some medium from the 
kind of units prevailing prior to inconvertibility. In this sense, the 
existing de facto standard of value becomes a rather subtle entity, although 
its nature is found in the fact that the public continues to accept mere 
pieces of paper in exchange for various quantities of goods and services. 
In other words, in actual trade it is ready acceptability rather than sub- 
stance that forms the fundamental characteristic of all money. It is 
conceivable that people might continue indefinitely to use a paper-money 
system, if, of course, the quantity of such paper v/ere kept within 
reasonable bounds by strict and incorruptible governments. So long as 
people were willing to accept the paper readily in trade, an intricate 
fabric of price ratios and relationships of one thing to another might be 
created, and the paper would accomplish the purpose of a medium of 
exchange, even though the ultimate standard of value would have to be 
distilled theoretically from the entire mass of goods and services obtain- 
able for the paper money. Since it is this acceptability that gives all 
money its essential characteristic as money, it follows that the quantity 
of pieces or specific units of such money in circulation is an important 
element so far as concerns the making of price levels. Although in most 
monetary systems of modern times there is, or has been, a specific metallic 
standard unit, the amount of metal legally designated as a dollar or a 
pound or a franc has no direct relationship to the number of money pieces 
actually circulating, once we include all the paper mediums and sub- 
sidiary coins as well. To speak historically, the setting of a definite 
metallic standard money made of metal established in most countries 
the acceptability of the money and of all the substitutes readily con- 
vertible into it. But a money system once established can conceivably 
perpetuate itself without an effective metallic standard so long as general 
acceptability continues. If the paper or other forms of money be issued 
in such quantities that awkward or ridiculous quantities must be used in 
trade, acceptability rapidly becomes impaired, and if it should fall toward 
zero the money system collapses. There have been dramatic episodes 
of such occurrences throughout history, especially following World 
War I, when Europe experienced extreme and tragic cases of hyper- 
inflation and extreme depreciation. 

In substance, then, the metallic standard underlying a money system 
is principally important as (1) a means of accomplishing and maintaining 
acceptability, (2) a means of controlling the quantity of paper and sub- 
sidiary coin that is kept convertible with the standard, and (3) a means 
whereby a given money system finds a workable relationship with foreign 
systems. It should be added that if coinage terms or the definition of a 



monetary standard consisting of actual metal are varied, more or less 
extensive changes will be produced in the price system, which will cause 
an immediate change in the rates of exchange against foreign currencies. 
This is true regardless of any change in quantity. Under these conditions 
prices may also rise if there is a general suspicion that further changes 
will be made and if speculators become active in the commodity, property, 
and foreign-exchange markets. If such an operation takes the form of 
reduction in the weight of standard coins, we have what is called ‘devalu- 
ation,’^ which tends to raise the price of imported goods as well as of 
exported goods. This rise may extend to the entire price system, 
because under the new conditions either there will be more standard 
coins made from given quantities of metal or a larger amount of paper 
and subsidiary pieces will become convertible into a given physical stock 
of standard money metal. There have been many such devaluations 
of the coin or money standard throughout history, and in most instances 
those have represented the desperate measures of bankrupt kings or 
hard-pressed politicians to obtain additional money to meet emergencies. 
Our own devaluation of the dollar in 1934 was not exactly of this nature, 
since it represented rather an attempt to augment the monetary reserve 
of the country quickly in order to bolster commodity prices faster than 
could be expected as the result of the natural processes of gold produc- 
tion. This will be further discussed in Chapter 14. 


What has been said is probably sufficient to impress the reader with 
the complexity of the various factors involved in the possible variability 
in effective money supply issued for circulation by government. That 
supply may vary because of changes in the definition or unit weight of 
standard money, changes in the amount of standard metal available 
as the result of its production, use in the arts, and export and import of 
coin and bullion, changes in the amount of paper money supplementing 
the standard coin and subsidiary coin, and especially changes resulting 
from the issue of inconvertible paper money in times of stress. But this 
is not all. Paralleling and vastly extending the scope of the monetary 
system is the banking system. Throughout our own history, banks have 
supplied the circulating medium with a variety of credit instruments. 
By banks we refer primarily to the “commercial” banks, which are in a 
position to generate by their own operations and by virtue of their own 
credit standing what is virtually a paper currency capable of serving most 
purposes of exchange as effectively as money, so long as it is readily 
convertible into money. In order to attain this convertibility, banks 
of the commercial type maintain readily available reserves of standard 
money to redeem such of their own paper as the public may wish to 



redeem. The amount of reserves so held either may be a matter of 
banking judgment or may be dictated by legal regulations. In terms of 
fundamental principle, what is readily convertible into the standard 
serves most of the purposes of a medium of exchange. Furthermore, 
since the prime characteristic of the medium of exchange is acceptability, 
there ordinarily will be demands for the redemption of bank paper only 
for purposes of foreign trade, for the use of the standard money metals in 
the arts, or for reasons of the convenience of individuals. 

It follows, therefore, that banks in the course of their operations may 
introduce into the system of payments a total amount of paper credit 
that may be five or ten or twenty times as much as the reservo of standard 
money held in their vaults. This becomes a system of fractional 
reserves, the latter being always much less in amount than the super- 
structure of circulating credit. Should there be doubt as to the possi- 
bilities of redemption, those who hold bank paper become fearful of 
the integrity or reserve position of the banks; there may be sudden 
demands or “runs” upon the banks for redemption, with the result that 
more redemption is demanded than the banks can immediately accom- 
plish. Under conditions of widespread hysteria banks close their doors, 
specie payments are suspended, and trade is abruptly demoralized over a 
wide area. Thus the system of fractional reserves in a commercial 
banking system, although it greatly economizes standard money and 
provides an extremely flexible means of facilitating commercial require- 
ments, has at times become a source of widespread ruin among business- 
men as well as depositors. This illustrates an economic process subject 
to violent distortion, because it functions upon a very delicate balance 
easily disturbed by unusual circumstances. Stated in another way, it is 
an example of the principle of “trading on the equity.” Obviously the 
commercial bank, as a credit institution, is in a position to make advances 
to businessmen needing credit or working capital considerably in excess 
of bank liquid capital plus primary deposits of cash and, like all such 
pyramiding of obligations upon a narrow base of assets in hand, forces 
upsetting the delicate balance can create violent and cumulating losses. 
This has happened many times in American history, and these occasions 
of breakdown coincide with many of the severe business crises of our past. 

Commercial banks sustain obligations to the public in several ways. 
They may issue promissory notes, supported by convertibility into cash 
and readily acceptable in payments throughout the community. Actu- 
ally, bank-note issue has been more and more circumscribed by law, 
particularly in the United States, and bank notes have in late years 
become analogous to Government paper money with respect to con- 
vertibility and acceptability. Much more important as a factor in 
augmenting the general circulation is the use of bank credit in another 



form. Commercial banks may grant to customers who borrow the 
privilege of drawing checks upon deposits that are created through the 
borrowing transaction and that can presently be converted into cash. 
These deposits, originating from the making of bank loans, accomplish 
their ^^circulating” function through the checks drawn upon them. 
Today the use of these checks upon commercial banks has become the 
predominant element in all modern monetary systems, and in the United 
States checks probably accomplish over 90 per cent of all the money 

Governments have been rather slow to regulate the terms upon which 
commercial banks may expand such credit advances and hence liabilities, 
since all such deposits are theoretically subject to withdrawal by those 
receiving checks drawn on them. In the United States particularly, 
there has long been legal regulation as to minimum bank reserves to be 
held against such deposit liabilities, but our commercial banks have in the 
past been permitted to maintain relatively large maximum amounts of 
deposits in relation to reserves. If national (or historically local) 
governments maintain or control central banks, the obligations of these 
banks may also count as assets of the commercial banks available for their 
reserves. This introduces into the financial system a further degree of 
pyramiding or flexibility of expansion and contraction. 

During our earlier history several of the state governments set up 
their own public or central banks in order to make possible a further 
expansibility of paper reserves” wherewith the individual banks could 
meet their credit obligations. Today we have an elaborate and powerful 
Federal Reserve System, which enables the member commercial banks to 
regard as a part of their effective reserves the amounts that they have on 
the books of the Federal Reserve Banks as deposits. These deposits in 
the central banks may themselves be expanded well beyond the actual 
gold or equivalent reserve held by those banks. This is cited to show the 
enormous potential flexibility of a banking system that not only pyramids 
upon fractional reserves but may do this with one potential pyramid 
resting upon another. So long as demands for actual convertibility of 
bank credit into money are on the very limited normal scale, there is no 
difficulty; but let the demand be accelerated by fear or even violent 
speculative excesses in trade and the smooth functioning of the system 
may be threatened. An enormous degree of “leverage” may exist in 
the credit and currency system in the event that a metallic money 
standard is suspended so that extension of bank credit is based on 
reserves consisting of inconvertible paper of some kind. Under Govern- 
ment pressure or in a war emergency, the credit deposits generated by 
the central bank in loaning to the Government in turn become available 
as reserves for the commercial banks in making their advances to industry 



and trade and to individual buyers of the Government bonds. It was 
this process that proved so inflationary in World War I. 


We may turn now to a factual study of the dynamics of the American 
money and credit system and the relationships that have prevailed 
between its variations and the volume of business to form the pattern of 
the general price level. The first problem is to construct an index of 
changes from year to year in the effective monetary or currency^ circu- 
lation or, rather, that preponderant part of it which may logically be 
expected to be a reliable gauge of the total means of payment capable of 
affecting the general level of prices. 

From the beginning of the nineteenth century to 1879, the end of the 
interval of suspended specie payments after the Civil War, the two most 
important variables in our total monetary circulation were (1) issues of 
inconvertible Government paper money and (2) a very substantial 
amount of circulating credit arising from the loans and investments made 
by commercial banks. During much of this period the circulation of 
actual coin was still important, since the commercial banking system was 
in process of development and Government inconvertible paper circulated 
actively only during the War period and a few years beyond. During 
these years, therefore, beginning at 1811 and ending at 1878, a credit 
and currency index has been constructed from three elements, Federal 
Government notes (and equivalent irredeemable notes or certificates), 
total loans and investments of the banks, and the amount of specie 
estimated to have been in actual circulation. ^ We shall first consider 
the circumstances that created marked changes in the amount of effec- 
tive currency units in use in this period and the relation between 
the variations in the index of credit and currency to changes in the 
production and monetary stock of gold and silver in the United States. 

Our index begins at a time when Europe was in the throes of the 
Napoleonic-British Wars, which had alternately stimulating and depres- 
sing effects upon American export and import trade and which finally 
culminated in the involvement of the United States between 1812 and 
1814. By this time business conditions had substantially deterioriated. 
The British had already abandoned the convertibility of Bank of England 
notes. The strain of the War forced the United States to abandon con- 

1 The term currency’^ will be used not in a technical banking sense, but to desig- 
nate in a general way means of payment accomplishing the exchange function. 

2 It is important to note that these elements are selected as being significant 
indicators, not because they are necessarily the best means of defining money or credit. 
A more detailed explanation of the construction of this credit and currency index will 
be found in Appendix 3. 



vertibility of all paper money and bank notes from 1814 until 1818. 
Prior to the War of 1812, our banks had considerably expanded their 
credit circulation, but there was some element of restraint in the existence 
of the first United States Bank (1791-1811). The removal in 1811 of the 
restraints exercised over the other banks by this Federal central bank 
led to reckless expansion of banking operations and bank credit in 
circulation. United States Treasury notes also circulated during the 
War. When the time came for resumption of specie payments there was 
again in existence (beginning operations in 1817) a second national 
central bank, whose loans and investments are included in our index 
figures. The return to specie payments took the form of convertibility 
into standard coin. The United States was operating under a bimetallic 
standard that happened to be maintaining such a coining ratio that gold 
did not readily circulate; even the silver money was a mixture of domestic 
and foreign coins. But the act of reestablishing convertibility with 
metallic money served to reduce the mass of paper circulation. 

We may refer now' to Chart 8, at the top of which appears the index 
of credit and currency. It will be seen that a marked decline in this 
index occurred after 1817, but at about 1823 there began a gradual rise, 
considerably accentuated during the early Thirties and reaching a peak at 
1837. During these years the general circulation appears to have 
adjusted itself with some degree of conformity to the changes in the 
amount of specie forming the available monetary stock of the country. 
This is shown in the second curve from the top on Chart 8. Below this 
is shown also the annual amount of coinage of gold and silver. This 
remained fairly steady until the 1830’s, when a rapid rise occurred to 1836. 
The metallic resources forming the major part of bank reserves thus 
expanded rapidly, and bank credit itself appears to have increased 
steadily and rapidly amidst an era of widespread and reckless specu- 
lation. Banks at this time operated under little restriction, save that 
which from time to time was provided by the United States Bank or some 
State Banks. The Second Bank of the United States ended its career 
in 1836, but as early as 1832 circumstances had arisen and abuses had 
been suspected that led Andrew Jackson in that year to announce his deci- 
sion not to continue the charter of the Bank beyond its legal expiration. 
This tended at once to release a considerable amount of luxuriant local 
bank credit, principally in the interest of land speculators in the far- 
flung frontier. As a result, the monetary index shows an extraordinary 
expansion. This occurred under conditions of ineffectual restraints, no 
standardization of banking practices, and the prevalent Jacksonian idea 
of small banks for small business and as many banks as could be organized 
per square mile. The period was perhaps one of the most extraordinary 
in our history as to unrestrained banking, much of it directed to question- 



able uses and all of it accelerated by an adventitious expansion in reserves 
with enlargement of the stock of specie, mostly silver. 

Chart 8. — Supply of metallic-money and effective-currency index, 1810-1880. Sta- 
tistics relating to coinage, changes in supply of monetary gold and silver, and production of 
gold and silver are from the reports of the Director of the Mint. The estimates of supply 
of specie are from reports of the Comptroller of the Currency and the Secretary of the 
Treasury. The figures are exclusive of Treasury holdings and money held for redemption 
of United States notes. The curves in the middle section show the principal annual 
changes contributing to the total stock of circulating metallic money. 

At 1836 a dramatic event occurred paralyzing much of this riotous 
frontier credit manufacture. President Jackson ordered that all pay- 
ments to the Government for public lands would be demanded in specie. 



This served to break the land boom and for some years to cause a more 
moderate temper in the circulation of bank credit. Previously a change 
had been made in the coinage laws, setting the coining ratio of silver to 
gold at 15.7 to 1 by weight. This caused gold to flow into use as money, 
silver coins to flow out. Part of the sharp decline in the annual coinage 
appears to have been a delayed result of this change. It was not until 
the remarkable gold discoveries of the late 1840's and early ’fifties 
(principally in California) that another marked increase occurred in the 
metallic money available for use in ultimate bank reserves. Beginning 
at 1845, we can for the first time trace the actual production of gold and 
silver in the United States. This is shown in the continuation of the 
third curve in Chart 8. On the same (arithmetic) scale is shown the 
approximate net value of gold and silver available for monetary stock 
after allowing for export and import of coin and bullion. This resulting 
net amount is interesting, since it is much more fluctuating than the 
amount of production of the precious metals; it further shows a declining 
tendency almost from the beginning of the gold discoveries until 1872. 
It will be noted that each of the net increases in gold and silver records 
itself as additions to the total supply curve. 

During the 1850’s the country tended to become more and more 
established on a virtual gold standard, but this was interrupted by the 
Civil War and the large issues of inconvertible Federal notes (greenbacks) 
between 1861 and 1865. The greenbacks remained inconvertible into 
gold until 1879, and from that time forward until World War I, the 
United States, for practical purposes (although not in a strict sense), was 
on a gold standard. It will be noted that for a considerable time after 
the War of 1812 and also after the Civil War, the index of credit and 
currency remainded at a level relatively higher than in conformity to the 
volume of monetary specie in the country. But in the latter ’seventies, 
with the prospect of assured redemption of the greenbacks following the 
Act of 1875, there was a large increase in the importation of gold. This 
for the first time brought the annual additions to the monetary supply 
well above those resulting from production alone. It is of interest to 
reflect that although the credit and currency index showed a fairly 
sustained volume of circulation following the Civil War period, both 
business conditions (lowest curve, Chart 8) and the actual importation 
of hard money showed a marked expansion as soon as provisions were 
made to retire the excessive Civil War greenbacks. This involved a 
somewhat greater dependence of bank reserves upon actual specie and 
the threat of some contraction in the total amount of bank credit in 
relation to general business growth. As a result, there was strong agi- 
tation from the cheap-money element for more liberal currency issues. 
But the banking system was now restrained not only by an oflicial policy 



of sound money, in terms of the gold standard,^ but also by the rapid 
development of the National Banking System after 1865. This system 
introduced the feature of restricting circulating bank notes to those of 
national banks, secured by Government bonds. There was also more 
effective supervision of capitalization, reserves, and banking practices 
generally. But the cheap-money advocates insisted upon restoring 
monetary abundance and rising prices, through either bimetallism or a 
single silver standard. This pressure, especially from the rural sections, 
gave us the ridiculous silver legislation of 1878 and 1890, providing for 
specified Government purchases of silver, not to establish a costandard 
with gold, but rather to ‘Uimp along with gold in the hope that the total 
amount of circulating money and bank credit would expand. The silver, 
however, accomplished little. 

As we turn now to Chart 9 and observe the behavior of the credit and 
currency index from 1880 to 1890, we find that its general drift more or 
less paralleled the rate of change in the gold stock. * There was a rapid 
gain in the amount of available gold between 1879 and 1881, but after 
1887 the net amount of gold for monetary use (after allowance for export 
and import), as well as the net amount of gold for the arts, declined, in 
spite of a larger gold production in the United States. This did not 
much affect the credit and currency index, which maintained a fairly 
level position until 1897. The bizarre experiments in the ^eighties and 
until 1893 for halfway reestablishment of silver actually led to a con- 
siderable demoralization of public and private finance in the United 
States. The system contributed to export of gold and the Treasury was 
forced to borrow by rather unusual means in order to maintain converti- 
bility of the various Government paper in gold. As soon as these experi- 
ments ended at 1893 and the drift toward sound money was again 
confirmed in the election of 1896, there occurred a remarkable increase 
in the available gold monetary stock and an almost parallel upward trend 
in the credit and currency index. The change during this period was a 
spontaneous response of banking operations to the underlying expansion 
in available gold reserve. It will be noted that the net annual contri- 
bution of gold to the monetary supply was fairly large and in some years 
exceeded our domestic production. During the period from about 1896 
to 1906 there was also a rapid rise in the business-activity index. 

Between 1915 and 1920, we enter another period of inflation, which in 
this case was continued beyond the conclusion of the War. The most 

^ This was virtually initiated in 1853, when the silver dollar and other silver coins 
were reduced in content to keep them in circulation, and in 1873, when Congress 
dropped the silver dollar entirely from the coinage, although it did not proclaim the 
gold standard in specific language. 

* The index after 1878 consists entirely of credit elements. See Appendix 3. 



remarkable changes were in the net available monetary gold. A change 
both definite and startling occurred in the financial position of the 
United States. We shifted from being a predominantly debtor nation 
to being a nation surfeited with foreign gold. Gold production, some- 
what discouraged by the conditions prevailing after 1915, declined 
moderately, but the annual net additions to our monetary gold stock rose 
tremendously as the result of the consignments of military supplies and 
foodstuffs to Europe. We entered upon a period of violent monetary 
disturbance that has not ended. It has, indeed, brought the country to 
an entirely new stage of monetary experimentation and control, against 
a background of world-wide monetary revolution and the possession by 
the United States of most of the world’s gold resources. 


As we compare the index of monetary gold stock with the credit and 
currency index in Chart 9, we are struck by the recent general parallel 
movement, although in 1920 there was a decline in monetary gold stock 
due to temporary interruption of gold imports after the Armistice, 
whereas the credit and currency index rose rapidly to a high peak as the 
Federal Reserve System assisted the member banks in providing an 
enormous volume of credit. Remarkable also was the relatively minor 
decrease in the monetary index in 1921 and 1922; another rise followed 
to a still higher level in 1928-1930. Large net imports of gold occurred 
between 1921 and 1924, partly reflecting heavy food and material 
purchases by Europe. Thereafter, until about 1933, the net flow of 
gold, as well as domestic production of gold, continued to be relatively 

Although from about 1880 to World War I, the credit and currency 
index very closely paralleled the changes in our gold monetary stock, 
there was a growing disparity in the succeeding period, especially in the 
minor fluctuations. At the very end of the period the disparity rapidly 
increased. During the past quarter century, effective currency in use has 
adjusted itself less and less to the changes in available gold reserve and 
more and more to legislative and administrative controls exercised by the 
Federal Government. World War I brought into existence far wider 
fluctuations in the annual movement of gold to and from the United 
States. Gold movements no longer reflected trade conditions but rather 
reflected the shifting of liquid capital seeking safety from the encroach- 
ment of new dictatorships, the renewal of war preparations, and the 
threat of public seizures of wealth. Finally the gold movement broke 
away completely from the previous range of fluctuation, the annual 
increments to our monetary stock soared upward explosively, and the 



future of the gold standard as a basis for international exchange suddenly 
became highly uncertain.^ 

It will be noticed that monetary gold stock in the United States rose 
rapidly in the first years of World War I, but after 1917 there was a 
decided setback, accompanied by substantial net gold exports. It was in 
these years that the Federal Reserve System established the new machin- 
ery for control of commercial banking reserves and enabled the member 
banks of the system vastly to augment their lending power. During the 
War emergency, it was impossible for individuals to obtain gold upon 
demand, either from the Government or from the banks, unless it was 
needed for legitimate industrial purposes or international payments. 
The movement of gold into hoarding or back into banking reserves was 
thus temporarily checked, although later in the 1930's, hoarding again 
became a very conspicuous and embarrassing factor. It will be noticed 
that despite an abrupt slackening in monetary gold supply, the credit 
and currency index continued to rise very rapidly to a high peak in 1920. 
This was accomplished not only by lower reserve requirements but 
especially by the flexibility with which credit could be pyramided within 
the Reserve System. In fact, there would have been by 1919 a severe 
credit stringency had it not been for the facilities now available to the 
member banks for rediscounting approved assets and borrowing at the 
central banks. Such borrowing augmented member-bank reserve 
balances, just as a business firm^s ‘‘cash^^ balance would be augmented in 
its bank account as the result of a bank advance. Credit advances by 
the central banks became a basis for multiplied credit advances by 
member banks. Thus the gold held by the Reserve Banks served the 
dual purpose of supporting their outstanding credit in the form of deposit 
balances and also the credit represented by their note issues. The 
Federal Reserve issues of circulating notes gradually supplanted the old 
National Bank notes, although they were not to be used by other banks 
for reserves. In addition to the creation of credit on behalf of the 
member banks, the Federal Reserve Banks also contributed directly to 
the total credit instruments in use by directly purchasing certain approved 
types of commercial paper (including Federal obligations) in the open 
market. The Treasury could not sell bonds and notes directly to the 
Reserve Banks, but indirectly much the same result was accomplished. 
In view of this, the credit and currency index includes in its composition 
not only the loans and investments of both member and nonmember 

^ A part of this rise was due to the devaluation of the dollar in January, 1934, as 
indicated on Chart 9. But even at the old rate of $20.67 per fine ounce, there was a 
tremendous rise in the gold imports. By the end of 1940, the monetary gold stock 
had reached the enormous total of 22 billion dollars, valuing at the revised rate of 
$35 per fine ounce. The devaluation is discussed further in Chapter 14. 



commercial banks but also these advances made directly by the Federal 
Reserve Banks themselves through purchases made in the open market 
from 1915 forward. 

It will be noticed that the collapse from 1930 to 1933 in the credit 
and currency index was much more clear-cut than the irregular and 
slightly downward movement of the monetary gold stock. The decline 
in bank loans and investments was primarily a result of the tremendous 
sweep of the depression, involving liquidation of enormous totals of 
assets and the impairment of billions of dollars in securities. Federal 
emergency measures, in addition to the devaluation of the dollar, extended 
to the removal of all gold from circulation and even from individual 
bank reserves. The gold was impounded and represented for banking 
purposes by gold certificates to be held only by the Federal Reserve 
Banks. Gold today is still available for the needs of industry and 
the legitimate settlement of foreign financial balances, but credit 
instruments are no longer internally convertible into gold. This and 
subsequent monetary policies are fundamentally phases of a world-wide 
tendency to remove the erratic influence of gold expansion or contraction 
from the credit system and to place the creation of credit increasingly 
under political control and manipulation. A mere glance at the great 
gold explosion shown in Chart 9 is sufficient to demonstrate that some 
type of control of this nature is inevitable. 

It is entirely possible that the gold standard, as it was known prior 
to World War I, may never be restored. The United States has become 
more and more an exporter of goods and services to be paid for in gold; 
and prior to World War II we afforded a financial haven for a world 
subject to unprecedented fears of war and revolution that forced gold 
here primarily for safekeeping and only incidentally for use as active 
balances. Had the gold imports and additions to our monetary stock 
after 1933 been quickly translated into new circulating credit through the 
operations of commercial banking, we should have faced inflation possi- 
bilities immeasurably more serious than ever before, even apart from the 
renewed war conditions of the 1940's. This tidal wave of gold reaching 
our shores has a definite meaning, too, for the monetary and financial 
systems of other countries. Although world gold production has con- 
tinued at a somewhat accelerated pace (largely because of political 
stimuli), most of the commercial countries no longer possess gold reserves 
capable of sustaining their credit operations unless there is provision for 
a larger amount of credit circulation per unit of reserve than formerly 
and unless continuous political control over the monetary and credit 
system is exercised. There cannot be concentration in the holding of 
the world^s gold on the recent scale if a working international gold 
standard is to be maintained in the future. 



Hence, in summarizing the recent relationships demonstrated in Chart 
9 between the credit and currency index and the American holdings of 
monetary gold, it can be said that all important nations of the world are 
moving swiftly toward systems of controlled currency and credit, because 
they have no alternative. In the United States it is now within the power 
of the Federal Reserve authorities to vary, within fixed but rather wide 
limits, the reserve requirements of the member commercial banks. 
Effective banking reserves can thus be deliberately reduced or expanded 
overnight. The Federal Government, as the result of the devaluation of 
the dollar in 1934, has set up a huge secretly operated ^^stabilization” 
fund of several billions, which enables it to accomplish continuous 
manipulation of foreign-exchange rates, bond prices, or perhaps other 
financial variables within certain limits. The Treasury has greatly 
increased its average working balances and, by shifting these balances 
geographically from time to time, can directly influence the effective 
reserve position of the banking system. This extension of Federal 
control and manipulation of bank credit is but one example of what is 
occurring in other major fields of business, which we shall presently have 
occasion to discuss. If we are actually moving toward a system approach- 
ing collectivism, this control of the central nervous system of finance and 
credit is surely one of the most potent assurances of progress toward 
such a possible objective. 


Before concluding the discussion of gold in relation to bank credit 
and to the perplexing new problems arising from acute concentration of 
the world^s gold store in the United States, something may be said in 
retrospect of the manner in which gold output has been affected by the 
price level and hence the cost of its production. The impression may 
have been created that additions to the world^s gold have come about 
spasmodically as a result of the purely chance discovery of new sources. 
The discovery of gold in California in 1848 appears to have been a 
genuine case of such random discovery having important consequences. 
The discoveries in Australia in 1851 also appear to have been of a more or 
less accidental nature. But although this erratic factor in finding gold 
deposits capable of being profitably worked has been of prime importance 
at certain times, such random circumstances by no means account for all 
variations in gold output in the past century. An increasing proportion 
of the world supply has been realized from relatively low grade deposits, 
whose working has depended in increasing measure upon calculations of 
profit or loss. This has been particularly true of the very important 
production sources within the British Empire, foremost of which has been 
the Witwatersrand of South Africa, discovered in 1865. Shortly after 



this discovery of deposits of vast extent but relatively low grade ore, 
important advances were made in the technique of refining. The use of 
cyanide opened up such fields to intensive and systematic exploitation. 
The cyanide process was also used in the development of the discoveries 
in the Yukon and Klondike Region, after 1890. 

But the profits obtainable from the working of gold deposits have 
depended not merely upon the technological progress of the industry but 
upon the purchasing power of gold itself. Obviously gold has been 
peculiar as a monetary metal in that gold-standard countries, until 
recently, have paid fixed (or virtually fixed) amounts of coined money for 
gold bullion of the proper degree of purity. Gold as a commodity, 
therefore, has had essentially a fixed price in terms of money pieces. 
But these money pieces have had a purchasing power over other goods 
and services, depending upon a variety of factors, working out their 
influence through changes in the total amount of credit currency in 
actual use. Hence occasional additions to effective bank credit in circu- 
lation, although based upon larger gold output and banking reserves, 
have raised the level of prices and thereby have introduced some advances 
in material and service prices that constitute costs in gold-producing 
operations. There is thus a process of action and reaction here. Under 
certain conditions more gold could spread about among the important 
commercial countries and increase their bank reserves, thus producing 
conditions more or less favorable to credit expansion and a rise of prices, 
but the cost of gold mining in many parts of the world, in particular 
from the lower grade deposits, would rise, and a lower rate of output, 
barring fresh discoveries or technical changes, would result. In this 
sense the gold standard had in it some elements of automatic self- 
balancing so long as other things remained equal. 

We are able to study the effect of the purchasing power of gold for 
over a century by using the net price of bullion and wholesale prices in 
the London market, which represents a close approximation to the world 
market. Great Britain was on a gold standard effectively from 1821 
until the autumn of 1914, when the government suspended the con- 
vertibility of Bank of England notes into gold. The same gold standard 
was resumed in 1925, only to be suspended again in September, 1931, 
perhaps definitively.^ In Chart 10 is shown the world^s production of 

* In the United States the complete effectiveness of the gold standard was fre- 
quently in doubt and was not finally confirmed until 1900, although practically it was 
in effect from 1879 until 1933. Another reason to study the British rather than the 
American gold market to detect the influence of the purchasing power of gold upon 
its production is that so much of the world's gold in the last century represented the 
activity of British enterprises for whose operation the commodity price level, as 
recorded in London markets, was most representative. 



gold (in ounces) and the index of commodity purchasing power of gold in 
London since 1830.^ 

Let us observe the relationship of the purchasing power of gold as a 
commodity to world gold production. It was previously stated that 
the discoveries of 1848 and 1851 were of the spasmodic nature, but it is 
interesting to notice that there had been a rising drift in the purchasing 

Chart 10. — Gold production and purchasing power of gold, 1830-1940. 

power of gold for more than a decade prior to these discoveries. These 
discoveries seem to have occurred under conditions growing somewhat 
more favorable to profits of those who did engage in this glamorous 
enterprise. As prices rose in the 1850^s, the purchasing power of gold 
was restrained along a horizontal drift until the middle ^seventies, and 
gold production not only failed to increase but followed a generally 
declining trend. But after its purchasing power again rose between 1874 

^ Gold production in the first 15 years of this period is estimated roughly in terms 
of 5-year averages, but after 1845 the curve represents annual estimates; these become 
increasingly accurate. The purchasing power of gold is seen to respond mainly to the 
changes in the general level of wholesale prices, although there are from time to time 
very minor changes, prior to World War I, in the precise price given by the Bank of 
England as the official purchaser of bullion. Beginning with World War I and the 
existence of a situation during most of the period since that time in which gold has been 
relegated to the position of a commodity having its own variable price, the purchasing- 
power index reflects both the forces operating upon the prices of commodities and 
those operating upon the price of gold in the London market. 



and 1896, there followed about a decade later a significant increase in 
gold production that may well have been affected by the purchasing- 
power factor. From 1900 to about the time of World War I, gold 
production, curiously enough, was being undertaken under conditions 
of declining purchasing power, but probably this was more than offset 
by the influence of the cyanide process in rapidly bringing into profitable 
production some of the low-grade and remote deposits. During the 
remainder of the period, disturbed by wars and the breakdown of inter- 
national finance, the relationship between purchasing power and the 
rate of production nevertheless remains fairly close. Gold has risen in 
price relatively more than commodities, and in spite of the brief inter- 
ruption in this tendency in 1938, an upward drift appears still to be in 
progress. If gold production in the next few decades were to depend 
primarily upon its purchasing power, we could expect still larger addition 
to supplies, and these might continue to flow to a considerable degree 
toward the vaults of the United States, where the yellow metal is again 
buried to await its ultimate fate as a money metal. ^ 


We return now to examine the credit and currency index in its 
relation to changes in the index of business volume and changes in the 
general price level. These relations are shown in Chart 11. At the top 
is shown the annual credit and currency index extending from 1811 to 
1940. We have seen that the course of this index has been determined by 
a number of different factors. War financing has produced several 
bulges in the course of the general upward drift, denoting either large 
issues of inconvertible Government paper or inconvertible bank credit. 
Over considerable periods, however, the index has responded to more 
gradual undulations in the available national stock of specie or, in later 
years gold, the basic credit reserve. Occasionally there have been out- 
bursts of speculative promotion giving rise to credit excesses. Finally, 
during the latest years, there has been far more governmental control 
over commercial credit. This has been stated once again to emphasize 
the point that fluctuations in the course of the generally upward drift 
of effective purchasing mediums (mainly consisting of credit in one form 

^ The index of the purchasing power of gold in London is based upon an unpub- 
lished manuscript, ‘‘The Purchasing Power of Gold in England, 1560-1939," by 
Roy W. Jastram and H. B. Woolley, Stanford University. Production of gold taken 
from R. S. Tucker, Review of Economic Statistics^ Feb. 15, 1934, and, since 1909, from 
Reports of Director of the Mint. Production figures include estimates for Russia. 
The data from 1830 to 1844 used by Tucker represent estimates of Alexander Del Mar, 
from his ^‘History of the Precious Metals," 1880. Data from 1845 to 1875 are esti- 
mates of Joseph Kitchin. 





or another) should not be interpreted in terms of a single motivating 
factor. We must not oversimplify the process. The pattern that 
finally develops is highly irregular, and it is obvious that it bears little 
resemblance to the pattern of the business activity index shown in pre- 
vious charts. In Chart 11, the credit and currency index is so drawn 
that its average of the entire period is made to coincide with the average 
of the intermediate trend of the business index. Here we bring the 
monetary and the trade-volume elements in our general equation of 
exchange into close relationship. 

The question immediately arises: What allowance is made in develop- 
ing this relationship for the factor of the so-called ^‘velocity of circu- 
lation '' of the effective money and credit? Thus far we have said 
nothing about velocity or the possibility of a measure of the average rate 
of monetary or credit turnover. Strictly speaking, the credit and 
currency index is not complete. It reveals from year to year merely how 
much money, both coin and Government paper, has been outstanding 
and available for trade purposes and how much change in bank credit 
in use may have resulted from variations in the earning assets of com- 
mercial banks. Of course, during a given period of time, a given amount 
of circulating money can accomplish numerous transactions as it passes 
from hand to hand. Similarly, loans or investments made by banks 
result in deposit accounts that may be kept in existence or shifted from 
bank to bank and used to perform numerous exchanges before being 
liquidated. If we had chosen to express the credit resulting from banking 
operations in the form of average annual deposits subject to check rather 
than earning assets (roughly equivalent magnitudes), we could then say 
that the velocity of the deposits could be represented by the ratio of 
total check transactions to the average deposits in banks subject to 
check. Now it is not to be denied that the velocity of circulation of both 
legal tender money and credit instruments does vary, the velocity of 
credit varying probably more than that of money. But it has been 
clearly demonstrated by Carl Snyder,^ over periods of time long enough 
to be significant, that annual variations in the velocity of turnover of 
bank deposits agree closely with the minor fluctuations of the volume of 
business about its intermediate trend. Hence if we are developing a 
ratio of effective credit and currency to trade volume to express the two 
great variables determining the average amount of money per unit of 
trade — the general price level — the velocity oscillations in the numerator 
will tend to offset the cyclical oscillations of limited duration in the 
denominator. We can then use the ratio in terms of the credit and 
currency index, excluding velocity changes, against the business index, 

* ** Capitalism the Creator,^’ pp. 39 and 428, New York, 1940. See also Turnover 
of Deposits, American Bankers* Aesodalion Journal^ February, 1924. 



excluding the short cycles, or, in other words, its intermediate trend. 
These are the elements shown in Chart 11. 

What is the result, then, when we plot the ratio between the credit 
and currency index and the intermediate trend of the volume of business? 
The result is indeed startling when it is brought into comparison with the 
actual course of the general price level (Snyder’s index). We find 
definite verification of the principle of price-level determination. The 
long-term trend movements in the general price index are essentially deriva- 
tives of two forces — the wave trend of business volume and the rather irregular 
variations in the circulation of credit and currency. Such a degree of 
covariation between two statistically independent indexes cannot be 
accidental. To be sure, there are occasional discrepancies that must be 
set down to the unavoidable minor inaccuracies of the data. This com- 
parison of the two sets of measurements carries the verification of the 
basic principle involved in the determination of prices far enough back 
historically to enable us to survey the experience of well over a century. 
These results also are important in demonstrating the overwhelmingly 
great importance of the check circulation (checks drawn upon bank 
accounts) in the make-up of the monetary elements capable of influencing 
the general price level. Observe also that the patterns of the monetary 
and trade measures show little tendency to agree. This leads us again 
to the conclusion, previously expressed in Chapter 4, that to identify the 
long-term drift of the price level with the ‘Tong waves” described by the 
volume of business activity is an inherent fallacy. Over short periods 
and in terms of monthly data, prices do reflect the oscillations of the 
trade cycles, but in the broader perspective we have no such evidence of 
sympathetic action. 

In the lower portion of Chart 11 is shown an index of Federal Govern- 
ment expenditures for war and defense purposes, expressed in relation to 
the index of business activity in order to eliminate long-term trend. 
These fluctuations are drawn on a greatly reduced scale. The purpose 
is to show that the most pronounced cases of inflation in the general price 
level have been clearly due to war expenditures. The marked rise in 
prices in 1836-1837 is probably a case of unrestrained speculative activity 
for which the banking system was exploited. The rise in prices after 
1897 and down to the period of World War I was primarily, although not 
entirely, a matter of gold discoveries and additions to gold stocks and 
bank reserves. War expenditures incident to the very brief and rela- 
tively unimportant clash with Spain in 1899 contributed very little to the 
price movement. During the 1920\s, the secondary period of prosperity 
following World War I had in it elements of reckless use of credit in 
speculation in securities and real property rather than in commodities. 
During the entire period from World War I to 1940, effective credit in 



circulation has remainded far above the center of gravity of the business 
volume index, and the general level of prices has consistently remained on 
a level far above the trough of the middle 1890^s. 

If we were to compare the pattern of the general price level with that 
of wholesale prices of commodities, we should find no marked difference 
in short-term movements; but the latter index would describe a long- 
term trend gradually diverging from that of the general price level in a 
downward direction. This growing divergence in long-term drift is to be 
explained primarily by the inclusion within the general price-level index 
of elements representing various types of service that, as we have already 
noted, have tended to move higher or to resist deflation at the same 
time that prices of many raw materials were drifting irregularly lower. 
In later chapters, we shall have occasion to return to this interesting 
phenomenon of the divergent long-term trend within the general price 
level. It has some important economic implications. 

Since the index of the general price level describes a pattern that is 
inverse to the purchasing power of money,” the view has prevailed in 
certain quarters that the value of the dollar is essentially highly unstable. 
Some economists have referred to the never-ending dance of the 
dollar.” They have admonished the Government to bring this dance to 
an end and to create a stable” dollar by keeping the quantity of dollars 
in sober step with trade requirements. But one conclusion that follows 
from the foregoing measurements is that the dollar dances about most 
wildly when the monetary and credit system is subject to the political 
pressures of war and the makeshift financing methods that always seem 
to accompany war emergencies, except where dictatorship prevails. If 
this one factor had been completely removed from the course of our business 
history, almost all the instability in the purchasing power of the dollar would 
have been eliminated! 

To control the value of money and make it stable is doubtless a most 
commendable objective. To accomplish this end, however, an indispen- 
sable requirement would be avoidance of wartime inflation and its sequel 
of disastrous deflation. This might be accomplished either by dis- 
continuing wars or by the alternative of introducing in wartime such 
dictatorial economic policies that war could be conducted with complete 
control over all production and trade by the State. Since wars seem to 
have developed to the global scale and make stupendous demands upon 
industrial output, an ominous path is being marked out tow'ard political 
regulation of consumption, production, and price systems, along with 
everything else. If in the future we must have wars, far more drastic 
regimentation may prove inescapable if national security is to be 
defended. The alternative of uncontrolled distortions of the monetary 
system and recurrent inflations of price levels by exposing the social 



order to chaotic stresses would bring us in the end to a like result. This 
has been the little heeded lesson of Europe after World War I. If we are 
to have a reasonably steady general price level in the United States in 
future decades, there must also be reasonable stability in prices in other 
great nations, and this means either further extension of controls through 
complete economic regimentation to afford military security or the 
abandonment of the crude and wasteful device of war as a method of 
settling essentially economic problems. The mere juggling of monetary 
systems or money markets is no solution. We shall return to this 
problem again at the end of Chapter 24. 



The preceding discussion of the relation between money and credit, 
the volume of trade, and the general price level has been primarily his- 
torical and has been illustrated by statistical measurements over a long 
period. Let us now turn to a brief analysis of the logic underlying these 
observed relationships. 

We can best develop this phase of the subject by means of symbols 
and simple equations such as have been made familiar to students of the 
subject in recent years. The writer proposes, however, to state these 
equations without attempting the excessive degree of refinement that 
might be appropriate in an extended treatise on the intricate subject of 
price-level analysis.^ The method of stating the relationships among the 
various factors in the general equation of exchange will depart in certain 
important respects from the form adopted by previous writers, notably 
Irving Fisher, in his Purchasing Power of Money’’ (1911). 

The simplest expression of the equation of exchange for a given coun- 
try and time period might be written as 

Here P stands for a measure of change in the general price level, M for 
the amount of money used, and T for a measure of the volume of trade 
accomplished by means of money, but valued in constant prices. We 
must clearly understand the meanings by explaining that P is strictly 
an index number of change from a given starting point or base in the 
general price level; M may be considered as the money that has been 
spent in all types of purchases during a stated period of time. T is the 
'‘value” of the trade accomplished in that period, valued at the prices 
of the base period and hence expressed independently of any variations 
in P, The terms M and T can also be considered as index numbers 
relating to a base period identical with that used for P.^ 

* See, for example A. W. Marget, ‘^The Theory of Prices,” Vol. 1, New York, 1938; 
Vol. 2, 1942 — an extremely detailed analysis. 

* It can be shown mathematically that in order to be strictly accurate, such an 
equation requires that the index number for P must be eitlier an aggregative index 
with the weights taken as the quantities of the given ycnir (not the base year) or an 
index such as the “ideal index” of Irving Fisher, which is a geometric average of 




If we should conceive M as referring to the average stock of money 
circulating during a period (let us say a year), then the expression for the 
money expenditure will become M multiplied by the average rate of 
circulation, which we may call y, and the equation then becomes as 



( 2 ) 

In this form, the equation would read: The price level index varies as the 
ratio of an index of money in circulation, multiplied by the index of 
average money velocity, to an index of all trade. Since, as we have 
previously seen, the short-term or minor cyclical fluctuations in trade 
activity more or less synchronize with the fluctuations in the velocity of 
circulation of the mediums serving the purpose of money, it follows that 
V in equation (2) would tend to fluctuate in accordance with the cyclical 
fluctuations in the denominator T. If we canceled out this much of the 
changes, we should come back substantially to equation (1), in which T 
would be defined as the trend of trade activity.^ Our previous statistical 
measurements essentially in terms of this interpretation of M and T 
conform so closely to the pattern of P, as independently measured, that 
we can consider the importance of V as mainly confined, either causally 
or a resultant, to the short-term cyclical fluctuations of P. If we could 
accurately measure V over very long periods, it might be found that the 
pattern has not exactly paralleled that of T but that the discrepancies 
apparently were not of great significance. 

With equation (2) before us, it is well to turn to some questions that 
thus far have not been sufficiently considered. These become important 
when such an equation forms the framework for theoretical analysis, 
especially for arguments as to causation and the direction in which the 
causal forces operate. There has been long and voluminous controversy 
on these matters. Our statistical results in themselves do not immedi- 
ately furnish the answer to questions such as the following: Are price-level 
changes always the result of the factors on the right side of the equation? 
Does causality run from M/T ioP ov also from P to M/P? If it is true 

two aggregative indexes, in one of which base year quantities are used and in the other, 
^tren-year quantities. By using P in either of these forms, it will be theoretically 
correct to say that the change in price level will be in exact proportion to the ratio of 
the change in money circulation to the index of physical trade change^ if it is assumed, 
of course, that a completely representative measurement is made of all those variables. 
Actually, our best available measures are but sampling estimates. 

^ See Carl Snyder, The Problem of Monetary and Economic Stability, Quarterly 
Journal of Economics^ February, 1935; also, his ‘‘Capitalism the Creator,^' p. 428, 
note 14 to Chapter 3. Snyder conceives the trend of T as the secular trend; the 
present writer refers to the intermediate trend. 


that the price level is invariably determined by ratio of money elements 
to trade elements, is the effectiveness of this influence mainly determined 
by changes in the numerator or in the denominator of that ratio? 


In order to keep our thinking straight, let us be precise as to the mean- 
ing of P. We have defined it as an index number of general price change. 
But what are prices Are they invariably the prices paid in actual 
transactions? In order to keep the equation always in balance, this 
might seem to be necessarily true. But are there not many “prices,’' 
such as quoted “bids^^ and “offers,” prices that sellers are hoping to get, 
and prices that buyers would be willing to pay? These may not represent 
any actual transactions. These potential prices that at the moment are 
merely quotations may nevertheless have a causal bearing upon changes 
in money use and trade activity without appearing directly in the equa- 
tion. Let us keep clearly in mind, therefore, that while in the equation 
as stated we refer to transactions that actually occur during a given period 
of time and all the prices represent actual transactions, it is logically 
possible for important changes in quoted prices to affect the terms on the 
right side of the equation referring to money expenditure and trade 

Examining more closely the meaning of M, or money, it is obvious that 
to be wholly realistic we must expand this into its constituent parts and 
designate them precisely. In a society not using refined systems of bank- 
ing and credit, M would presumably refer to coins or to paper money 
circulating as the convenient representation of coin, bullion, or other 
forms of recognized money. If such paper circulated without converti- 
bility into real wealth (as, for example, the greenbacks), this element in 
the circulation might be the outstanding factor capable of producing 
changes in the other variables. Under more normal conditions in a highly 
developed commercial country, we should need to have represented in the 
equation in the right-hand numerator all the elements entering into what 
we may call means of payment for goods and services. But there is a 
further question as to any one of these elements, whether coin, paper 
money, bank notes, or bank deposits subject to check — do these represent 
only the circulating means of payment as they have appeared in transac- 
tions, or are they to be understood to mean the total or average available 
amount of such means of payment, qualified by a turnover factor? 

Another way of stating this, if we take account of the velocity of 
circulation F, is to ask whether this should refer to the intensity of turn- 
over of the circulating medium (that is, all money and credit that circu- 
lated at least once) or whether velocity refers to the over-all degree of 
activity of an average inventory of M, This is a very basic question. 



The equation of exchange has been used as a basis for theoretical argu- 
ment with the premise that M represents only the circulating means of 
payment, that is, the flow; but before the argument is completed, the 
monetary factors suddenly appear as the average inventory of the means 
of payment.^ In order to be entirely definite and consistent on this 
point, let us consider that each of the monetary factors in the exchange 
equation refers to the average amount available for use, while the velocity 
factor, if used at all, qualifies these by expressing their average rate of 
turnover during a period of time. It must be recognized in so doing 
that velocity is capable of a double meaning, just as in the case of the 
cars of a railroad ; we can refer to the average speed of the cars that are 
moving and again to the average intensity of use of all available cars. 

Considering that M will refer to the average stock of all available 
legal tender money, we can proceed to break this into two parts: that 
which is held in bank reserves and that part which is in pocket, in safe 
deposit boxes, in the public treasury and the tills of business firms, that 
is, in the hands of the public.’^ There is, of course, a constant give 
and take as between these holdings, but it is desirable to distinguish the 
portion of the total money that is in banks, especially in central banks 
serving the purpose of reserves, from that part which is in the hands 
of the public and is mainly in the form of smaller denominations of legal 
tender paper and subsidiary coin. Since the M in bank reserves is so 
large an amount, we shall use M to designate that segment ; the average 
stock of money that is in the hands of the public may be designated as 
m and its velocity by v. We then have MV mv. 

We must still further expand the numerator of the M/T ratio to 
include the important element of ^‘checkbook money, that is, bank 
deposits subject to check and their rate of turnover in making payments. 
Let us take a snapshot of these deposits at a given instant. We are not 
interested in bank deposits that are not subject to check, since use of 
such deposits involves handling of actual funds equivalent to pocket 
money or till money. Confining our attention to total bank deposits 
subject to check, which are being continually drawn upon to make pay- 
ments comprising the bulk of all trade circulation, just what do these 

^ Irving Fisher, whose Purchasing Power of Money,” 1911, has done so much to 
make the equation of exchange a working tool of economic analysis, seems to have 
shifted his meanings constantly as between “money in circulation” and “money 
supply,” or average inventory. Thus (p. 24) M is defined as the average amount of 
money in circulation in the community during the year. But at a later point (Chapter 
III, Sec. 5) M is used as though it referred to the average stock of money serving as 
bank reserves and having some consistent relation to the inventory of bank deposits. 
At still other points, Fisher speaks of M as though it meant the stock of money as a 
complete monetary metal inventory, which varies as the result of production or net 
import of gold. 


deposits mean ? Obviously they do not physically represent actual money, 
because banks do not keep available more than a very small fraction of 
such “demand liabilities’’ in the form of cash money. When checks 
are drawn against deposits, what is it that is turned over or transferred 
as a means of payment? The answer is that it is mainly “credit,” 
built up and maintained by the continuing flow of commercial banking 
operations. It is a mass of credit whose validity ultimately rests with the 
assets, such as loans and investments, of the banks. 

But we must now be careful not to confuse ourselves by confining 
attention to an individual bank and its particular asset and liability 
account. We are here thinking of all commercial banks and the sub- 
stance of what is used in payments, and when we do this the accounting 
distinction between assets and liabilities disappears. What we have at 
any moment is a total that can be broken down into holdings of money 
and holdings of claims upon all those who have borrowed from commercial 
or credit-creating banks. These banks, in the aggregate, can validate 
checks drawn upon them to the extent that they hold vault cash, plus 
the extent that they are able to liquidate at once other assets and translate 
them into actual cash. The checks drawn on “deposits ” in the aggregate 
accomplish the means of payment so well simply because those who 
receive these checks for the most part do not question the ability of 
banks to validate or “redeem” them in money. Hence this vast magni- 
tude of credit remains suspended in existence as an addition to actual 
money, performing most of the functions of money, except in times of 
panic, when there may be acute fear and loss of confidence and an 
unusual amount of checks is presented suddenly to banks with demand 
for payment in actual money. 

The point that is most important here is that when we speak of 
“deposits subject to check” for all the commercial banks combined, we 
are dealing fundamentally with two elements — that portion of so-called 
“deposits” which has come into existence as the result of banks extending 
their own credit in making loans and investments and that part (omitting 
any earning assets provided by capital and surplus) which has been 
actually and physically deposited in money in checking accounts and 
which remains at a given time in the banks collectively as deposits of 
money but physically identical with what appears on the asset side of each 
individual bank among its cash reserves,^ This point is not entirely' easy 
to grasp, and it has been commonly overlooked in discussions on this 

^ This oversimplifies the situation to the extent that commercial banks have most 
of their reserve on deposit with the Federal Reserve Banks, but in principle we may 
merely extend the foregoing statement to include the Reserve Banks in the mechanism. 
To the extent that these banks issued no notes and made no loans, their deposits and 
reserves would be almost equal, and the deposits would represent deposited cash 



subject. In other words, for the purpose of our equation, we can consider 
that what these checks are drawn against is ultimately the money com- 
prising bank reserve, plus that part of the deposits subject to check that 
represent merely advances of bank-created credit — a magnitude that 
we shall refer to as C. It is difficult to measure this exactly, but it is 
important to recognize that logically the ability to write checks and make 
payments with them is, for the community as a whole, the right to turn 
over certain deposits that physically are actual money, plus deposits 
that are book items maintained in existence by the flow of banking 
operations. If commercial banks are holding large amounts of deposits 
subject to check in the form appearing on individual bank statements 
in the asset column as reserve but are making small amounts of loans and 
investments, element C will probably be limited, and the ability of people 
to write checks in making payments will also be limited, because deposits 
subject to check vary mainly with lending operations. In the converse 
case, when banks are making large advances of their own credit and are 
also receiving additions to their cash assets by way of cash deposits 
(insofar as these are subject to check), it will be possible for the com- 
munity to draw many more checks and the circulation of the means of 
payment will expand, as we have noted in historical instances. 

We may now express this in our equation as 

P = (3) 

In this form the money in banks is separated from the money in general 
circulation and nonbanking reserves. The bank money (apart from 
what may be a small portion of bank capital and surplus) is both asset 
and, since it is deposited by customers, liability. The rest of the deposits 
are liabilities created in the form of pure credit expansion, and they are 
represented among the assets by various noncash items, claims upon 
borrowers. But for the equation, the deposited cash that is held as 
reserve against claims of depositors is itself part of what banks call 
their demand deposits and these deposits {M + C) have an average turn- 
over V during a given period. The money in outside hands is a smaller 
segment of total purchasing power and has its specific velocity term v.^ 

^ An interesting verification of the manner in which m is correlated with P in terms 
of cyclical deviations from long-term or secular trend is to be found in a chart prepared 
by G. F. Warren and F. A. Pearson, based upon money in circulation outside banks 
and commodity prices, 1830-1931. See Hearings before the Svbcommittee of the Comn 
mitiee on Banking and Currency, HR 72d Congress, First Session, Mar. 28 and 29, 
1932, p. 25. 

MV + M'V' 

Irving Fisher expresses the equation as P = , referring to Af as 

money, and M' as bank deposits subject to check. The ambiguous character of both 


We have made, in other words, a logical distinction between the cash 
element and the bank-created credit element in the checkable deposits, 
that is, M as distinct from (7. This is desirable because significant rela- 
tionships exist, as between {M + C) and M and also between M and m, 
in view of the traditional and legal requirements governing the holding 
of reserves against deposits.^ In other words, C depends partly upon 
M, when we consider the banks in the aggregate, as common prudence 
and (in the United States, particularly) the banking laws set certain 
limits beyond which C cannot be expanded per dollar of M. Usually 
this is stated the other way around, in terms of the minimum reserves M, 
to be held against {M + U).^ In our own banking experience, it has 
already been made clear that {M + C) has varied over a fairly wide 
range with respect to M, and the complete expression {M + C) F, if we 
could accurately measure it, would probably exhibit a somewhat greater 
degree of variability. 

It is possible that the element M, bank reserves held against deposits 
in American practice, may expand without affecting C either temporarily 
or over extended periods. Also, C may expand and contract inde- 
pendently of M temporarily and within certain limits. Conceivably M 
might expand considerably without any expansion in C if there were a 
situation persistently unfavorable to the enlargement of bank loans and 
investments. We must avoid falling into the error, which has long been 
prevalent in monetary thinking in the United States, of assuming that 
merely an addition to bank reserves (perhaps as the result of large gold 
imports) must automatically increase credit and the means of payment 
and create immediate inflation. But actually, if enough time elapses, 
there will always be at least a partial and perhaps substantial rise in either 
bank loans (including discounts, acceptances, etc.) or investments in 
securities, or both, when larger amounts of cash come in from depositors. 
Naturally some of investments are made with cash and do not involve 
credit (C) expansion.^ 

his M and M' should now be obvious. See ‘^The Purchasing Power of Money, 

^ The term deposits’’ here refers, of course, to {M + C), the usual relation of 
“reserves to deposits” in banking and legal terminology being really the relation of 
M to (M + C), not M to C. 

* We are speaking of reserves against checkable demand deposits. Whereas 
demand deposits of commercial banks are usually subject to check, some time deposits 
may also be under certain conditions or to a limited extent subject to check, and to 
that extent M as minimum reserves would have to be redefined. This, however, is 
not of much practical consequence, especially since about 1935. 

• Lauchlin Currie, in his study ‘‘The Supply and Control of Money in the United 
States,” Harvard Economic Studies, 1935, Chapter 5, carefully states his reasons for 
approving the practice of monetary theorists in considering bank deposits subject to 



We now have the equation so stated that the right-hand numerator 
breaks down into the turnover of an average supply of potential means of 
payment. But we still have made no place here for the possible existence 
of bank notes. In some banking systems notes are still an important or 
even predominant means whereby commercial banks extend their credit. 
But in our own system bank notes have in recent years become essentially 
Government paper money, that is, circulating paper backed by gold certifi- 
cates, which, in turn, are now backed by gold held in the Treasury. 
Insofar as such notes are legal tender, they would be included partly in 
M as well as in m. If such notes are not legally available for use as 
bank reserves against deposits, the amount in public hands would appear 
onl}^ in 7n. To the extent that the notes are specie certificates, the money 
serving as redemption fund is excluded from M. This would be true 
of our pwesent Federal Reserve notes. 

Having now clearly in mind that our monetary numerator contains 
specifically a substantive element of supply that is regarded as ^Hurned 
over’’ in actual trade, we must logically develop a similar concept for the 
right-hand denominator, which thus far has been expressed merely as 

check as the entity whose use by means of checks accomplishes the making of pay- 
ments. He then definitely restricts the term “credit to the deposits and at the same 
time vigorously denies that bank loans or bank investments can or should be con- 
sidered as being credit. 

His reason is mainly that variations in the earning assets of commercial banks 
need not correlate exactly with variations in deposits or, more particularly, demand 
deposits subject to check. He cites cases in which earning assets may be increased 
by enlargement of bank capital, surplus, and undivided profits; or in which banks 
may borrow from the central banks and thus maintain earning assets constant, even 
though deposits may be declining. There may also be changes in earning assets 
unaccompanied by corresponding variations in “individual” deposits. Currie also 
calls attention to the fact that if bank investments were to be included in the concept 
of effective credit, it would involve attaching to time deposits (which mainly take the 
form of investments in the asset account) as well as demand deposits a “credit” 

In the previous chapter, we used, as our measure of the historical changes since 
1878 in effective credit and currency in use, banking earning assets rather than deposits, 
but this is not necessarily inconsistent with Curriers contentions. Variations in 
earning assets (loans plus investments) are a sufficiently accurate indicator of varia- 
tions in deposits of commercial banks to warrant their use in this fashion. Even 
rediscounting operations are not undertaken by such banks unless credit expansion is 
being effected by loans and corresponding additions to demand deposits. If deposits 
are enlarged by holdings of idle cash, indicated by large “excess reserves,” the earning 
assets are a better indicator of credit in use than are the total deposits. Today a 
fairly large part of demand deposits is certainly not credit, even though those may be 
withdrawn by the use of checks that are credit instruments. 

As for the matter of time deposits and bank investments, it will be noted that in the 
foregoing we have considered reserve held against time deposits as part of m, and hence 


T (trade). This is a point at which in the past much equation making 
has gone wrong, with unfortunate results. Most equations have pre- 
sented an inadequate basis for reasoning in the fact that although they 
may include in the numerator a term referring to monetary supply or 
average amount of deposits, at the same time no attempt is made to 
factor out the element of T or trade into comparable aspects of supply 
and rate of flow. Hence, naturally, the numerator of the equation readily 
becomes in the argument the powerful and active agent in governing the 
price level, whereas trade comes to be regarded merely as a kind of fait 
accompli, having no degree of causal potency whatever. We are certain 
to fall into inconsistencies if we fail to factor out T completely.^ 

any increase or decrease in time deposits or in the investments corresponding there- 
with would be mainly allowed for in fluctuations in this reserve element. At the 
same time it may very well be true in considering the entire banking situation that at 
any given time among the demand deposits there will be ‘^derived elements, originat- 
ing in the making of investments by banks on the basis of increases in their tinn^ 
deposits. These funds, resulting from security purchases and probably mainly in 
the form of credit, as they circulate through the system of business, take the form of 
demand deposits in banks and may for a considerable period remain suspended in the 
total of bank credit, the element C. It will be shown in later sections that on several 
occasions a much better measure of the effect of bank credit upon the general price 
level could be obtained through observation of loans and investments rather than 
deposits subject to check because the changes in loans particularly correlated more 
closely with the total turnover of deposits than with the average amount of deposits. 

This seems to have been true, for example, in the period from 1926 to 1929. When 
Currie says (p. 54) Loans and investments . . . grossly exaggerate the rate of 
expansion of the money supply up to 1929 . , . the writer believes that he is 
definitely in error if he means by money supply the total effective credit and monetary 
contributions to changes in over-all trade values. This is confirmed by the measure- 
ment already presented in the preceding chapter. It is a fundamental principle of 
commercial banking that it is the loans (and investments in some measure also) that 
mainly create the demand deposits, not vice versa. 

Another point at which Currie appears to the writer to have made unnecessary 
and not altogether constructive criticisms of central bank policy in the United States 
is his insistence that the Federal Reserve authorities in the 1920^s were too much 
concerned with the “qualitative” aspects of bank credit, that is, the composition of 
the earning assets of member banks and the nature of rediscounted collateral, whereas 
inadequate attention was paid to the “quantitative” elements that have to do with 
the general price level or level of total trade values. Currie's criticism fails to take 
into account that there may be qualitative aspects of the manner in which banks 
circulate their credit and make advances to business or speculation that in the long 
run do have very potent effect upon their ability to continue to serve the community 
and effects, also upon the extent to which the banking system may become over- 
sensitized to disturbing factors. This is further discussed in Chapter 11. Currie’s 
concept of qualitative credit policy and control, like much of the rest of his analysis, is 
decidedly narrow. 

^ The failure to factor T into its separate aspects is a notable defect in Irving 
Fisher’s theory of the relations between money, trade, and prices. 



To illustrate, let us go back to equation (1) in its simple form. P 
will be expected to rise if M remains constant and T declines. This 
might actually be true, perhaps in terms of a long-term change in condi- 
tions, but it would be untrue of changes occurring in the course of a 
typical business cycle. A pronounced and general cyclical decline in 
trade is very seldom correlated with rising prices except under war 
conditions. Conversely, the price level does not ordinarily fall when 
trade is increasing during the prosperity phase of a typical cyclical move- 
ment. Thus the use of trade in this form as an element in the equation 
that supports causal reasoning leads to irrational results. The reason 
lies in the fact that T, in the sense of a measure of the over-all physical 
turnover of business, represents trade 'performance^ in which prices and 
money and credit have done their work. As such, it is logically necessary 
to consider it as a passive resultant It is passive virtually by definition. 
This explains why Irving Fisher so frequently in his discussions of his 
equation of exchange (P = MV/T) was able to refer to trade as of little 
if any dynamic effect in the mechanism, something restricted in its 
changes to the limits of productive capacities and techniques. Thus his 
denominator of the equation ratio plays a role of an idler pulley, and the 
numerator represents the prime mover. Here we are bound to recognize 
the necessity of careful statement of monetary principles. The excessive 
emphasis that much accepted doctrine places upon the effectiveness 
of the monetary and credit factors (and hence monetary and credit policy) 
through the use of imperfectly factored equations and elliptical reasoning 
may not be valid for all circumstances and conditions, even though it 
may occasionally apply to cases in which there happens to exist a rela- 
tively violent change in the money-credit variables. We have seen that 
these are almost entirely wartime contingencies. 

Can we factor this T or total trade activity into its component ele- 
ments for logical purposes? Let us first divide the measure of total 
trade into two parts, one consisting of the movement of physical goods, 
materials, and property (even though represented by paper claims), the 
other consisting of all the intangible services. One important distinctior 
between the two arises from the fact that for physical trade there is 
always likely to be a related element of physical inventory that is distinct 
from current production and distinct again from the flow or movement 
of the goods. For services, there is only in a more remote sense an inven- 
tory, in the existence of potential capacity to render service; but the 
service that forms a part of the concept of trade, involving circulation of 
money and credit, is something that exists only during the rendering of 
the service, and we cannot always think of this as being the “turnover'' 
of a capacity. 

Let us now consider the cases of tangible goods and property and 
negotiable claims thereto. For the purpose of the equation, we could 


express such trade in terms of initial inventory, plus production during a 
period of time. This would represent the available average supply, 
which is then further qualified by a rate of turnover R, For the sake of 
consistency with our numerator, expressed in averages, it is best to 
regard these supply terms as averages of a number of observations during 
a time period. For each interval of observation we have supply composed 
of (1) inventory carried over and (2) new output added during the 
interval. The average of the physical inventory terms plus the average 
of the production terms times the average percentage of R = T, trade. 
The supply (/ + O) “turns over'' in the sense of moving along the line 
toward final possession and utilization. The concept T may, however, 
include many circular transactions affecting the same item, especially 
in speculative markets. 

We may now write the equation as follows: 

p — + C) y mv __ monetary turnover , . 

(/ + 0)i2 + >S trade turnover ^ 

I is the inventory component, 0 is the current output component, so that 
(7 + 0) becomes all available average supply during the entire period. 
The rate of movement of this total available supply into the hands of 
purchasers is expressed in the average rate of turnover R, This is a 
percentage of supply actually disposed of in trade. This brings into the 
denominator of our equation a substantive magnitude of supply that is 
coordinate with ilf or C or m. Observe that (7 + 0) may vary directly 
or inversely with T according to conditions. The term 7 may vary 
independently through production, being carried beyond the rate of 
current requirements, without regard to price. Hence I can affect P 
directly, especially in periods of excessive output of basic raw materials, 
excessive construction activity, or speculative inventory accumulation 
by merchants. P can then in some degree affect M, C, and V, 

We may also extend the denominator by including the element of 
service as an index of that part of T which involves no physical inventory. 
We may simply write S to represent this factor, being careful to remember 
it refers to units of service activity valued at constant prices or rates. ^ 

1 If we wish to take into account the element of service capacity, we may use 
equation (5) 

^ (/ -f 0)R -f (Sc)r 

S is the result of the average rate of utilization r of the average potential capacity Sc 
to render services during the time period. Thus, for example, if we are considering 
those aspects of total trade having to do with the labor market, we can consider all 
potential man-hours available on the average during a given period, modifying this 
by the average rate of utilization r, which would give us the man-hours actually 
worked and paid for (at constant wages). This form of expression, however, is not 



In using the equation as a logical tool, we must remember that P 
is an index number of change in general price level — including commodi- 
ties, property, services — in other words, a comprehensive entity involving 
all prices whatsoever but not including rates of interest or the prices of 
bonds or other debt claims. The P of the equation of exchange excludes 
prices, representing merely the exchange of present money for future 
money. These are transactions within the numerator of the M/T ratio 
and do not in themselves introduce changes in the value of the ratio. 
Prices that represent what is paid as rental for the use of property refei* 
to that part of T classified as service, since there is no exchange of property 
against money or credit, but the price involved in such transactions is 
analogous to other service prices. Of course, the P index could be broken 
down into many types of goods and service markets. But statistically, 
this would involve a separation of the monetary, supply, and trade- 
turnover terms into corresponding detailed classifications, and from a 
statistical standpoint this would involve great difiiculties. Nevertheless, 
it is frequently useful as a way of keeping our thinking straight to 
segregate some particular markets of exceptional importance and trace 
their probable relationships to the exchange process as a whole. 

On the right-hand side of the equation, the term expressing velocit}' 
does not represent quite the same thing as that expressing rate of use, 
although the meanings are analogous. Money and credit have an 
essentially “ circular velocity, since they are continually turning over 
in making exchanges without ever reaching what may be called a final 
destination. In the denominators R and r refer to turnover as used in 
the merchandising sense — the average extent to which existing goods, 
tools, property, and labor available for sale are actually moved along 
in the direction of the final buyer. Purely speculative transactions, how- 
ever, have a circular and often very rapid rate of velocity. The element 
that expresses the rate of utilization of service facilities or potential 
capacity r expresses a different kind of turnover in the sense of intensity 
of utilization. But all these various terms have the common property 
of expressing the degree to which certain average amounts of money, 
credit, goods, or property and human capacity are being moved during a 
given time period or utilized in particular channels of activity and 
involve money and credit payments at each turn. In both numerator 
and denominator of our equation we distinguish the factor of activity 
from the factor of average available supply or quantity. 

easily applicable to all phases of service, since it is not always possible to express poten- 
tial capacity in a definite way or in terms of statistically measurable units. Theoreti- 
cally, however, it is desirable, as far as possible, to make a definite place in the equation 
for the element of supply as distinct from the element of turnover or utilization. 



We are now in a position to visualize the mechanism through which 
the forces operating upon the general level of prices exert their influence. 
It has been persistently contended by adherents to the so-called ‘‘ quantity 
theory of money and credit that the general price level usually varies 
as the monetary factors vary. According to the more extreme statements 
of this view, it is the numerator of the fraction, not the denominator, that 
does the work of moving the price level up or down. From this dogma 
naturally flow plausible plans concentrated upon monetary policy and 
credit control and fiscal administration designed to rectify the influences 
bearing upon prices, under any and all conditions. But let us examine 
some of the logical possibilities, to see if such interpretations are sound. 
Let us first study the denominator of the right side of the equation. To 
what extent, if at all, are the expressions (/ + 0) and Sc, which we may 
call ‘‘supply,’’ related to the price level? The reader undoubtedly is 
familiar with the fact that in the usual demand-and-supply analysis of 
particular commodity markets, it is rate of supply changes, not trade or 
production, that is considered to be the variable coordinate with the 
influence of demand. We have brought this element of supply, in an 
aggregate sense, explicitly within the framework of the general equation 
of exchange. What takes place in the entire economy within a year’s 
time is the establishment more or less simultaneously of many prices. 
All these prices are established as the result of human desires, of the 
changes in availability of money and credit, the rise or fall of the supply 
of goods, and the varying forces contributing to that supply, among 
which international forces, political pressures, technological factors, 
and the willingness of those who control goods, property, or service to 
sell or rent them.* 

^ It has been claimed by Irving Fisher that what takes place in the equation of 
exchange is essentially different from what takes place in an individual market. It 
has been elaborately argued, and strangely enough has been little questioned, that 
in an individual market both demand and supply factors operate within a price levels 
which is determined by the equation for all markets and apart from mere demand-and- 
supply mechanics. In other words, it is claimed that we cannot explain what takes 
place in the equation and at the same time assume that equation in our analysis. 
Fisher, for example, (“Purchasing Power of Money, pp. 176-181) says that the price 
level so transcends all individual supply-and-demand situations that the general level 
cannot be explained by observation of these individual situations. He illustrates 
this by reference to the price of sugar; an increase in the price of sugar would not 
represent a rise in the “demand'' if the entire price level also were rising. This is 
really intended to mean apparently that we cannot draw conclusions as to changes in 
the consumer marginal utility of sugar under conditions of a rising price unless we know 
how that price stands against the general level of prices. This much is true, but the 



The supply factors we are using in the denominator are theoretically 
just as potent with respect to the price level as the monetary or credit 
supply or the velocity factors in the numerator. Supply of goods, of 
labor power, of property, taken in conjunction with their rates of turnover 
or utilization, cannot simply be thrown aside into a passive ^Hrade’^ 
element and regarded as of no dynamic consequence. In fact, there are 
important possible relationships between supply and prices. Consider 
the case of raw-material prices such as wheat, copper, livestock during 
limited periods of time. Why is it that these markets are repeatedly 
subject to such violent price disturbances? Is it merely the variation 
in money or credit that causes these wide advances and declines in basic 
raw-material markets and their effect on the entire level of prices? 
Decidedly not! Money and credit factors do exert great influence upon 
occasion, especially in war periods, but this is not the whole story. 
Changes in supply, because of conditions peculiar to those industries as 
well as the human equation, actually explain many of these cyclical 
fluctuations in prices. In inelastic markets it requires but minor shifts 
in supply to cause wide variations in price. 

It is true, of course, that disturbances in the credit system or diffi- 
culties relating to money supply may accentuate a weakening of demand 
schedules pertaining to such raw materials, while production (0) con- 
tinues its routine way, and inventory piles up. Output may continue 
unadjusted to demand because of the pressure of debt burdens or the 
competition coming from virgin areas of high yield or areas previously 
without transport facilities.^ But this piling up of inventory (/) that 

fact remains that this utility, or psychological aspect, is extraneous to the main problem. 
A given quantity of sugar in the market selling at a higher price means a shifted posi- 
tion of the schedule of demand. It is one thing to say that demand, as actually 
expressed in money or credit, is strengthening or weakening but quite another thing 
to say that these changes signify something in the psychology of the buyers. Fisher 
here confuses a demand situation and a utility schedule. Actually there is no sound 
reason to believe that what takes place in the equation of exchange, if it is properly 
stated, is not exactly the same as what takes place in individual markets when we 
consider them functioning simultaneously and do not insist that every variation that 
occurs measures something psychological. 

1 Some writers have expressed the exchange equation as merely P = MV. J. S. 
MilFs statement, as expressed by J. L. Laughlin (*^The Value of Money*') is equiva- 
lent to P *= MV, with no place for T, on the amazing assumption that this was fixed 
or its variations unimportant. Such assumptions have usually been associated with 
the belief, long cherished by economists of the ‘^static*' school, that there can be no 
general overproduction (or imderproduction) of goods. This dogma applies to the 
metaphysical “long-run,” not the actual business world, and these hazy generaliza- 
tions fail to provide for the very realistic possibility that excesses or deficiencies in 
important, basic, particular markets may have far-reaching effects in the general trade 
and price situation for months or even years. 

Another line of thought that denies T or supply any effective causal influence in 


tends to produce a decline in price is not necessarily explained by mone- 
tary and credit conditions. In fact, it may affect these, either directly 
or via P. If the supply factors alone rise or fall in such a manner as to 
influence price level, these price changes, in turn, can transmit influences 
upon offers to purchase and prices and therefore upon the rate of 

use of the existing supply of money and creation and use of circulating 
credit. We have included in P, price level, only those prices actually 
representing transactions, but when inventory begins to accumulate 
and trade activity does not absorb it, the factor R declines, and as 
nominal prices quoted decline, actual prices paid also tend to be weakened. 
This may even cause some reduction in T, which can decline at the very 
same time that inventory in certain strategically important markets is 
increasing and total supply (7 + 0) is temporarily becoming larger than 
what can be sold at the former price level, unless there happens to be 
an independent expansion in M or C or m. Under these conditions this 
would be unlikely; the monetary velocities would decline in sympathy 
with the decline in P. When supply in important segments of trade 
abnormally increases in this fashion, it tends to influence prices in the 
sense of ^‘bids and offers.’^ We see this constantly in the commodity 
markets, in the stock market, the labor market, and the real-estate 
market. The importance of this is simply that quoted prices are one 
of the hidden and usually overlooked connecting links between supply 

the equation is Fisher's insistence that over short periods (the ^‘business cycles") T 
is motivated by P. He has sought to demonstrate statistically that the variations of 
trade identified with the business cycle are merely complex resultants of changes in 
the rate of change in the price level. By expressing this as a rate of change and "dis- 
tributing" the results according to a complicated weighting system, Fisher obtains 
cyclical curves that closely parallel the price-index movements in cyclical pattern, 
even though the actual cycles of prices tend to follow rather than to lead the pattern 
of trade activity. These demonstrations, however, are not conclusive nor are they a 
basis for considering the rate of change in the price level as having any causal effect, 
inasmuch as there are several other similar lagging factors with respect to physical 
trade or production. Probably much the same effect could be obtained, if we mani- 
pulated our figures sufficiently, with industrial wages or interest rates or commercial 
failures or the cost of living — any of which might be made to show an artificial time 
lead, in terms of rate of change. 

There is lacking a thoroughly empirical basis explaining why this should be true 
and why it may not be equally true that prices merely adjust themselves to certain 
phases of the business cycle so that peaks of booms cause the most rapid rate of change 
in prices while the bottoms of depressions happen to be productive of the fastest rate 
of decline in prices. To the extent that the latter might be found true, it would 
doubtless hold much more for commodities or for other items subject to speculative 
influences than for the price level as a whole. This theorizing is merely one phase of 
the general argument, which the present writer is disposed to question as a general 
proposition, that all the disturbances in the economic system are created through price 
disturbances, rather than through financial and trade maladjustments. 



(I + 0) and price level and possibly both prices and credit (C). The 
effect of prices on M or m is usually not so important as its effect (particu- 
larly when declining) upon the more flexible factors C and V, There 
may also be shifts from ilf to m if hoarding occurs; or shifts from mio M 
or enlargement of m by Government paper issues if (I + 0) is relatively 
low and a national emergency such as war brings terrific pressure of 
demand on scant supply. 

We have now brought into the equation all the factors that appear to 
be potent and capable of causal effectiveness. The forces do not work 
in simply one direction, but within limits they operate in either direction. 
The bearing upon monetary and credit policy is obvious, and we shall 
refer to it again in later chapters after examining first some of the concrete 
dynamic behavior of a number of key phases of industry. Those who 
have been enthusiastic in proposing monetary remedies as panaceas 
for stabilizing the price system or the business cycle have principally 
built up their case around an imperfectly formulated equation. Hence 
they invariably fail to concentrate upon particular phases or markets that 
may originate far-reaching maladjustments. Instead of shooting with 
a well-aimed rifle they use buckshot and trust that it will do some good. 
Such an attitude also conduces to unwillingness to anticipate disturbances 
and vibration through selective policy and preventive action aimed at 
averting the use of checkbook money'' (C) in ways that are dangerously 
topheavy and recklessly speculative. The result is that when such 
credit collapses and a void has been created in the total currency circula- 
tion the void must be filled by some kind of new credit capable of even 
more dangerous potentialities. Thus we need no longer pay for our 
financial mistakes and never learn to avoid them. 

In our previous discussion and statistical illustrations of the relation 
between credit currency and the long intermediate trend of trade, we 
found that it was possible to explain almost all the fluctuations in the 
price level as to both trend and cyclical movements in the United States 
through a long period. How does this demonstration fit into the theo- 
retical principles just stated? From a statistical standpoint anything 
like a complete demonstration of the equation of exchange is, of course, 
impossible. We can attempt only approximations, and even these do 
not throw light on the direction in which the causes work and on which 
elements are dynamic, which passive. We expressed the terms of the 
equation incompletely, showing merely variations in (Af + C) as meas- 
ured indirectly and for part of the period in m, and the denominator 
appears merely as T, insofar as industrial activity reflects it. The data 
previously presented do not enable us to examine the movements of V, 
V, /, 0, Rj Scy or r. The results indicate that P = (M + C)/T, so that 
the omitted variables at best are relatively minor or offset each other. 


Particularly, the nature of total output, inventory, and supply cannot be 
detected and their relationships observed. During intervals of prolonged 
hesitation in business activity, the index of trade as we have used it 
may represent changes that are not necessarily uniform throughout the 
business system and that do not indicate the behavior of raw-material 
supply or inventory. In other words, prices may be declining over a 
wide front, as they did in the 1870^s or in the 1930\s, and declines of such 
unusual intensity and duration may be at least in part traceable to raw- 
material-supply maladjustments rather than to changes in the circulation 
of money or credit. At such times T may indicate a slackening, but some 
markets are being weakened by a rise in (7 + 0) that is offset and con- 
cealed by a decline in R but is at the same time pulling down prices. 
There are occasionally such hidden factors buried in the measurements, 
but if brought to the surface they would disclose expanding unsold 
stocks, accumulation of foreclosed property, or idle labor — a drastic fall 
in R and r, paralleling and probably causing a fall in V, Thus, although 
our statistical representation definitely establishes a dynamic relationship 
among the three main factors, it does not tell the whole story of causal 
influences or the factors contributing them. The influences within the 
exchange system are therefore complex and capable of action in several 
possible directions. 

It follows, as a broad principle, that derangements in the price system 
as a whole may arise from monetary or from supply conditions. In 
wartime the former factors always predominate, but in normal times and 
particularly over shorter periods the price variations are capable of being 
initiated by production and inventory factors in the raw-material and 
land-using industries. This means that there is no single formula or 
remedy for price-level stabilization. There is no merit in the proposition, 
so commonly urged during the past generation, that the general price 
level is merely a resultant of monetary conditions and must therefore be 
stabilized only by schemes of a monetary nature. This is a dangerous 
fallacy, notwithstanding the fact that in w^artime it points to the factors 
that require very special control. 

There is still another phase of the equation of exchange that calls for 
brief comment. Some economists in recent years have sought to develop 
subequations in order to concentrate the analysis upon those prices or 
those classes of goods or services that they consider of exceptional 
importance or that they imagine relate particularly to the interest of 
labor or consumer or political objectives. This has been a favorite 
device among leading British writers upon the subject, such as Keynes, 
Robertson, Hawtrey, and others.^ The attempt is most commonly made 

^ J. M. Keynes, for example, has factored what roughly corresponds to an equation 
numerator into means of payment, pertaining specifically to individuals, to business 



to link the monetary and credit mechanism with analysis of those forces 
having to do with wages or national income. If, however, we attempt to 
explore this new tangent of theorizing, we find the results disappointing. 
Intricate complexities of shifting meanings and abstruse overrefinement 
serve as barriers to clear-cut and significant results. The equations so 
specialized tend to give the same excessive emphasis to the monetary 
factors that we have noted in Fisher's form of the general equation. This 
involves the possibility that one may overlook disturbances in some 
omitted sector of the price system that may bear indirectly upon the prices 
or values under special consideration. Breaking down the equation is 
legitimate and can be useful if the various parts are not considered to 
be independent of each other. It was just this tendency to depart- 
mentalize and pigeonhole the workings of the credit system and the price 
system of the United States during the 1920's that brought such confusion 
of policy and lack of efliciency in the control of one of our worst inflations. 
It is most important at this juncture that the reader have a firm grip 
upon the basic mechanics of the exchange system as a whole and then 
make his particular analyses without the preconceived idea that an equa- 
tion of exchange is the correct or invariable framework for that specific 

One further point is important. The mechanics of the equation of 
exchange in the general form developed above must be understood to 
pertain not merely to definite time periods but also to a given commercial 
area. Influences may be transmitted from prices, monetary factors, 
foreign-exchange rates, production, inventory, turnover, etc., in a given 
area to price conditions outside the area. If we took the entire world 
and its commerce as the area and made suitable adjustments for the 
diversity of money, credit systems, price quotations, etc., the problem 
of intersystem relations and many minor indirect influences would be 

firms, and to other groups, and the equivalent terms in the denominator become the 
correlated specific transactions representing labor, transfer of goods, transfer of 
property, etc. But the meanings are subject to various interpretations, and there 
are many highly artificial assumptions not capable of verification. The separation 
of the exchange mechanism into watertight compartments also involves the logical 
difficulty that causation may not run in the same direction or in the same manner as 
it does in the general equation. Hence conclusions based on general equation causal 
relationships may be carried over into the departmentalized equations, with erroneous 
results. By substituting such partial equations, all in a form that exaggerates the 
monetary and credit factors, for straightforward demand-and-supply analysis, conclu- 
sions can be derived that appear to support the thesis that industrial wages or the 
national income can be raised by money juggling. This has become a favorite past- 
time with economic thinkers who do not carry their analysis beyond money prices 
ard money values into the realities of actual wealth, real income, and the physical 
aspects of their enhancement. See J. M. Keynes “General Theory of Employment, 
Interest, and Money,'' London, 1936. 


eliminated. Actually, however, we should find this global analysis of 
baffling difflculty statistically. If the price system or equation of 
exchange only for the United States is considered, it must be remembered 
that our level of prices may be affected by the occurrence of numerous 
minor changes, such as the change in definition of money in a foreign 
nation, tariff laws abroad, etc. Or we may redefine our monetary unit, 
as was actually done in 1934, and thus directly by legal act influence 
the rates of foreign exchange and thereby also prices of commodities 
exported and imported. The price system of a given area, in other 
words, includes elements that involve trade with outside areas and that 
reflect the influence of possible changes in translating dollars into other 
currencies, and vice versa. The extent to which the rest of the world is 
doing business on a gold standard or a paper standard thus has a direct 
bearing upon our price level. It may have indirect effects through gold 
movements or even changes in the supply of basic commodities. The 
definition of what a dollar is naturally is a legal matter; what it may mean 
in terms of price level can be interpreted by correct use of the equation 
of exchange. 


In conclusion, let us summarize the discussion of the dynamics of 
money, credit, trade, and prices in the following propositions : 

1. The equation of exchange expresses algebraically the factors in a 
ratio whose changing value is associated with change in the general level 
of prices in a given area and unit of time. 

2. The familiar quantity theory of money is not a satisfactory 
designation of the general price-making process, because it insists that the 
price level varies proportionally with changes in the quantity (often 
ambiguous) of legal tender money, without necessarily including credit 
circulation or velocities. Furthermore, by stressing quantity of money 
or even the quantity of money and credit, there is inadequate attention to 
other factors, such as changes in trade and the component factors of 
supply and turnover that affect prices directly and may also affect money 
and credit circulation. 

3. Bank-reserve money has a relation to the credit circulation created 
by bank loans, but the relationship is not rigidly fixed or constant. In 
general, so long as bank-created credit C is convertible into cash, the 
expansion and contraction of bank credit depends upon expansion and 
contraction in reserves, but in short periods this may not necessarily be 

4. Money in the hands of the public usually varies in accordance 
with the changes in price level and trade; it is not a major causal element. 
Its velocity of circulation v tends to be lower than the velocity of bank 



demand deposits V, Government paper money issues not convertible 
into specie may cause m to vary considerably more than ilf + C, and in 
periods of extreme inflation there may be a fantastic expansion of m 
and an exceedingly rapid turnover v. Inflation can also develop through 
the exploiting of a banking system by governments seeking to issue 
evidences of debt without limit and thus virtually monetizing the public 
debt to finance war or other emergencies. 

5. The velocities associated with money means of payment or credit 
vary more or less directly and proportionally with the rates of turnover 
R and r of supply entering into trade T. The intermediate trend of 
trade, therefore, indicates the path that total means of payment should 
follow in order to keep the general price level stable. Any temporary 
excess or deficiency in the means of payment about this trend affords 
a practical means of formulating public policy to correct the variance, but 
such policies must also give attention to unnecessary variations in trade 
activity, possibly arising from supply and production abnormalities. 

6. The general price level does not necessarily move, cither during 
short periods or long periods, in exact conformity with the changes in 
commodity prices or other specific price groups. In order to examine the 
forces pertaining to changes in these segments within thci price system, 
we may form subsidiary equations, but it is probably better practice to 
analyze the dynamic factors involved in each phase with attention to 
detail and not merely in terms of an exchange equation assumed to be 
similar in its mechanics to the general equation. 

7. Although price level is primarily the resultant of changes in the 
money /trade ratio, a change in the numerator or some part of it may 
transmit effects through price level to the denominator and vice versa 
Such causal influences may also pass through quoted prices that are not 
included in P. The changes in the ratio affecting P may arise in either 
the numerator or the denominator or both, and attention exclusively 
to the monetary factors is inadequate analysis. 

8. It frequently happens that supply in the basic raw-material 
markets or in property development, productive equipment, or mercantile 
inventory becomes excessive in the sense that financial involvement of the 
holders and forced liquidation occurs. In these cases, there is a rise in 
/, producing a fall in related prices (particularly in quoted prices), and 
a shrinkage in bank credit may result from the combined effect of price 
decline, excessive supply, and impaired trade conditions for a period of 
time. Conversely, a shortage in supply may raise prices and stimulate 
activity, with the result of enlarging credit and spreading the price rise 
over many markets. 

9. It is possible for deficient supply and urgent need, as in time of 
war, to affect prices overnight and to force the Government in making 


purchases to expand the means of payment through issues of inconvertible 
paper money. 

10. The relations existing between M and C, or M and {M + C), are 
substantially those that govern the short-term rate of interest in the 
money market. These rates are not part of the price level, but they are 
derivatives from factors in the equation to a very important extent. 
Changes in the money market rates may affect long-term interest rates 
and hence have a bearing upon the return on investments, the tempo of 
business activity and even employment generally, although here again 
we do not have unilateral causation. The rate of interest or discount 
may also be affected by relations existing between M and m. Although 
through the rate of interest, some factors in the equation may operate 
upon other factors, the extent to which the rate of interest is itself a 
factor capable of effecting major changes in P has probably been greatly 
exaggerated in theoretical discussion (see Chapter 16). 

11. There has long been an excessive degree of importance attached to 
changes in the price level as a basis for Government policy in controlling 
the business cycle. As will be demonstrated in later chapters, the 
business cycle is not primarily a function of price-level movements. In 
most cases, cyclical movements in industry and trade originate in financ- 
ing practices and promotional activities at levels in the business system, 
where changes in prices capable of being attributed to monetary influences 
are of relatively minor importance. 

12. Although the long-term trend of gold production in the past 
has conformed to the broad trend of physical trade reasonably well — 
being stimulated in periods of falling general prices and curtailed in 
periods of rising prices — the more recent concentration of the world\s 
gold in the United States raises disturbing questions as to whether a 
stable currency system can still be based upon a gold-reserve foundation 
without the addition of continuous political manipulation and adjustment. 

13. If gold is abandoned as a more or less self-balancing and yet 
flexible medium for ultimate bank reserves, the alternative appears to be 
the use of Government paper or paper representing the public debt or 
some combination of selected bank assets as equivalent to the basic 
reserve against deposits subject to check. A combination of basic 
commodities might take the place of gold as an ultimate standard, but 
convertibility problems are then rendered complex. 




Since we have at least a fairly reliable measure of changes in the 
general level of prices and also an index of changes in production and 
trade, it would seem logical that the product of these two indexes would 
measure changes in the total value of all business transactions. Theo- 
retically, this is an entirely logical assumption.^ If our index of the 
general price level were meticulously accurate, as well as comprehensive, 
and if our index of the physical volume of trade included not only com- 
modities but also personal and other services, we should be able to secure 
a very reliable index of change in the value of all business transactions 
accomplished.^ This result would be influenced by the fact that during 
the course of time a great many kinds of goods are exchanged over and 
over in speculative ^Tutures’’ markets; securities are turned over in 
similar fashion, and even in production operations the original raw 
materials are handled again and again in the successive operations. 
Hence it follows that a measure of changes in the value of ^^all trans- 
actions^^ contains much haphazard and probably meaningless weighting. 

The actual aggregate value of the annual turnover of goods, property, 
and services in the United States would reach astonishingly high figures, 
possibly approaching 1,000 billion dollars in recent prosperous years. 
Although the annual value of all transactions would trace the course and 
the continual fluctuation in the nation’s economic activities, the result 
would not be adaptable to certain purposes that are important. It 
might not be an accurate measure of change in the value of national 
income. When the term income” is used, attention is primarily 
focused upon the useful end products of these multifarious business 
processes. It is necessary then to exclude the repetitive turnover of all 
the speculative markets. It is also necessary to extract from the aggre- 

1 Subject only to minor discrepancies if the index numbers are not precisely 

* This result would not, of course, include numerous kinds of direct service ren- 
dered gratis or the personal enjoyment of the utilities derived from sources or objects 
not requiring compensation; nor would it take account of direct exchange by way of 
barter. But as the use of money and credit enters into such an overwhelmingly large 
part of all the activity having to do with the creation and transfer of wealth and serv- 
ice, the omission of these items would be of no consequence. 




gate value of trade the duplications resulting from valuing materials 
over and over as they move through the stages of production. The 
income concept, therefore, is associated with calculations of what might 
be called the ''net,'^ rather than the gross,’' value of the products, if 
final form within a given period of time is assumed. For manufacturing 
operations, the total values that would be pertinent would be a sum of the 
net values added by all the processes of manufacture to the value of the 
original materials. If we could total the net values in this sense all along 
the line, not only in manufacturing but in construction and transportation 
and service and industries, the final aggregate value would represent a 
highly significant figure — the net value of business performance. 

Such a total of the net value of production and service would be 
considerably smaller than the over-all value of gross transactions. And 
the average change in prices in referring to national income might be 
somewhat different in pattern from that exhibited by the general price 
level, although marked discrepancy is unlikely. Unfortunately there is 
no long-term measure of changes in this subgroup of net prices or net 
unit values. Obviously the prices would be mainly those pertaining to 
raw materials and service, and the latter element would be of considerable 
importance. Each price element would be associated with a particular 
value representing payment accruing to economic function, not neces- 
sarily business units. The difference between the net values or value 
added in productive operations, as computed by the Census of Manu- 
factures, and the value of income payments would be mainly in the fact 
that the former may include a sum of value retained by business units as 
addition to surplus (that is, not disbursed). A further minor difference 
arises from the fact that there may be income payments representing not 
current production but the use of facilities or properties created in the 
past. Approximately, however, the flow of payments as income to 
people closely parallels the net value of the nation’s economic effort 
currently. But for the appropriate price index corresponding thereto, 
we have at present no satisfactory independently constructed series; we 
must fall back upon such rough approximations as measures of th^ 
general price level or perhaps the cost of living. 


It is not necessary, however, that we restrict ourselves to the fore- 
going method in measuring changes in aggregate personal income by the 
net value of production and service minus surplus of business units. The 
aggregate values can be approximated by adding up payments (or esti- 
mates thereof) during a given period of time to the various groups of 
recipients of business, property, and governmental income. To these 
totals various adjustments can finally be made to allow for business sav- 



ings and capital formation. Estimates of the national income, in the 
sense of aggregate payments to individuals, have been prepared by Robert 
F. Martin, reaching as far back as 1799, although from that point until 
1899 the available estimates provide a figure only at 10-year intervals, 
thereafter annually.^ For the National Bureau of F^conomic Research, 
Simon Kuznets has also prepared very careful estimates of national 
income, beginning at 1919 and continuing earlier and less complete esti- 
mates of W. I. King and others. A third source of income data is the 
U.S. Department of Commerce, which has drawn upon the methods of 
the two foregoing agencies in making estimates beginning at 1929 and 
extending in monthly form currently. Prior to 1900 the best we can do 
is to carry backward Martinis figures, after making some minor adjust- 
ments in the totals, using our annual index numbers of physical trade 
adjusted by a general price-level index as the basis for this annual 
extension. 2 

Another way of expressing national values of the flow of useful 
wealth might begin, not with payments to all individuals but with the 
outlays made by consumers. Adding to such outlays for goods and 
services the capital expenditures, such as for housing, durable household 

^ This series of income payments for the United States was prepared by the 
National Industrial Conference Board under the direction of Robert F. Martin. The 
results are contained in ^‘National Income in the United States, 1799-1938,^' New 
York, 1939. In this volume will be found totals of national income, private-produc- 
tion income, income from government and miscellaneous sources, and also data 
classified according to industrial and functional groups. 

* Our index of national income extends back the total national-income estimate 
from the 1900 figure obtained by Martin, after an alternative segment for Martinis 
agricultural income has been substituted. From 1900 to 1928 the adjusted figures of 
Martin are used and from 1929 to the latest available date, the figures of the U.S. 
Department of Commerce for income payments to individuals without the detailed 
adjustments for pensions, benefits, or relief payments. It is surprising to find that 
the adjusted figures of the Conference Board, when compared with the estimates 
arrived at in the latter fashion, agree very closely for the years in common. Further 
details are given in Appendix 4. 

The brilliant work of Simon Kuznets in connection with the National Bureau of 
Economic Research investigations in national income is embodied in a number of 
detailed volumes, and his discussion of concepts and description of methods may be 
found in “National Income and Capital Formation, 1919-1935,” New York, 1937, and 
in the more recent and complete study “National Income and Its Composition, 1919- 
1938,” 2 vols., New York, 1942. For a description of the U.S. Department of Com- 
merce figures on national income, mainly prepared under the direction of Robert R. 
Nathan, Frederick M. Cone, and E. A. Tupper, see the pamphlet “Monthly Income 
Payments in the United States, 1929-1940,” U.S. Department of Commerce, and the 
pamphlet “Income in the United States, 1929-1937,” published by the U.S. Depart- 
ment of Commerce, November, 1938; also, occasional issues of the Survey of Current 
Business, Revisions of these figures are made from time to time, and the user of such 
statistics must keep in touch with these changes. 



equipment, etc., the results would be roughly equivalent to those arrived 
at by the preceding method. Both methods might afford national- 
income results equivalent to the adjusted net value of current production 
and service. In other words, national income can be conceived either in 
terms of the adjusted net value of production and service or from the 
standpoint of the outlays made by, or payments made to, individuals. 
Perhaps the clearest way to summarize the ideas involved would be to 
say that totaling the payments made by all business to all individuals 
(including those who work for themselves) constitutes a highly significant, 
statistically practicable way of conceiving and estimating the national 
income. A broader concept would be arrived at by allowing for the 
undistributed savings made by business units and by governmental 
bodies; and if we allow for such savings (considering them as plus or 
minus, as the case may be), our totals would be equivalent to the ‘'net 
value’’ of all economic or commercial production. This latter total 
would include the net value of all consumable finished goods produced 
plus additions to inventories of goods and exports of goods and services, 
the latter items being, perhaps, a form of capital formation or saving. 
In the statistical results of the National Bureau of Economic Research 
and the U.S. Department of Commerce will be found estimates con- 
forming to both these ways of conceiving national income. 

A marked advantage of a measure of national income in any of the 
foregoing senses is that we can make some comparisons among the various 
economic segments for which data may be available. This cannot always 
be done with significant results in terms of physical volume of production 
or trade. It must be remembered that although physical magnitudes are 
our only reliable measures of change in total real income, the investigation 
of dynamic changes in the distribution of real income are best arrived 
at by the use of money values. And for some special purposes of impor- 
tance, the physical product alone tells us very little with respect to 
either the money income or the real income of a particular group. One 
of the most important of such cases is that of agricultural income. 


Although the farm population of the United States is now barely 
one-fourth of the total population, the opinion is still frequently expressed 
that the gross income accruing to farmers or the degree of pecuniary 
prosperity among the rural population has a very considerable influence 
upon the soundness and vitality of the entire business system. Of 
course, it is obvious that agriculture is not in fact a single and homo- 
geneous industry. The term “agriculture” is applied loosely to what is 
really a conglomerate of many distinct occupations, which differ one 
from another in mau^ pjiportaiit respects. They differ to a certain 



extent for reasons of geographical location and concentration. But in 
spite of these diversities there are certain more or less common char- 
acteristics involved in the raising of crops from the soil and the breeding 
of animals. This justifies the attempt to measure the movement of 
prices, production, and income for the ^'aggregate farm enterprise’^ 
as well as for particular subgroups of farmers. 

Before discussing these measurements and their relationship to the 
general long-term drift of national income, it is well to remind ourselves 
of some of the peculiarities of most farming operations. Agriculture is 
in some respects a type of business.” Yet in other respects it is, in the 
common phrase, a “way of life.” Most farmers live with their work, 
and the business aspects of their operations are peculiarly intermingled 
with the maintenance of household and family. To take farmers gen- 
erally, they represent the survival of small individualistic enterprise, 
despite the fact that there has been a fair development of large-scale 
and even incorporated farming enterprise. In certain localities of the 
South and the Pacific Coast, these are mainly adaptations of “planta- 
tion” systems. There has been a gradual drift toward a larger propor- 
tion of tenants and a declining proportion of cultivators who own and 
operate their properties. But despite all this, the farmer remains the 
outstanding type of medium and small-scale entrepreneur. He typically 
operates in a highly competitive market, which, despite tariffs, is affected 
by world-wide conditions of agriculture, prices, warfare, and prosperity. 
In recent years the stark results of competitive forces upon American 
basic agriculture have been tempered by governmental farm-aid policies 
and the development of a greater degree of coordinated and cooperative 
effort among farmers in production, marketing, and finance. If we take 
a long view of the fortunes of agriculture in this country since the begin- 
ning of the nineteenth century, there is revealed the drama of hundreds 
of thousands of producers alternately prospering and suffering from the 
results of their individual miscalculations and the impact of varying 
demand for their products throughout a virtually world- wide market. 
The individual by his own plans and efforts has no effect upon the general 
market forces controlling the value of wheat, cotton, and similar basic 

Farming has been a relatively easy industry to enter. Even today 
it is still true in many rural sections that the farm unit is essentially a 
household, all of whose members contribute to the enterprise. Farms 
pass from one generation to members of the next. Once established, 
however, a farm of even modest proportions tends to be continuously 
worked, to the point of complete erosion of soil or radical population 
shift. Farm production from year to year, particularly field-crop 
production, is geared to weather conditions that are not yet capable of 



long-range prediction. The raising of crops requires a large expanse 
of area to provide exposure to sunlight and other atmospheric and 
chemical factors. The acquisition of land requires capital, and the 
young farmer more often than not begins his career in debt, even if he 
carries on the family enterprise. The equipment, the structures, and 
the drainage system, however limited in scale, represent financial com- 
mitments and obligations that tend to hold the farmer to his land, unless 
extraordinary circumstances tempt him or force him off. As long as he 
continues to produce (and it is estimated that it requires seven or eight 
years before the typical farmer begins to earn anything on his invest- 
ment), the processes tend to be continuous. The farmer essentially 
produces ahead of demand. A given crop, once planted, is not likely 
to be abandoned regardless of market conditions. In times of depressed 
prices, there may be a tendency to introduce some diversification, if that 
is possible, or to vary proportions as among several possible crops. But 
these responses to market conditions are slow and irregular. 

American agriculture has long been characterized by a high degree 
of specialization with respect to important products. Although this 
condition is now in process of gradual change toward gi'eater diversifica- 
tion, in past decades the concentration in such products as corn and 
hogs, cotton, wheat, and even some fruits hsis been a typical and impor- 
tant characteristic of our agricultural system. In these more specialized 
segments, such as cotton in the Old South — perpetuating a plantation 
system — the response of plantings to previous market conditions has 
been notably imperfect. Occasionally, exceptionally favorable market 
situations will lead cultivators to expand their acreage recklessly and 
even to migrate to new areas to take advantage of boom conditions, and 
production consequently expands. Curiously enough, although such 
occasional exceptional price stimulation to production has usually 
resulted in some additional output, the reverse conditions of very low 
prices and low money returns have not tended to decrease the incentive 
to produce, either promptly or in degree. In fact, there is reason to 
believe that when markets are very unprofitable, the typical farmer still 
continues the routine of seeding and cultivating and harvesting, and in 
highly specialized agriculture there is really no alternative. The reason 
lies in part in the overhead charges, which are relatively high in agri- 
culture; a small crop or none at all provides no answer to the individual 
farmer’s financial problem. As previously stated, and the point is worth 
repeating, agricultural production tends to vary from year to year in 
close correspondence with the yield per acre, which is a function of the 
weather primarily, while the acreage responds irregularly and usually 
slowly to market factors. The production of animals represents some- 
what different types of routine revealing curious examples of cyclical 


pattern and responses to internally generated relations between prices 
of products and cost of feed. 

To measure annual changes in agricultural income, our index will 
be built up from the value of the products rather than the payments to 
those participating in farming. These values will be gross rather than 
netf because we are dealing with extractive activity and raw materials, 
priced at the source of operations. This gross income will not be pre- 
cisely comparable with that developed for national-income payments 
as a whole, but significant comparisons will be possible. Let it be recalled 
once again that total national income, as we are conceiving it, represents 
all payments to individuals corresponding to the value of their participa- 
tion in production, as measured by wages, salaries, the receipts of those 
operating their own enterprises, interest, rent, dividends, etc. ]3ut in 
the case of farmers and also miners, lumbermen, fishermen, etc., the 
income is considered to represent the value of what is produced (with 
minor adjustments). We must be careful not to interpret such income 
(or, for that matter, national income) as implying anything in the nature 
of net profits. 

The gross value of the products of agriculture, then, represent the 
money values of the crops on either a calendar- or crop-year basis, at 
prices receiwd by farmers. There are fairly reliable official figures 
available for these ^‘farm values,’^ beginning in the 1870's. Prior to 
that period we must carry back the record by data approximating such 
values, as explained in Appendix 5.^ 

Let us now turn for a moment to physical production. Since the 
various types of agriculture have their own peculiar rc'lationships to 
weather conditions or, in the case of animals, to the production cycles 
and since there are many hundreds of farm products, an index of physical 
production, representing average changes in the grand total, has an 
important characteristic that distinguishes it from total industrial out- 
put. An annual production index for agriculture would accomplish the 
smoothing out of many diverse output patterns. If we take, let us say, 
a number of series of field-crop production and combine them in an annual 
index, with appropriate weights expressing the relative importance of 
the products, the index would describe a succession of elevations and 
recessions. But this pattern would not closely correspond to the produc- 
tion patterns of the individual crops, unless a group happened to be very 
heavily weighted by a crop having a distinctive production pattern. 

^ From the total farm values, a deduction of roughly 12 per cent would allow for the 
value of seed and fertilizer and depreciation of equipment. Duplication is avoided 
by interpreting ‘‘production** as that portion of total output which is either marketed 
or used for consumption by the farm family but excluding that portion which is fed 
to animals or used in further production, whose final values alone are counted. 



The more items we include in such an index of agricultural production 
the more weather and other erratic factors tend to offset each other in 
their effect on particular products, and the line is thus smoothed out to a 
remarkable degree. 

Chart 12 (upper curve) shows this principle very clearly in terms of a 
comprehensive farm-products index. From year to year the changes 
in aggregate volume are relatively small. Compared, however, with 
the pattern of agricultural 'price changes, prepared on an equally com- 

Chart 12. — Total agricultural production, trend of demand for farm products, and 
agricultural prices. The trend of agricultural profluction in the United States precisely 
parallels the trend of demand for farm products expressed in an index combining total popu- 
lation and the physical volume of agricultural exports {V. S. Department of Agriculture 
data), the latter weighted proportionally to the ratio of farm export values to national 

prehensive basis and plotted on the same ratio sale, the production 
variations fade into insignificance. Here we are dealing with a field of 
operations in which prices happen to be predominantly important, not 
only in themselves and in their relation to the prices that fanners pay 
for what they buy but as contributing to fluctuations in the value of the 
output. Market prices, as they vary, generate most of the variability 
in values, and output enters in mainly in terms of its long-term growth 

In Chart 12 there will be noticed another striking characteristic of 
agricultural production in the aggregate. Through the variations in the 
production index a trend has been drawn. Just below this is seen another 
trend of almost exactly the same gradient but entirely independent. 



This is an estimate of the trend of demand for total farm output. It is 
based upon the hypothesis that the drift from year to year in aggregate 
demand for farm products is determined by two factors — the domestic 
market and the foreign market. For the foreign market we have export 
figures (in the form of a volume index) to trace the course of that phase of 
total demand. For the domestic market we use (as a preliminary 
hypothesis) an index of total population. The justification is obviously 
that apart from a few items such as textile materials, hides, feed, etc., 
most agricultural production is used for food. There cannot be more 
food consumed in the country than the average capacity for absorbing 
food-energy units multiplied by a population factor. Biologists have 
shown that this average per capita food intake, although subject to minor 
changes, is surprisingly steady from year to year and over extended 
periods. To be sure, there has been some gradual shifting in the food 
use per capita. We average today perhaps a somewhat lower per capita 
intake measured in calories than was true a century ago, when more 
physical effort was necessary in the everyday activities of individuals. 
Today we are more sedentary, and both work and recreation are lightened 
physically by the use of power-driven apparatus. The increased use 
of power equipment in agriculture has been a minor distorting factor 
by reducing the demand for feed for draft animals and therefore reducing 
the human per capita demand for grains. There is a shifting from 
breadstuffs to vegetables and sugar; there are other shifts to or away 
from various animal products. 

Nevertheless, if we combine in an index number the two simple 
elements previously mentioned, total population (given the major 
weight) and the index of volume of farm exports (the latter smoothed 
out), we obtain a composite demand trend that so closely parallels the 
trend of agricultural production that for all practical purposes the one 
curve is indistinguishable from the other. It is on the basis of this principle 
that we can work backward historically to periods where actual produc- 
tion data do not exist to obtain a reasonably close approximation to 
farm production as one factor in farm income. The population index, 
establishing for practical purposes the drift of total farm production, 
adjusted by an index of average change in the price of many agricultural 
products (these figures being now readily available) provides an approxi- 
mate index of the value of farm production capable of being carried 
back to the beginning of the nineteenth century.^ By keying these 
index numbers into the gross income values, as computed in more recent 

^ It should be added, as explained in Appendix 5, that in the case of cotton it was 
found possible to estimate the annual value of the crop, and these estimates of value 
were added to estimates derived by the foregoing method of value approximation, 
excluding cotton. 



years, we can extrapolate backward to obtain an extended continuous 
series of estimates capable of being compared with the estimates of total 
national income or other value data. By having long series, we may 
be able to draw conclusions that would not be possible from the study of 
a few decades only. 

ICOO 1810 1820 1850 1840 1850 I860 1870 1880 1890 1900 1910 1920 1930 1940 

Chabt 13. — Agricultural and business indexes, 1800—1940. For description of the data see 
Appendix 6. For identification of war periods see Note to Chart 7. 

In saying that agriculture is a type of enterprise in which (gross) 
income is peculiarly affected by price movements, it is necessary to 
formulate the principle a little more carefully. We must distinguish 
between long-run and short-run observations. From year to year it 
can be said with a fair degree of precision that the income of farmers 
(and those directly dependent upon farm revenue) will vary almost 



in unison with the average change in farm prices. Over periods of 
some length, such as several decades, this would not be perfectly true, 
because of a trend that might exist in the aggregate production. So long 
as this trend rises, the pattern of income accruing to agriculture will 
approximate that of the farm-price index tilted upward at the angle or 
gradient equivalent to the production trend. This appears clearly in 
Chart 13, upon which have been drawn the indexes of national income, 
total farm income, and farm prices.^ If the farm-price index, shown 
at the bottom of Chart 13, were tilted up to the proper slope, it would 
virtually synchronize with the index of agricultural income. In view 
of this vastly important influence of prices in determining the value 
of income and in view of the fact that the year-to-year farm price move- 
ments have such a close similarity to the broad variations in the general 
price level, discussed in Chapter 5, what conclusions can be drawn as 
to the effect of monetary inflation and deflation upon farm income? 
What effect does that income have, in turn, upon total national income? 
In investigating these important relationships as we proceed, the reader 
is reminded that it is important to distinguish carefully between the 
short-term, year-to-year fluctuations and the longer trend movements. 


We have already had occasion to observe in Chapter 2 that the trend 
of our population, which so closely governs the drift of total farm pro- 
duction, has for many years been rising more slowly than the trend of 
total production and trade. This would account for much of the gradual 
divergence between an index of national income (income payments) and 
that of total farm income (farm value of products). This growing dis- 
parity became marked following the Civil War. As for the pattern of 
major fluctuations ^ there is a high degree of similarity between the two 
income measures, although it was somewhat more marked prior to the 
Civil War than after. Since national income is made up of unit-price 
elements and physical- volume elements and since the price elements, 
as a whole, vary more or less in unison with variations in the general 
price level (and to a fair degree, also, the farm-price index), we should 
expect to find a certain degree of similarity between the fluctuations in 
the income patterns. But a close inspection of Chart 13 reveals that the 
farm income has experienced more violent changes during major price 
fluctuation than did total national income. This is seen, for example, 
in the movements culminating in 1821, when farm income declined 
much farther proportionately than did national income, and it continued, 

^ The price index shown in Chart 13 represents the wholesale prices of agricultural 
products rather than prices paid to farmers at the farm. In terms of index numbers, 
there is no appreciable disparity in these patterns on an annual basis. 



in fact, to decline for a year beyond the bottom established by the general 
index. In the succeeding pronounced rise in farm income, culminating 
in 1839, the momentum was somewhat more pronounced than in national 
income. It is interesting again to observe that farm income reached its 
peak slightly later than national income. The ensuing decline in farm 
income was much more pronounced than in the case of national income 
as a whole. The next period of pronounced general expansion was one 
of roughly parallel movements, interrupted by some irregularities prior 
to the Civil War. Following the income peak during the Civil War, 
when the greenback inflation was such a pronounced factor in the price 
level, we again see the tendency for farm income to shrink more violently 
than national income, which, in this case, moves along a more or less 
horizontal drift for more than fifteen years. And during the 1880^s 
and far into the 1890’s, farm income tends to be maintained on a fairly 
steady level, while national income describes a decided rising trend. 

The entire period following the Civil War reveals an interesting 
divergence between the broad movements of farm income and those of 
total national income. During this long interval prices of farm products 
were drifting along a definitely downward trend, which reached its 
bottom in 1896, about the same time that the general price level reached 
its lowest point. Thenceforward, farm income rose, probably as the 
result of infusion of new gold into the credit system and also as the result 
of the favorable market for agricultural products abroad and in the 
fast growing industrial centers of the country. But its rate of increase 
was not quite as marked, down to World War I, as was that of total 
national income. World War I brought a pronounced inflation of farm 
income, very closely approximating the pattern of farm prices. National 
income also spurted to a new high point, culminating in 1920, as the prices 
of many nonagricultural products, finished goods, and services reached 
very high prices in 1920. The reaction in national income in 1921 was 
again distintinctly minor in comparison to the deep decline in farm 
income and farm prices. It will be noted, however, that farm income 
reached its peak in 1919, and there were then two years of decline, whereas 
there was but brief interruption of a generally rising drift in national 
income in the year 1921. Farm income then recovered for a few years, 
tabled off, and relapsed into the deep depression of 1932, once more 
far exceeding the rate of decline in national income as a whole. 

It will also be noted that with the tendency for total farm production 
to drift sidewise in recent years, the income pattern for agriculture more 
and more closely approximates that of farm prices shown at the bottom 
of the chart. For some of the individual components of farm production, 
the correlation between prices from year to year and income is remarkably 
close, and in some cases this is even maintained over periods as long as 



several decades. More and more, therefore, American agriculture will 
be dependent upon prices for changes in revenue accruing to the farming 
segment of the population. This clearly explains the emphasis insistently 
placed by agricultural politicians and organized farm pressure groups 
upon 'prices, price relationships, and the monetary circulation. This is 
why inflationary ^'riders’’ are attached to appropriation bills in Congress. 
This emphasis is no mere accident or idiosyncrasy; it emanates from an 
inherent characteristic of this industry and an awareness of the manner 
in which income can be manipulated by exerting the proper degi-ee of 
pressure on the monetary and fiscal policies of Federal administrations 
incapable of resisting such group pressures. 

In the comparisons made possible by the indexes shown in Chart 13, 
one of our objects is to determine to what extent, if at all, the major 
fluctuations in agricultural prices and income have contributed to the 
long-term wave movements in general industry and trade. These wave 
movements appear at the top of the chart in the intermediate trend that 
runs through the general index of business. The second curve from 
the top is another agricultural measure, in the form of annual estimates 
of the “purchasing power of agricultural income. We are interested 
now in two relationships. First, we wish to observe the extent to which 
the pattern of the intermediate business trend may be accounted for 
by the major price and income changes emanating from agriculture. 
Second, we are interested in comparing the actual business index with the 
nearest available approach to an equivalent measure of real income for 

From the evidence presented in Chart 13, the conclusion may be 
drawn that whenever farm money income has suffered an unusually 
marked depression for an extended period, the intermediate trend of 
general business seems to have reflected this situation by moving through 
a trough rather than a period of unusual acceleration. This may be noted 
in the early 1820^s and to a certain degree in the early 1840^s and in the 
years immediately following the peak of Civil War inflation, although 
the succeeding flattening out of agricultural income fails to correspond 
to the pattern shown by the underlying drift of general production and 
trade. Following the downward inflection of the intermediate trend 
of business in the 1920^s and through the 1930^s, the index of farm income, 
although vibrating violently, pursues a definitely downward course, in 
contrast to the steadier behavior of total national income. These cases 
are not entirely clear-cut, but they tend to substantiate the view that 
unusually severe and prolonged agricultural depressions may be a con- 
tributing factor in restraining the progress of total production and trade 
to the extent that the intermediate trend of this activity is depressed. 
In the case of periods of unusual and relatively rapid expansion in farm 



income (still referring to dollar values), the principle is much less clear, 
and, indeed, it is doubtful that the available factual evidence would 
support the proposition that rapid acceleration in the intermediate 
trend of business volume is essentially dependent upon the behavior of 
farm income. 

Turning now to the relationships expressed in a different form, let 
us explain further the meaning of the second curve from the top in Chart 
13, showing an index of agricultural buying power. It is obvious that 
there are peculiar difficulties confronting the attempt to construct a 
physical index of the degree of farm ‘^prosperity.’’ This follows directly 
from the fact that fluctuations in total agricultural production, although 
they contribute to the shaping of the trend of farm money income, do not 
have much to do with the short-term variations in that income. This is 
even true in terms of changes in real income or purchasing power of the 
farmer’s dollars over nonagricultural goods and services. In years of 
relatively large production, farm prices fall, and total farm income usually 
declines unless, at the same time, there are opposing forces in the general 
price level of overwhelming importance. In other words, year-to-year 
changes in farm production as such do not establish corresponding varia- 
tions in farm real income comparable to those measured in the index of 
national real income as this responds to variations in general production. 
The real income of the entire nation does consist primarily of the current 
flow of product, of goods and services, and, of course, these include the 
products of agriculture. But the farmers’ aggregate claim upon all these 
goods and services is expressed in the market by the amount of money 
the farmer is able to offer in exchange, and this, by and large, is not a 
variable corresponding over limited periods to his total output. In 
order to compare annual changes in farm real income with change in 
total real income, as measured by the course of general production and 
trade, it is necessary to resort to an index of farm “purchasing power.” 
This expresses the changing value of farm products “deflated” by an 
index of the cost to farmers of things they typically purchase as a group. 
It might, of course, be argued that a close comparison of farm income 
with general income in dollars would of itself allow for this price element, 
to the extent that its pattern happened to be similar for farmers and for 
the total population. But insofar as the farmer’s typical outlays repre- 
sent types of goods or equipment differing in some measure from those 
associated with the outlays of the much larger urban groups, comparisons 
by way of money income alone are probably not completely satisfactory.^ 

^ Several types of index numbers of farm living and production costs have been 
prepared, notably by the U.S. Department of Agriculture. A careful comparison of 
the annual data from 1910 to 1940 discloses that it makes no great difference whether 
one uses indexes of the coat of commodities, used typically on farms, or more compre- 



The annual index of farm purchasing power shown in Chart 13 is 
based upon the principle that a ratio between changes in farm money 
income and prices of commodities that farmers buy approximately reflects 
the broad movements in the purchasing power or real income of the farm 
population. This is not the same as a measure of net profits of farm 
operators. As shown in Chart 13 this index, in comparison with the 
general business index in terms of intermediate trend, points to conclu- 
sions similar to those pertaining to income values. Again we find it 
true that extensive periods of depression in farm real income also mark 
long periods of hesitation or stagnation in general production and trade. 
It appears again that in periods of rapid acceleration in the trend of farm 
real income, there have been similar movements in the intermediate 
trend of general business. In this respect the comparison points in fact 
to a somewhat more positive result than in the case of the money-income 
data. During the long interval between the Civil War and World War 
I, the real income of agriculture tended to rise with less hesitation and 
cyclical irregularity than was noted in the drift of money income. But 
the trend is notably more restrained than the rapidly accelerated trend 
of general business during those years. In the period since World War I, 
about the same conclusions would follow as in the case of money-income 



To be sure, it can be argued that in these periods of major depression, 
as well as in long periods of general business acceleration, the causal 
influences may have run mainly /rom industrial to agricultural conditions. 
The writer is disposed to believe, however, that this is not the proper 
way to state the case as to the longer term variations. Tlu^ changing 
phases of farm income during what may be termed the major cycles 
appear, on the whole, to have contributed more to determine the pattern 
of general business than the reverse. Farmers have invariably increased 
their indebtedness during periods of exceptionally high prices, thus 
making the initial years of price-deflation periods of exceptional hardship 
and abrupt curtailment of expenditures in many directions. Further- 
more, it must be remembered that major difficulties in agriculture are 
transmitted throughout the business system in several ways. They 

hensive measures, including also such cost items as interest, taxes, wages, and depre- 
ciation. In order to work with long-term data, it seems best to deflate farm gross 
income by as homogeneous a commodity-cost index as possible. It is not wholly clear 
that even were the more complete cost measures available prior to 1910, they would 
reflect changes which are as typical of general farm experience in making expenditures 
as is the case with well-selected and weighted commodity data. See Appendix 5 
for the method of deriving the real farm-income (or purchasing-power) index. 



exercise an influence through the effects created on the credit structure — 
through the long-drawn-out processes of liquidation, foreclosure, and 
credit destruction — which leaves its trail of ruined rural banks and the 
effect of this ruin, in turn, on other banks. 

Periods of extended agricultural depression have always generated 
powerful social pressures and political movements capable of disturbing 
confidence and seeking in one way or another to raise or ^‘reflate” the 
price level and restore the good old days of farm prosperity and solvency. 
Unfortunately, these organized pressures have been capable of slowing 
the wheels of industrial progress by creating apprehension and uncer- 
tainty, discouraging capital investment and new enterprise. We shall 
defer to a later chapter some more detailed discussion of the acute 
difficulties arising mainly from agricultural maladjustment on a world- 
wide rather than merely national scale during the late 1920^s and early 
1930^8, a remarkable period of agrarian protest translated into far- 
reaching changes in the popular attitude toward finance, capital, industry, 
and productive progress. 

Before concluding, we may refer to still a third reason for considering 
that agriculture has primarily transmitted its influences to the waves 
of business conditions. As already stated, agriculture cannot readily 
readjust itself. The production routine permits but slow and gradual 
revision in the case of most of our basic products. A manufacturer can 
usually alter his procedures, his location, his business structure, even 
to the extent of introducing new types of products. For agriculture the 
problems of diversification or of shifting from one major product to 
another are tremendous problems. The rigidity and the force of custom 
are primarily rooted in the fact of direct concern with natural processes. 
Over periods of five or ten or fifteen years, possibly even longer, there 
may be persistent excesses of production, particularly during periods 
of major war and following cessation of emergency demands or readjust- 
ments of foreign markets, the term excess referring to such supply as 
creates pressure upon prices relative to other goods. 

The retail prices of farm products are less sensitive and volatile than 
are farm or wholesale prices. Consumers of farm products in the cities, 
therefore, do not find prices that they pay reduced during periods of such 
surplus production as much or as rapidly as one might suspect. The 
distributive system seeks to dispose of a larger total supply of food than 
can all be sold at the resistant prices prevailing in city markets. As a 
result, part of the raw-material supply accumulates as carry-over. 
Eventually a still more severe decline in prices is likely to occur unless 
export demand happens to expand. Although some urban living costs 
are cut, industrial employment may be reduced also if impairment of 
deiTiand or political agitation arising from rural discontent and protest 



act as restraints upon the aggregate demand for industrial products. 
Thus, in the farm production system, there seem to be potential forces 
capable of providing distinctive and potent influence upon the entire 
economy, not only through sustained aberrations in purchasing power 
but through the efforts of a large social group to regain lost purchasing 
power by political maneuvering that for years can effectively retard 
enterprise in other fields, where steady progress depends much upon 
confidence in the stability of the financial mechanism. 

Chart 14. — Relative changes in farm prices, per capita income, and farm exports, 


It has been suggested that declining farm prices are an advantage 
to industrial development because food and clothing are among the 
important costs in supporting the families of industrial workers, account- 
ing for roughly one-half of the total annual expenditures of urban wage 
earners. A reduction in such prices does not ordinarily increase the 
amount of consumption, although probably clothing purchases maj^ be 
somewhat expanded. Lower food and textile prices at retail, although 
not immediately responding to the sensitive wholesale or farm markets, 
eventually follow their course, and the result is no doubt a saving to the 
urban population. This saving presumably can be applied in other 
directions, to the purchase of houses, of automobiles, and of other equip- 
ment of a durable nature. This would increase the demand for many 
products of urban industry and for transportation and other services. We 
have already presented reasons, however, for believing that this process 



alone would not immediately serve to lift the general level of production 
and trade out of a long major depression. But if one will again observe 
the curve of the prices at the bottom of Chart 13, he will note an occa- 
sional contrast between unusual declines in farm prices in their later 
stages, as they approach bottom, with a volume of general business again 
beginning to accelerate enough to affect the intermediate wave trend. 
Notice, for example, the situation from about 1826 to 1830 and from 1880 
to about 1892. Perhaps we may say, as a tentative hypothesis, that 
long-continued declines in farm prices in their later stages do not seem 
to correspond closely to the pattern of general industry, and the reduction 
in living costs for maintenance of the urban population, after it has 
continued a long time, may contribute sufficiently to industrial accelera- 
tion to create something of a rebound effect still later to agriculture 

In concluding this discussion, it may be helpful to state these relation- 
ships in a somewhat different form. In Chart 14, farm income, relative 
to estimated farm population, is expressed as a ratio to per capita national 
income. In neither case were the income data adjusted to a real income 
basis. In this chart are also shown the annual ratios of farm-product 
prices to wholesale prices of nonagricultural products and two ratio series 
relating to agricultural exports. 


Let us refer first to the index of relative per capita farm income. 
This index clearly reflects the war periods of price inflation and the 
long-continued postwar deflation. In this form the data indicate that 
the relative position of agricultural income for many years following 
major wars is even more unfavorable than was suggested by Chart 13. 
It is evident also that following the major wars, the immediate decline 
in the relative income of agriculture is followed by several years of a 
sustained higher level, although following World War I this was much 
less marked than in previous cases. Another interesting feature is that 
there was a rising ratio of farm income to total income prior to each of 
the important wars, the War of 1812-1814, the Civil War, and World 
War I. The war-prosperity periods have the appearance of climaxes, 
topping off the rising drift of the preceding periods. When the index 
of relative farm income is compared with that of the ratio of agricultural 
to nonagricultural prices, there is more or less similarity of movement, 
but it is curious that the broad secular trend of this ratio is upward, 
whereas the broad trend of the relative income, at least since the Civil 
War, has been definitely downward. Not only are the trends in con- 
trast but the year-to-year changes also do not correlate in their move- 
ments in anything like the degree that one would imagine who may have 



done his thinking about agricultural problems under the influence 
of current political emphasis upon price parities’^ and price ratios. 
Despite all that may be said of the very important part that prices do 
play in farm income, the relative position of the farmer is not 'perfectly 
measured by this yardstick. 

Following World War I, the relative position of agricultural income 
was sustained for a brief period. Then came an abrupt collapse, followed 
by but feeble recovery. From this level a further decline brings the 
index to the lowest level of the entire period, and this is again followed 
by a relatively feeble recovery, then by relapse. The American farmer 
appears since 1920 to have been in a much less favorable position than 
is commonly supposed. While we are discussing these broad tendencies, 
let us seek the causes underlying this extraordinary sagging tendency in 
relative income. One of the underlying factors seems to have been the 
less rapid rate of growth of the general population, coupled with declining 
per capita consumption tendencies for several important staples produced 
on farms. Probably more important has been a progressive deterioration 
of the farmers^ export market. The failure to maintain even a reasonably 
satisfactory per capita relative-income position can be attributed largely 
to a substantial weakening of foreign demand that was actually begin- 
ning even prior to World War I and that, following the brief artificial 
stimulus of that period, has been intensified in recent years. 

Fortunately, we have good statistical data to demonstrate this 
tendency. Chart 14 shows an index of the ratio of the value of agricul- 
tural exports to farm income and also, beginning at 1866, an index of the 
physical volume of farm exports per capita of farm population.^ It was 
customary in the early years of the nineteenth century to think of farm 
exports as an outstandingly important phase not only of agriculture 
but of our foreign trade as a whole. From the beginning of the century 
until as late as about 1890, farm products constituted close to 80 per 
cent of the value of all domestic merchandise exports. After about 
1890, because of the extraordinary acceleration in manufacturing enter- 
prise, farm exports began relatively to shrink, until in recent years, prior 
to World War II, they were barely one-fifth of all export trade. When 
farm exports are expressed as a ratio to estimated total farm income, the 
long-term pattern is somewhat different. Apart from occasional war 

1 Since the official data of exports relate to fiscal years, ending June 30, the ratio 
shown in Chart 14 was worked out for export values on the basis of fiscal year exports 
set against farm income of the preceding calendar year (, calendar-year income of 
1900 against fiscal-year exports of 1900-1901). The data of volume of farm exports 
per capita of farm population relate to fiscal years and are plotted to correspond with 
the foregoing data. Farm population prior to 1850 was estimated on the basis of 
recent data of the U.S. Department of Agriculture, extrapolated backward propor- 
tionately to the Census data of rural population, calibrated to annual form. 



years, when exports were sharply curtailed, the proportion of total farm 
income represented by sales abroad rose during the nineteenth century 
from around 10 per cent to as high as 34 per cent in 1880. This was the 
historic peak from which there ensued a gradually declining tendency, 
intensified after the brief export recovery during and just after World 
War I. Prior to World War II we were again back to less than 10 per 

If we express export of farm products by an index measuring relative 
changes in the physical volume of a broadly representative list of items 
and express it in terms of per capita of farm population, we find that the 
export movement has indeed described a steeply dovmward trend, which 
World War II had not, at the time of this writing, reversed in the slightest 
degree (see the lower curve of Chart 14). When we realize that our 
total export trade has seldom reached much beyond 10 per cent of the 
estimated value of all American production, this shrinkage in farm- 
product exports assumes considerable significance. If we examine a 
number of leading products, the tendency becomes even more impressive.^ 
Through most of the nineteenth century and until World War I, cotton 
exports contributed nearly 70 per cent, one year with another, to the 
total gross farm income from cotton. By 1940, cotton exports had 
shrunk to little more than a million bales — probably an abnormal 
wartime condition. Exports of wheat have usually accounted for a 
much more variable proportion of the total farm income from that crop, 
ranging from 10 to 50 per cent; but since 1920, when Europe was restor- 
ing wheat reserves from our production, the wheat farmer has obtained 
less and less of his income from exports. Much the same is true of pork 
products, which have shrunk from a 30 per cent contribution in 1919 
to farm income in that division of agriculture to about 2 or 3 per cent 
in 1940. These are instances of major farm products, concerning which 
it had become customary to suppose that they would always be on an 
export basis and that occasional surpluses could thus be disposed of, at 
low prices if necessary. But the world that followed World War I 
became a different world, striving for self-sufficiency within national 
boundaries and requiring less and less from the United States. Finan- 
cial derangements, new tanffs, quotas all have done their work. The 
foods led this decline. Cotton was successful in more or less holding 
its own until the last few years. This was true also of tobacco. Some 
specialties among the fruits and the more concentrated dairy products 
have continued to find the foreign market important, although these 

^ Interesting computations, with the use of a slightly different method from that 
employed in the foregoing, supplemented by materials on individual products, will be 
found in Frederick Strauss, “The Composition of Gross Farm Income Since the Civil 
War,” Bulletin 78, National Bureau of Economic Research, Apr. 28, 1940. 



account for a relatively small proportion of total farm income. There 
seems, then, good reason to believe that the exceptional violence of price 
collapse that marked the Great Depression and the curious difficulty 
encountered in reviving agricultural prices, despite the deliberately 

Chart 15. — Agricultural results of World War I. As the result of World War I, farm- 
mortgage debt was vastly inflated out of all proportion to the very moderate expansion in 
the aggregate physical aspects of production facilities. The decline in farm property values 
after 1920 was much more rapid than reduction in farm-mortgage indebtedness. 

inflationary measures and political subsidization of the 1930^s, are 
traceable to this ebb tide of farm export, which individual producers 
were powerless to control. It goes far to explain the movements of 
relative farm income in Chart 14.^ 

1 Regarding the policies that have been adopted to deal with this persistent 
problem and the expressions of resentment and protest from farming sections, more 
will be said in later chapters. 



We may obtain a clearer picture of the recent unsatisfactory position 
of American agriculture if attention is given to the expansion of our 
production facihties during World War I and the way in which this 
period affected farm finance. The War and immediate postwar years 
provided extraordinary export opportunities to farmers. The accom- 
panying dramatic upward sweep of prices stimulated farmers to expan- 
sion that later brought many of them to grief. Although the experiences 
of that period cannot be generalized into principles that will invariably 
apply, the facts do afford an excellent example of the manner in which 
inflation of the sensitive prices of farm products may extend its influence 
to the value of farm property, thus encouraging tremendous speculative 
activity, not so much in the actual equipment of farm enterprise but in 
financial commitments and obligations with which agriculture is left 
to struggle for decades. In Chart 15 some of the essential facts are 
presented from just before World War I to the postwar depression bottom 
of 1933. Statistical data are available to illustrate clearly what happened 
during this period, but we cannot readily measure these particular factors 
for earlier war periods.^ 

It appears in Chart 15 that the per acre estimated value of farm 
land throughout the United States responded definitely, even though 
somewhat tardily, to the wartime rise in farm-product prices. This 
farm-property-value index is an average representing many types of 
farm production. In some of the areas whose products were most 
affected by temporarily expanded demand, the index rose considerably 
higher than for the country as a whole. The rise in values was par- 
ticularly pronounced in the South Central, North Central, and Great 
Plains areas. Thousands of people, many without previous farming 

‘ The data in Chart 15 were taken from the following sources. Indexes of esti- 
mated per acre value of farm real estate from the U.S. Department of Agriculture 
Yearbooks of Agricultural Statistics; total farm mortgage indebtedness from the same 
sources, expressed in terms of farm population. Indexes of the size of the farm enter- 
prise were taken from Size and Production of the Aggregate Farm Enterprise, 1909- 
1936, Works Progress Administration National Research Project Report A-6, prepared 
by R. G. Bressler, Jr., and J. A. Hopkins, 1938, p. 19. These indexes include acreage 
of crops and numbers of livestock on farms. The combination involves a weighting 
of the individual series in proportion not to values or income but to the estimated 
labor requirements of the various items. Despite this peculiarity of weighting, the 
index is a valuable measure of the physical variations in farm enterprise. The indexes 
were reduced to per capita basis by the writer. In connection with the trend of 
mortgage indebtedness, tentative and preliminary figures are available to show the 
amount of involuntary transfer of farm properties in selected areas. These will be 
found in The Agricultural Situation, February, 1940, p. 18. The figures are given for 
five-year periods, beginning at 1910, and show the following results for each five-year 
period ending at 1934: 100 (base), 148, 287, 465, 581. Similar indexes for voluntary 
transfers are 100, 108, 70, 73, 62. 



experience, were induced by promise of high returns to expand wheat, 
cotton, and animal production in areas that had previously been unde- 
veloped. A new migration of pioneers spreading over the plains resulted 
in removal of the original soil-binding grasses and conversion of what 
should have remained grazing land into grain acreage. By 1924 the 
Great Plains were growing some seventeen million more acres of wheat 
than in 1909. In Chart 15 is also shown the general expansion in Ameri- 
can agricultural enterprise in physical terms. The upper index curve 
on the chart combines a considerable number of products and types of 
farming and shows the average change in acreage cultivated and in 
number of animals raised. This is perhaps the best measure now avail- 
able of the over-all physical response to the price and income stimulus. 
Probably the most striking increase occasioned by the War was in acreage 
devoted to small grains, particularly wheat. The small-grains index 
rose nearly 30 per cent between 1912 and 1919, the peak year. 


It is also interesting to observe that although the aggregate farm 
enterprise expanded during the War period, this, after all, was a relatively 
moderate expansion compared with the rise in land values and with the 
most interesting of all these measures, the expansion in long-term farm- 
mortgage indebtedness. The War boom was predominantly a financial 
boom, an orgy of reckless borrowing to speculate in farm-land values. 
The addition to mortgage debt is seen to have been out of all proportion 
to the effect of expansion in the physical status of crop and livestock 
development. Many farmers who were successful and prosperous, 
instead of reducing their debt, could not resist the temptation to borrow 
more in order to expand operations. Lenders were glad to lend and threw 
conservatism to the winds in the way in which they appraised land values 
and solicited loans from farmers at interest rates of 6 to 8 per cent or 
more. With the dazzling prospect of almost overnight gains in values 
and income, the farm-mortgage indebtedness reached a peak considerably 
later than the peak in prices or farm income. For the country as a whole, 
the mortage peak was reached about 1924, but in the South Atlantic 
region it was not reached until 1927, followed by the East South Central 
in 1928, the West South Central in 1930, and the Pacific States in 1932. 

At the beginning of this borrowing movement, individual lenders 
provided the largest contribution to farm capital. The commercial 
banks were the most important of the institutional lenders, followed 
closely by life-insurance companies. In addition to mortgage loans, 
there was a large amount of lending at shorter term. Producers of 
animal products were accommodated by cattle-loan companies and 
commission lenders, whose advances were enormously stimulated by the 



high prices of livestock. The continued rise, after the peak in prices 
in 1919, in the long-term debt represented bv mortgages on farm property 
is explained by the fact that loans previously made at high prices on a 
medium-term or unsecured basis were refinanced into mortgage loans. 
Lessors now desired additional real-estate security. Many farm owners 
who previously had no mortgage indebtedness financed operating losses 
after 1920 by taking out new mortgages. There was thus a continuing 
expansion in mortgage debt due to the very reversal in the situation 
and superimposed upon that created directly as a result of the inflation. 
This is rather typical of debt creation during prosperity and through 
the immediate succeeding phase of reaction, financial reverses, and 
distress. We find it in commercial borrowing as well as in long-term 
borrowing operations. 

By the middle 1920^s, commercial banks had been able to turn over a 
part of their farm loans and mortgages to the life-insurance companies, 
which then continued for nearly a decade to carry the largest part of the 
institutional mortgage burden. Somewhat prior to that time, however, 
with growing distress among farmers who had overextended themselves 
during the inflation, the Federal Government had created the Federal 
Land Banks, supplemented by the less important Joint Stock Land Banks 
as institutions for direct long-term loans to agriculture. The Federal 
Land Banks, during the 1930^s, under the pressure of new difiiculties 
partly stemming from the shrinkage in export demand, were forced to 
‘‘bail out” part of the insurance-company and bank loans, and today 
the Federal Banks are carrying the preponderant portion of all farm 
mortgages. The present loans of the Federal Land Banks (the Joint 
Stock Land Banks having been virtually liquidated) plus a large volume 
of emergency loans made in the early 1930^s by the Land Bank Com- 
missioners to meet cases of unusual distress now amount to about 40 
per cent of the outstanding farm-mortgage debt. The proportion 
carried by individuals and loan companies is about the same. Starting 
from an inflationary debt expansion, it has thus been necessary to erect 
new institutions and to accomplish several emergency blood transfusions 
in the system of farm financing. 

We can now discern several general characteristics of agricultural 
finance in the United States. One is the absence in our earlier history 
of adequately developed and specially organized mortgage-credit institu- 
tions for agriculture, adapted to the slowly liquidating operations of that 
branch of production. Until very recently we have not had a system 
of long-term mortgage credit for farmers (or, in fact, for anyone else) 
distinct from demand-deposit banking institutions, equipped with 
facilities for the rehypothecation of mortgages, and providing ready 
emergency rediscount of sound obligations of farmers. This defect 



in our financial institutions created terrible weakness among the rural 
commercial banks, which failed by the hundreds through the 1920^s and 
1930^s. As for the life-insurance companies, most of them were vastl}) 
stronger than the rural banks, but the financial emergencies of the 1920^5 
and, again, of the 1930^s forced these companies to foreclose and reacquire 
an enormous amount of rural property.^ These acquisitions of farm 
real estate by the larger life-insurance companies have indeed shown 
surprising persistence. In 1929 they amounted to properties valued 
at 88 million dollars, which had become 465 million dollars by 1934. 
At this writing it is in the neighborhood of 700 million dollars. ^ These 
holdings are far larger than the combined holdings of farm real estate 
in the hands of other lenders. 

The second feature of special importance in farming finance, empha- 
sized by war-inflation experience, is the fact that loans were made to 
farmers to finance long-term operations but with relatively short maturi- 
ties andj in many cases, inadequate provision for regular amortization. 
This has been a common feature of mortgage financing in general in the 
United States. It has bearings, as we shall see, in many directions. 
This defect cannot be too strongly emphasized, because it has been 
strangely overlooked as a factor in generating economic disturbance and 
maladjustment. It underlies the failure of the capitalistic system to 
operate efficiently and its tendency to break down under the unusual 
stress occasioned by great political emergencies. The practice of creat- 
ing 25- or 30-year loans on a 5-year basis, throwing all the risks of non- 
extension upon the borrowers and making no provision for systematic 
repayment of principal, has been particularly flagrant among the com- 
mercial banks, but other sources of long-term (or what should properly 
have been long-term) financing were also at fault in this regard. One 
close observer of farm finance states the matter clearly by saying: '‘The 
banker, of course, had overlooked the desirability of long-time credits 
because they did not 'square^ with his idea of liquidity. Too few banks 
had ever made the requirement of any periodical principal payments. 
A five-year maturity made his farm mortgage liquid, in his judgment.^^^ 

In this manner, under the spell of the deceptive principle of "liquid- 
ity,^' an excessive temptation was spread before our farmers to "trade 
upon their equity"; only interest payments seemed important. Here 

^ Early in 1940 the five principal mortgage-lending insurance institutions were 
estimated by the U.S. Department of Agriculture to own not less than 28 million aenvs 
of farm land. This does not include the holdings of commercial banks, mortgage 
companies, and other similar groups that also held substantial acreage. 

2 Statistics presented by Norman J. Wall, U.S. Bureau of Agricultural Economics, 
at hearings before the Temporary National Economic Committee, Feb. 14, 1940. 

® A. G. Brown, Land Values and Commercial Bank Policy, Journal of Farm 
J^conomieSy February, 1939, p. 268. 



we deal with a phase of human nature that comes close to the problem 
of business disturbances and business cycles — the temptation to trade 
upon the equity through unamortized borrowing and to forget the 
cardinal fact that merely paying 7 per cent interest on long-term loans 
does not liquidate the loans or enable the borrower to remain solvent. 
The anxiety of the lenders in many instances to preserve their liquid- 
ity^^ by reducing the period and yet participate in the lucrative long- 
term interest rate amidst the mirage of a great inflation could result 
only in the ultimate freezing of those loans and the collapse of the entire 
system of private agricultural finance. It goes almost without saying 
that with the less favorable turn in farm exports following 1929 and a 
shrinkage in domestic demand for farm products, the weight of this 
accumulating and more or less frozen farm debt became acutely embar- 
rassing. Its effect became apparent far beyond the rural sections. 

When we examine these problems of long-term financing and the 
reckless use of long-term borrowing, there are, of course, marked differ- 
ences between one farmer and another. The shrewd and thrifty farmer, 
who resisted the temptation to overexpand his obligations during and 
after World War I, was able to salt away the handsome profits of a few 
good years; he was then in a position to purchase new equipment, to 
improve his methods of cultivation, and to avail himself of new develop- 
ments in soil technology, seed selection, etc. It was he who supplied 
urban industry with effective demand for its products. The period 
that we have considered divided farm operators into two broad groups : 
one very large segment pushed by foreclosure farther down the scale to 
struggle for mere subsistence and the other a relatively prosperous 
minority, continuing to produce economically and to benefit from 
improvements in equipment and methods. This segment has been 
able thus to defy the decline of prices by being able to produce more per 
acre at less cost per unit. 

As the farm situation presented itself to our legislators in 1933, after 
the second great deflation had brought some farming areas to the point 
of revolution, it was the hapless majority rather than the efficient and 
sober minority that exerted the pressure for the subsidization and 
paternalism that we shall consider further later. Agriculture, prior 
to the occurrence of World War II, was faced by the problem of per- 
sistent surplus, and after this present War has been concluded, surpluses 
may be even more embarrassing. Rapid improvement in cultivation 
methods and expansion on the part of the minority plus the persistent 
addition to supply made by the majority of more or less unprosperous 
farmers who will not shift to other occupations readily but who keep 
on adding to supplies will probably continue to afford a powerfully 
organized vested interest, demanding doles and subsidies for years to 



come, while at the same time the urban population pays excessive prices 
to keep inefficiency intact. 

There are many observers who hope that technological progress 
may eventually greatly expand the utilization of farm products in 
industry. Possibly we are already in the early stage of a further tech- 
nical or ^'chemurgic'' revolution, the outcome of w^hich cannot as yet 
be accurately appraised. We read of the use of cotton in the making 
of roadSy the insulation of houses, or in the production of certain types 
of cellulose products and plastics. The soybean is replacing wheat in 
certain areas, and plastics possibly suitable even for automobile bodies 
and similar products may be made from them. Thousands of acres 
of land may yet be cultivated to crops capable of yielding substitutes 
for hevea latex rubber. In many areas, particularly the South, where 
cotton as king may soon be dethroned, forestry and diversified agriculture 
are encroaching on what has been this country's most unfortunate plan- 
tation institution. Doubtless World War II will hasten these tendencies 
and stimulate research anew. But all these developments may not 
suffice to give to the rural or farm population the full employment or 
return needed to establish this entire group upon a more satisfactory 
and stable income level. 

There is now a surplus acreage of perhaps as much as 30 to 45 million 
acres. Agricultural experts claim that 50 per cent of the farm population 
produces 85 per cent of the products. This means that 50 per cent of 
the farmers are responsible for only 15 per cent of the production, and 
their average income must therefore be extremely low. Why should 
this be necessary? There has been a large potential reserve of unem- 
ployed and semiemployed labor, much of it representing the younger 
age group, on American farms. This reserve has been pressing upon 
the labor supply in the cities and upon the wage level. It is not remark- 
able, therefore, that prior to 1941 we had such unwieldy unemployed 
surplus in our industrial areas, threatening a chronic situation. If the 
agricultural labor surplus should be actually further enlarged by the 
progress of technology and by further marked shifts from old products 
to new, after World War II, and if this labor supply presses upon the 
cities as the result of the re-establishment of a more nearly normal migra- 
tion flow from country to city (which was interrupted for a good part of 
the previous decade), there will be repercussions throughout the field of 

We shall conclude this chapter on the general dynamics of agricul- 
ture by quoting from an experienced observer of the dynamics of farm 
enterprise, Alonzo E. Taylor, writing shortly before the beginning of 
World War II. 



We have in this country a farm population of about 32 million, including 
gainful workers approaching 11 million in number, operating not much below 
7 million farms, containing about 1,050 million acres. Available to this farm 
population on this area of land in farms is a constantly improving and expanding 
technique in the positive sense, with a continuously improving protection against 
deteriorating influence on crops. This is entirely too large a farm area and farm 
population for a total population of 130 million, living a highly mechanized life 
and having the international purchasing power necessary to draw from all parts 
of the world desired foodstuffs not produced in the United States. The agricul- 
ture of the white world is geared to an output of agricultural staples which is 
potentially in excess of the demand of the white world, and the actual output 
tends more and more to approach the potential. Agriculture thus faces techno- 
logical unemployment and externally has the prospect of an unexpanding, or 
even contracting, need for staples which are naturally in relatively inelastic 

This should be kept in mind in connection with our previous dis- 
cussion of the importance of physical supply factors as well as industry 
factors in the general price level. It is also of prime importance in 
developing sound postwar policy in the years to come. 

i<«Why Agricultural Gluts Develop,'^ p. 28, University of Minnesota Press, 
January, 1939. 



In the foregoing discussion, attention was given to the dynamics 
of agriculture viewed from the standpoint of the major fluctuations 
extending over decades rather than in terms of years or months. It 
remains to examine the patterns of the shorter intervals and what may 
be termed the minor cycles of change in prices, production, and income. 

One feature of Chart 14 provides a convenient point of departure for 
this analysis. Observe that in years of rising relative farm income, 
there has usually been a declining tendency in the export ratio. At 
first glance this seems rather curious. It is particularly evident in the 
shorter movements, from year to year. In Chart 16 there will be found 
a more detailed analysis of this relationship in terms of monthly prices 
and monthly export volume. It appears from Chart 16 that despite a 
number of exceptions, a rising tendency in the ratio of agricultural 
prices to nonagricultural prices is accompanied by a decline in the volume 
of agricultural exports, whereas a decline in the price ratio is accom- 
panied by a rise in the export movement. It should be kept in mind that 
the reference is to the physical volume of exports, not to the value. 
Although this interesting inverse tendency is not perfect, we can con- 
clude that it is low prices that primarily attract export and high prices 
that discourage export of American farm surpluses. Export has perhaps 
repeatedly assisted in absorbing some surplus, but its influence is tardy 
and is exerted only after markets and income have suffered. The 
foreign buyers of American farm products, by and large, have come 
into the market when the farmer had larger surpluses than usual and 
except in cases of extreme emergency demand, such as during wartime, 
these foreign buyers have shopped elsewhere when our prices seemed 
relatively high or out of line with those in other surplus markets. 

The question now arises, do the short (year-to-year) cyclical varia- 
tions in farm prices, values, or income tend to precede and perhaps 
contribute to those of the typical minor business fluctuations, or is the 
converse predominantly the best description of the situation? This is a 
matter that has been long debated, and opposing views have been illus- 
trated with more or less pertinent data, not always, however, preserving 
a careful distinction between short and long periods. We shall utilize 
annual data extending back to 1800 but for the most part shall eliminate 




those fluctuations clearly attributable to war conditions, since we have 
already seen that the peculiar influences associated with currency infla- 











Chart 16. — Cyclical movements of relative farm-product prices and volume of farm 
exports, 1919-1940. The farm-product export index, in terms of physical volume, as 
prepared by the U. S. Department of Agriculture, has been smoothed by a 12-month moving 
average. The above index represents the deviations from the long-term trend. The pur- 
pose of the chart is to show the degree of inverse movement in relative farm prices and 
volume of exports, apart from long-term trend. 

tion and postwar deflation are primarily transmitted from agriculture 
to other phases of the economy. 


Let us examine first the short-term fluctuations in agricultural prices 
relative to price changes in nonagricultural products. Chart 17 shows 
the annual data of these two groups, the upper portion being the index 
of agricultural and lower nonagricultural price movements.^ It will 

^ Data taken from Demand, Credit, and Prices, 1941, U.S, Department of AgrieitL 
iurt Agricultural Outlook Charts^ p. 12. The prices are at wholesale. 



be seen that the estimated trends trace the underlying drift preceding 
and following the exceptional price explosions attributable to the war 
emergencies. These flexible trends, based upon moving averages, must 
be very carefully handled, particularly in the periods just prior to wars 
that occasion extensive inflation. Most statisticians have merely run 

Chart 17. — Agricultural and nonagricultural prices, showing inflation periods and 
intermediate trends, 1800-1940. For description of data see Appendix 6, Sec. 3. For 
identification of the war periods see Charts 6 and 7. 

their moving averages through the entire series, regardless of the fact 
that wartime inflation so greatly distorts price movements that 
there ceases to be a homogeneous concept of drift through conditions 
of peacetime and conditions of wartime. If moving averages are used to 
express these broad trends, the usual result is to show a considerable 
rise in the trend possibly ten or fifteen or twenty years prior to a war, 
simply because as the average mechanically begins to pick up the infla- 



tion years (if it is assumed that average is centered), there is a decided 
rise in the trend, and the actual price level appears then to be depressed 
far below the ^Hrend.” This is illusory. The actual level of prices 
just prior to an inflationary explosion must be shown relative to the trend 
as it was determined prior to that inflation and on the assumption of a 
nonwar give and take. After war inflation has begun to reverse itself, 
some years elapse before it is possible to ascertain just where the broad 
drift of prices marks out its path and forms a new moving center of 
gravity balancing out the year-to-year fluctuations that we seek par- 
ticularly to emphasize for our present purpose. In Chart 17, the esti- 
mates of trend position have been carefully made with this specific 
purpose in mind.^ 

In Charts 18a and 186, the cyclical price movements, apart from the 
war-inflation periods, are shown separately for the nonagricultural and 
agricultural price groups. These are brought into close comparison with 
the corresponding cyclical changes in the general index of business, these 
fluctuations being the ratios of the actual annual index to the flexible 
intermediate trend. We are interested for the moment in observing the 
relation of the two groups of price movements to each other and their 
relation also to the general business cycles. It is at once evident that 
there are many minor divergences in the price cycles. In some instances 
one group will reach a peak or trough ahead of the other, and in other 
(uises the reverse will be true. There is no consistent lead or lag either 
l)etwecn the two sets of price cycles movements or between these and the 
business index. Broadly, it is true that when business conditions have 
been temporarily above the trend, the price cycles have also shown more 
or less clearly a similar position, and vice versa. Bub there is no possi- 
bility of drawing a definite conclusion as to leads and lags or of detecting 
the direction in which causation may run. 

On the whole, there seems to be a tendency for the nonagricultural 
prices more often to lag somewhat in their declines from high peaks, 
but their upturns from depression levels appear to be almost as sensitive 
and prompt as is the case with the farm prices. If we compare the 
agricultural price cycles with the cycles in the business index, the conclu- 
sion again, although not clear-cut, seems to be that the swings in business 

^ When the price movements during the war-inflation years are examined, it is 
clear that prices of nonagricultural products have actually reached somewhat higher 
inflation peaks on two occasions. In World War I, however, the agricultural groups 
moved somewhat higher in relation to the other group. When we confine our atten- 
tion to the shorter, year-to-year cyclical fluctuation, we see that the farm products 
display a much greater sensitivity and amplitude of fluctuations. This does not 
mean that in every single instance of upswing and downswing we can expect this to 
be true, but it would be true in the majority of cases. 


volume are just about as sensitive as those in farm price vibrations. 
In a number of instances there is a slight tendency for the business index 
to move a little ahead, as in 1836—1837, 1853, and 1882. On recovery 
turning points, business activity recorded a prior upturn in 1830 and in 



Chaet 18o. — R elation of agricultural and nonagricultural price cycles to business cycles, 
1800-1861. The cyclical comparisons omit periods of war inflation. 

1895 and a more vigorous upswing after 1921 than in the case of agri- 
cultural prices. 


Turning now to Charts 19a and 196, we can examine similar cyclical 
changes in several ratios, particularly from the agricultural standpoint. 
The cyclical pattern at the top is that of the ratio of agricultural prices 



to nonagricultural prices, the ratio rather than the individual series being 
adjusted for trend. In these charts all series are carried through the war 
periods to show the complete picture. The second series in the chart is 
the ratio of our index of real farm income to its long-term trend. When 

the comparison is made between these two sets of cyclical patterns, it is 
apparent how important the relative price position seems to be as it 
bears upon the cyclical pattern of real farm income or purchasing power. 
It can almost be said that if we omit consideration of production trends 
(which, of course, enter into the calculation of actual farm income) 
and confine our attention to the cyclical deviations from the trend, 
relative prices tell the story about as well as relative real income. 



When the agricultural real-income cycles are now compared with the 
business index, the result is again to leave in doubt the matter of consist- 

Chart 19a. — Relation of agricultural price-parity and real-income cycles to business 
cycles, 1800-1870. The agricultural price-parity cycles are deviations from long-term 
trend. The real-income cycles are deviations also from long-term trend, the r«al-income 
index being based upon farm gross income deflated by nonagricultural prices. See also 
Appendix 6, Sec. 2. 

ent lead and lag relationships. There are about as many cases in which 
one of the indexes leads as the other. In some instances the turns are 

eimultaneous. Broadly speaking, the business index has shown some 



of its most emphatic cyclical gyrations when agricultural real income has 
behaved likewise. Notice, for example, the extremely violent change in 
both indexes since World War I, A careful examination of the chart 

Chart 196. — Continuation of Chart 19o. 1870-1940. 

suggests that in somewhat more cases than not, the downturns from peaks 
have come first in the business index, whereas in several cases the agri- 
cultural index has shown the first indication of recovery from depression. 
Probably business conditions can transmit suurt-term reactions to agri- 



cultural income, but the longer term depression forces, as we have clearly 
observed, seem to be mainly in the reverse direction. 

The somewhat inconclusive deductions that have just been drawn 
are, after all, entirely natural when we realize that we are dealing not 
with a specific and homogeneous branch of industry but with many 
branches of an extractive group. Apparently demand-and-supply forces 
interact constantly in each market. It is only when we carefully analyze 
each particular segment of this farm enterprise with respect to production 
and prices and demand that we are able to decide more specifically 
whether changes in the harvest bring about price fiuctuations capable 
of any general effect upon urban industry or whether annual changes in 
urban income arising from industrial or financial conditions can sharply 
affect the demand for a farm product and hence the income from its 
disposal. To analyze particular markets in such detail would carry us 
far beyond the limits of this book, and it is intended here merely to 
emphasize the importance of such study in forming a complete picture 
of the dynamics of agriculture capable of affording a proper basis for 
policy. There is considerable diversity among the various products of 
the farm, the manner in which these forces operate, and the direction in 
which the causation may be expected to move. 

The annual changes in production of field crops arc naturally closely 
governed by weather conditions. This comprises the effect of heat, mois- 
ture, wind, and the indirect effect of weather conditions upon insects, 
blight, crop abandonment, etc. We enter here into the field of meteor- 
ology, and considerable attention might be given to the various theories 
that have been evolved to explain the variations in harvest by reference 
to the heat of the sun or the variations thus produced in atmospheric 
pressures and precipitation or by reference to other phenomena in the 
realm of solar physics. As will be illustrated in Chapter 22, there is a 
fair amount of statistical evidence pointing to the existence of definite 
cyclical waves in the emanation of heat and radioactive energy from the 
sun, but their relation to the actual condition of growing crops has led 
to somewhat uncertain conclusions. Although there is doubtless a 
connection between atmospheric conditions and moisture elements 
capable of contributing to large or small yields, many disturbing counter- 
influences prevent us from drawing any broad conclusions at this time.' 

1 In this connection, the work of Henry Ludwell Moore in attempting to trace 
statistically the relations between planetary conditions and rainfall, on the one hand, 
and production and prices of several crops, on the other, is of particular importance. 
See, for example, ‘^Economic Cycles, Their Law and Cause,” New York, 1915; “Gen- 
erating Economic Cycles,” New York, 1923; also, P. G. Wright, Review of Moore's 
Investigations, Quarterly Journal of Economics^ May, 1915. Among the British 
writers on the subject, see particularly W. S. Jevons, “Investigations into Currency 
and Finance,” London, 1884, and Sir William Beveridge, Weather and Harvest 



It will suffice for our present purpose to say that for any given crop, the 
annual fluctuations in yield per acre are more or less irregular in their 
occurrence and show no conclusive tendency to coincide with any regular 
periodic function, such as is defined by a sine curve. Since it is claimed 
by meteorologists that the alternations in solar radiation conform more 
or less closely to a regularly recurring rhythm, it is obvious that various 
extraneous influences serve to bring about the erratic year-to-year 
fluctuations in actual crop yields. For most of the important field crops, 
the total production in the United States is much more closely related 
to the yield per acre than to changes in acreage planted or harvested. 
The amount of acreage utilized will itself respond in a slow, uncertain, 
and irregular fashion to the degree of farm prosperity or depression and 
the principal inflationary and deflationary movements in price of a 
particular crop. But it is the changes in yield per acre that are most 
pronounced and that dominate the annual fluctuations in production 
and hence in relative prices. 

As the production cycles are studied in relation to the price of a 
particular crop, such as potatoes, wheat, or cotton, it is usually found 
that the closest (inverse) relation between production and price is in 
terms, not of actual prices but of relative prices. This naturally follows 
from the fact that the broader price movements, in which monetary and 
war finance factors exert the major influence, tend to form tidal-wave 
patterns quite independent of the short-term changes in production and 
supply. Hcmce if the prices of potatoes or corn are analyzed as ratios to 
general wholesale prices, the specific influence of the supply factor becomes 
more readily apparent. It is also desirable to express the final relation- 
ship in terms not of 'production but of available supply from year to year. 
This involves the amount of carry-over or surplus that at any time 
(‘xpresses the result of a previous lack of perfect market clearance or 
equilibrium. The production of a given year affects the relative price 
to the extent that it alters the position of the available supply known to 
exist. In some cases, such as in the case of wheat and cotton, the com- 
modities are bought and sold on organized speculative exchanges, and 
the ^Tutures'^ quotations express the aggregate opinion of the buyers 
and sellers as to the position of supply and demand several months ahead. 
These prices in the futures markets are highly sensitive and are con- 

Cycles, Economic Journal, December, 1921. See also C. G. Abbot, Solar Radiation 
and Weather Studies,” Smithsonian Institution, Washington, D.C., 1935; C. G. Abbot, 
assisted by Gladys T. Bond, “Periodicity in Solar Variation,” May, 1932; Hannay 
and Lacy, Influence of Weather on Crops, selected bibliography, U.S. Department o] 
Agriculture, Miscellaneous Publication 118, 1931; V. P. Timoshenko, Variability in 
Wheat Yields and Outputs, Stanford Food Research Institute Wheat Studies, April, 



Btantly vibrating. The price in what is termed the ‘^cash” or ‘^spot^’ 
market will usually be influenced by what the futures markets are doing. 
Because of the diflBculty of keeping supply in perfect adjustment to total 
demand, the price responds more to supply than to demand variations. 

At a given time or over very short periods, a relatively small variation 
in available supply of a field crop is likely to have a relatively large 
effect upon price. Conversely, a shifting of demand one way or the other 
will cause any existing supply to vary much more than proportionally 
in price and in value. Individual products, of course, differ materially in 
this respect. The degree of ^‘elasticity'' in the market, in the sense of the 
willingness of buyers to accept or their ability to utilize larger quantities 
or to forego purchase if quantities are reduced, would be very low for such 
a commodity as potatoes, fairly low for wheat, slightly higher for cotton. 
The degree of elasticity depends mainly upon the variety of uses to 
which the commodity may be put and the extent to which it serves a vital 
human need, having relatively inflexible per capita limits. When busi- 
ness conditions are prosperous and national income is rising, the demand 
for cotton will accelerate, and supplies will be more widely used for a 
time in the manufacture of textiles, tire fabrics, and numerous industrial 
products for which cotton is adapted. This expansion, however, would 
be much more limited in the case of per capita consumption of wheat or 
potatoes. The foods as a group are mainly of the inelastic demand type, 
and changes in production from season to season tend to create more than 
proportionate inverse changes in price (relative to the general price level). 

It should be kept clearly in mind that this tendency holds from year 
to year but is not necessarily true over long periods of years. Hence 
it is not in itself an adequate basis for artificial or arbitrary administration 
of agricultural output designed to raise the values or gross income 
accruing to crop farmers. This is important, because artificial scarcities, 
having the objective of increasing farm values, and therefore gross 
incomes, if continued mechanically over a period of years, will probably 
have a tendency gradually to discourage consumer use and to encourage 
the use of alternative products. Such a policy (unless world-wide in 
scope) will also have the effect of encouraging sooner or later larger 
additional production in outside areas beyond the range of the control 
measures, and hence ultimately there will be a larger world supply that 
directly or indirectly will affect particular markets. This has been the 
usual result of restrictive measures and may be the ultimate result of 
our own policies of agricultural adjustment if they do not take into 
account the possibility of lowering costs by greater efficiency as a factor 
in farm earnings. 

The varying relations between annual production, total supply, and 
relative price, in the case of wheat in the world market, are shown in Chart 



20. Since this chart is drawn on a uniform ratio scale, it can readily be 
seen that the response of price (that is, relative price) to a given change 
in the supply is volatile, indicating an inelastic demand. It is also 
apparent that although available world supply conforms generally to 
the changes in production, this is not invariably true. The available 
supply has a slightly less variable tendency than production itself. If we 
were to observe the relation between supply and relative price of a certain 

Chart 20. — Production, supply, and deflated British price of wheat, 1922-1939. Pro- 
duction and supply exclude Soviet Russia and China. Price of British parcels is deflated 
by the Statist index of wholesale prices and converted to American currency at par exchange. 
This is roughly indicative of the world basic price relative to other commodities. The 
years are crop years, beginning July. {Data from U. S. Department of Agriculture,) 

variety of potato raised in a given area, it would be found that relative 
price is even more sensitive to the changes in supply, and the supply 
will vary almost exactly with seasonal production because of the fact 
that the carry-overs of a highly perishable crop tend to be much smaller 
than for products that can be safely stored. If the cotton market were 
to be examined in similar fashion, it would be found that the American 
crop, plus carry-over, is usually the most important single factor in 
relative price change. Other factors entering into the price position 
(in the world market as it functioned prior to World War II) would be 
changes in the production and carry-over of Indian and other types of 
cotton and in the demand for cotton as affected by the general industrial 
cycle and consumer income variation. The fluctuations in mill consump- 



tion of raw cotton are relatively wide in amplitude, but the timing is 
closely geared to the minor fluctuations of the general business cycle. ^ 


These illustrations will perhaps suffice to demonstrate the important 
characteristics of price behavior of most field crops. The potential 
behavior of these markets may be illustrated in simplified fashion by the 

Chart 21. — Graphic comparison of price changes under inelastic and elastic market 
conditions. Inelastic conditions are shown at the left, elastic at the right. 

diagram in Chart 21. This is designed to emphasize the contrast between 
a typical field-crop market and the market for a typical manufactured 
commodity. At the left are a number of diagonals, rather steeply 
inclined from left to right, indicating the successive possible positions 
of the demand situation. On each of these curves, any given point would 
indicate at what price (vertical scale) the supply (measured horizontally) 
would be wholly absorbed within the normal marketing period or season, 
with a normal working surplus. Alternatively, any point would also 
indicate how much would be taken by all cash buyers at that price. 

These schedules of the various possible relationships of supply and 
price (always in terms of relative price) shift to the right or the left, 
depending upon the strength or weakness of demand as it may be affected 
by the varying incomes of consumers, the nature of the speculative inter- 
est, consuming habits, or the breadth of the market in terms of population. 
Under any given conditions of general business, national income, popula- 

^ This matter is further developed in Chapter 19 . 



tion, customary use, proportion of waste, etc., the pattern of demand 
relationships represents the play of a single factor — the utility of the 
commodity to the typical potential buyer. It shows what would happen 
to price offers if there were sudden changes in supply impinging upon 
this sense of the importance of having more or less to use. When con- 
sumer willingness to purchase is affected by a new set of conditions altering 
their purchasing power, the variety of uses the commodity may serve, or 
their familiarity with it, the schedule will shift bodily to the right or 
left, as the case may be, and a new set of prices will then measure the 
utility variable. 

In the case of field crops, these shifts are, of course, transmitted 
through various intermediary markets until they reach the farmer and 
are expressed in price at the farm. The amount of demand shift to the 
right or left will roughly express the extent to which changes in general 
economic or technological conditions induce ultimate users of these crops 
to extend or contract the amount that they are willing to buy at given 
prices (adjusted to price level), or, conversely, the (adjusted) prices that 
they are willing to give for additional specific amounts. This shifting 
of position tends to be narrow, relative to the shifts in economic condi- 
tions, for most of the typical farm field crops. In the case of cotton, the 
shifting occurs over a wider possible range for the reasons already given. 
In general, a market will absorb readily a given quantity; an increased 
supply quickly becomes excess and encourages waste, and a sudden 
contraction of supply produces lively bidding and an abrupt rise in 
relative price. 

Contrast the mechanics of these farm markets with the situation 
shown at the right, again simplified to bring out essential features. Here 
we have a typical widely used fabricated product but selling in a market 
not yet wholly saturated and subject to the familiar industrial conditions 
of relatively flexible adjustment in the rate of production. The com- 
modity is offered by manufacturers in quantities more or less prompth^ 
adjusted to the demand conditions existing in the market from time to 
time. The pattern of demand at any given time is elastic in the sense 
that it expresses the willingness of purchasers, under any given set of 
economic conditions, to acquire more at lower prices but unwillingness 
to purchase as prices rise. These schedules or patterns of demand also 
shift back and forth according to the changing conditions supporting 
purchasing power and utilization. There is considerable elasticity, 
therefore, in this sense, too. 

In the case of a semiluxury product, the shifting of demand to right 
or left may at times occur over a wide range. But the slope of the lines, 
expressing mainly the utility pattern, graduates gently toward the right, 
and as the schedules shift back and forth, they tend to produce a less than 



proportionate alteration in the price of any given supply. The more nearly 
elastic are the utility patterns the more this will be true. In other 
words, the supply can vary during moderate periods without having the 
effect of violently changing price, as it does in the case of the typical field 
crop. Furthermore, producers of fabricated articles usually are able 
readily to control the rate of additions to supply, and they aim to stabilize 
the price by varying the volume offered to the market in some rough 
relation to what they observe to be the shifting of the demand schedules. 

As the result of these dynamic differences in the two types of market, 
we find most of the explanation of the much wider range of fluctuation 
in farm prices and the source of the complaint of the farmer that he 
purchases what he needs in the cities at prices that are rigid and inflexible, 
whereas he sells his own commodities always at wholesale and in the 
rough at prices that soar and collapse with astonishing volatility. This 
is further discussed in Chapter 24, since the point has obvious political 


Before concluding, let us observe some further illustrations of the 
dynamics of farm prices taken from the markets for animal products. In 
these cases we have interesting patterns of price cycles^ that is, rhythmic; 
variation, internally motivated. Let us observe first the hog market. 
It is a familiar fact that most of the corn crop is fed to hogs and marketed 
in this form. There is, therefore, a close functional relationship between 
the price of corn and the price of hogs. Corn makes up over two-thirds 
of the feed used in pork production. It has become customary, therefore , 
to express the advantage of raising hogs by the ratio of hog prices to corn 
prices or the ‘‘hog-corn ratio.^’ As usually stated, this expresses the 
number of bushels of corn equivalent in current farm value to 100 pounds 
of live hogs. Throughout a long period of time this ratio has varied 
above and below an average of about 11.6 bushels. A rise in the ratio 
indicates that corn is cheap relative to hog values and that hogs can be 
fed cheaply; a decline in the ratio means that corn is increasing in its 
purchasing power over hogs and that hog raising is discouraged. It must 
be kept in mind that the variations in the ratio come about in response 
to change in both the price of hogs and the price of corn. 

^ In recent discussions of the apparently inflexible prices of many manufactured 
goods, it has been incorrectly assumed that elasticity of demand is relatively high, 
and therefore a larger quantity can be sold at little concession in price, but much of 
this reasoning confuses the elasticity in the sense of a broad shift in consumption, 
as the market is widened by mass-production techniques, with elasticity in the usual 
sense of the immediate responses resulting from utility calculus. Actually the differ- 
ences in elasticity in this sense, as between one commodity and another, are not ao 
great aa is commonly assumed. 



The actual price of hogs is shown in the lower curve of Chart 22. 
Apart from the inflation period of World War I, hog prices have been 
high when the marketing of finished hogs to the packing plants (second 
curve from the bottom) was relatively low, and vice versa. ^ But the 
hog-corn ratio also expresses the effect of the size of the corn crop, 
plotted as the second curve from the top. When the crop is large, 
the ratio of corn to hogs tends to rise. The fact that hog marketings 
(monthly data smoothed) appear to move in cyclical waves, about two 
years later than the corresponding changes in the hog-corn ratio, is 
explained not merely by the production incentive arising from the hog 
market but by price spreads influenced by the corn crop. When there 
is a relatively large supply of corn there will be smaller marketings of the 
available hog supply than otherwise, because animals will be withheld 
from market for breeding and feeding purposes, with the use of cheap 
corn. This automatically reduces the meat supply and brings the price 
of pork products to a higher level than might otherwise exist. In other 
words, this causes the spread expressed by the hog-corn ratio to rise 
abruptly, and this, in turn, adds more stimulus to hog raising, which 
appears as larger marketings within a year or two. The marketing of 
these hogs lowers pork and lard prices, but the marketings will be affected 
also by the extent to which corn supplies may be reduced through smaller 
production and through the greater utilization of the existing corn supply 
in the previous period of enlarged breeding and feeding. 

Along with these factors there must also be considered the influence 
of consumer demand, which, through most of the period covered in 
Chart 22, includes an export element. In good business years and with 
large export demand, pork prices will be higher than otherwise, and vice 
versa. But pork products are to such a large extent a staple commodity 
that the shifting of the demand patterns back and forth along with 
corresponding changes in general prosperity and income is less pronounced 
than it is in the case of beef, lamb, poultry, or specialized dairy products. 
A more or less downward trend of hog marketings, as well as hog prices, 
from World War I to the beginning of World War II represents progressive 
shrinkage of the export market more than it does impairment of domestic 

The hog market thus represents to an unusual degree a tendency 
toward repetition of cyclical movements in production and prices. The 
variation in the corn crop is probably at the basis of these variations, but 
the influences resulting from the price of corn are greatly amplified as they 
affect incentives to raise hogs by the intermediary effect upon the market- 
ing of available live animals. The resulting swings in building up and 

^ Other disturbing factors are seen in 1934 and 1936, when extreme drought condi- 
tions affecting the corn crop led to heavy slaughter of pigs. 



reducing the total supply of hogs are wider in amplitude than would be 
accounted for by the variations in the corn crop alone or by variations 
in the price of hogs alone. Putting all these together, we obtain a more 
or less self-generating series of variations that tend to be carried through 
regardless of intervening minor changes in 'prices or business conditions. 

1901 1905 1910 1915 (920 

Chart 22a. — Factors affecting hog prices, 1901-1920. The trend of hog marketings is a 
smoothing of the actual monthly data. 

The resulting swings in hog prices do not repeat themselves with exact 
periodicity, but there is a rough approach to a five-year cyclical 

By taking into account all the related variables, including, of course, 
the influence of demand conditions, it is statistically possible to arrive at a 
fairly accurate forecast of the hog market more than a year in advance.* 
But the raising of hogs represents a branch of farm production less 
motivated by forecast than by existing market conditions and income 

1 See Haas and Ezekiel, Factors Affecting the Price of Hogs, U,S, Department of 
Agriculture Bulletin 1440; C. F. Sarle, Forecasting the Price of Hogs, American 
Economic Review^ September, 1925; and O. V. Wells, Farmers’ Response to Price in 
Hog Produpt^oij ^md Marketing, U,S, Department of Agriculture Technical Bulletin 359, 



possibilities. As the result of this, hog raisers do most of their marketing 
at the lowest prices, and their sales of hogs to the packing plants are 
lowest when prices are high. Their incomes tend to be higher when prices 
are high than when they are low. Hence there is the possibility of 
persistent complaints that the packer exploits the producers. The 
repeated investigations of the meat packing industry by the Federal 

Trade Commission are primarily the result of the mechanics of the indus- 
try. A further result has been to make the packing industry extremel}^ 
efficient, with exceedingly close profit margins. 


Another interesting example of a more or less self-propelled price- 
production cycle in agriculture is found in the case of beef cattle. In this 
case, the production period is considerably longer than in raising hogs. 
Preparations for raising large herds of cattle constitute a substantial 
undertaking, requiring a fair amount of capital. If the cattle-price 
situation becomes increasingly favorable, some time will necessarily 
elapse before those connected with, or interested in, this industry begin 



operations. The relatively slow response of supply to price movements is 
an important feature of the dynamics of this market. But once the cycle 
of cattle breeding and feeding is well under way, it continues, almost 
regardless of external conditions, until the herds of cattle and calves have 
attained a size representing very considerable expansion from the original 

Chart 23. — Factors affecting cattle supplies and prices, 1890-1940. The chart is 
drawn to arithmetic scales, but the scale figures, except for net annual changes in supply, 
are omitted in order to simplify the chart, as the cyclical movements are of primary interest. 
The figures of total cattle slaughter include calves. 

The operations of the industry are shown in Chart 23.^ At the bottom 
appears the relative price of beef cattle, expressed in terms of general 

' Data for this chart were obtained from Farm Economics (Cornell), June, 1941; 
U.S. Department of Agriculture Technical Bulletin 703, pp. 112-114; Livestock, U.S. 
Department of Agriculture Outlook Charts^ 1941; and U.S. Bureau of Labor Statistics 
Wholesale Price Bulletins. 



wholesale prices, since the direct costs in cattle raising involve a wider 
range of commodity elements than in the case of hogs. As the cycle of 
relative cattle prices ascends, the next curve above, indicating the annual 
change in herd numbers, also rises. This denotes, first, that year by year 
there are smaller reductions in herds and, later, that there are increasing 
additions to herds. As this index of changes crosses zero upward, it 
marks the point at which the existing herds of beef cattle and calves are 
at a minimum. As herds are built up, actual numbers rise to a peak 
when the index of changes has again declined through zero. There is 
thus a lagging cycle of the actual number of cattle on farms, the peaks 
and troughs appearing from about four to six years after those in the rela- 
tive price movements.^ As cattle numbers increase, there is a still later 
tendency to expand the marketing and slaughter activity, but this does 
not usually begin until the index of relative price has reached a high peak. 
Thereafter the marketing expands, and the meat packers prepare and 
dispose of increasing quantities of beef and veal. The cyclical movements 
in this phase of the industry tend to be somewhat irregular because of 
occasional factors entering the market from the standpoint of general 
consumer demand, which has somewhat greater influence here than in 
the case of the pork market, and also weather conditions affecting the 
forage and feed supplies. Drought in the corn belt may force the cattle 
feeders to sell to packers prematurely, as was the case in the unusual 
years 1934 and 1936. When herds are being built up from a relatively 
low level, several years elapse during which the amount of finished beef 
and veal output declines as more cows and heifers are withheld for breed- 
ing purposes. 

The peaks in meat packing and marketing tend to occur considerably 
later than the peaks in numbers of beef cattle on farms. An interesting 
instance is seen in 1909. In 1918 there was a high point in meat produc- 
tion, coinciding with a peak in the number of cattle on farms, but this 
was followed by a decline and a second top in 1927, the decline having 
been due to the ending of the War and the brief depression of 1921. 
But thereafter there was still a liquidating tendency that, with improving 
business conditions, forced a large amount of beef into final feeding and 
into the packing plants, so that herds reached a minimum again in 1928. 
In the past few years herds have been built up rather rapidly under the 
stimulus of a rising relative price, and probably large supplies of beef 
and veal will have been prepared for market for a number of years after 
1 940. The wholesale price of finished beef at Chicago is shown as the top 
curve in the chart. There is some tendency for slaughter and meat 
prices to move inversely. If this relationship is examined in the light 

* This is another example of the relation between an mcremeid variable and a total 



of general business and income changes, it will be found that large 
slaughter in good years does not lower prices so much as in poor years 
and that low periods of slaughter do not raise prices so much in poor 
years as in good years. Note particularly the situation in the 1890^s 
and also during the period of World War I. 

Usually, it will be noted, changes in the amount of beef cattle reaching 
the packing houses move inversely to the relative price of cattle, and 
hence there emerges a recurring cyclical tendency, expressing itself in 
a rising and falling index of change in numbers of cattle, or what might be 
termed the expansion and liquidation phases of the industry. As in 
the case of hogs, by the time the livestock farmer comes to do most of his 
selling, he does so at the lowest relative prices and frequently at low 
actual prices. The length of the cycles that emerge from this process are 
much longer in duration than the average hog cycles. From peak to 
peak and trough to trough of relative price movements and supplies of 
cattle, the period varies from about fourteen to sixteen years. ^ 

We have now seen that it is inadequate to discuss agriculture and its 
dynamics merely from a generalized standpoint, since farming abounds 
with great diversity in detail. But having pointed out some of the 
interesting and useful features of this detail, we may close the discussion 
by referring once more to comparative changes in farm income in recent 
years as shown in several important segments. Chart 24 brings out the 
fact that since the boom conditions of World War I, total farm income has 
maintained itself much better than has the total income derived from 
wheat, cotton, and hogs, all of which have encountered not only the 
marked irregularity in domestic demand, particularly after 1929, but also 

^ The long-term trend of per capita beef consumption in the United States is 
gradually declining, but the trend of veal consumption has been rising. Since World 
War I, United States exports of beef have become of little importance. There is a 
gradual tendency to increase herds of dairy cattle more rapidly than those of beef 
cattle, partly as a result of the foregoing conditions. The occasional incentive to 
market cattle quickly has the effect of increasing the proportion of calves and yearlings 
sold to the packers. There are also constant interactions as between beef-cattle and 
dairy-cattle operations. 

Good current discussions of the livestock situation as to both beef and hogs are 
to be found in publications of the U.S. Department of Agriculture, particularly the 
monthly issues of The Livestock Situation, A part of the exhibit in Chart 23 is based 
upon discussions of livestock conditions contained in Farm Economics, issued by the 
Department of Agricultural Economics and Farm Management, Cornell University. 
See also Alonzo E. Taylor, ^^The Corn and Hog Surplus of the Corn Belt,^' Food 
Research Institute, Stanford University, 1932. On the economic phases of the beef- 
cattle industry, see also, Beef Cattle Production in the Range Area, 1937, U,S, 
Department of Agriculture Farmers* Bulletin 1395. Also U.S. Department of Agricul- 
ture Technical Bulletin 764. It may be added that other examples of delayed long- 
term responses to price incentive can be found among the vine and tree crops. Space, 
however, does not permit further multiplication of illustrations. 



the undertow of a shrinking export market. Farm income from wheat, 
cotton, and hogs is shown separately at the bottom of the chart. It will 
be noticed that wheat particularly has suffered much more heavily in 
the shrinkage of gross farm value than has total farm income. The latter 

Chabt 24. — Components of contrasting trend in gross farm income, 1890-1940. While 
farm income from wheat, cotton, and hog products has shown a declining trend since 1919, 
the income excluding these items has been well sustained, particularly as a result of such 
Items as fruits, dairy, and poultry products. 

has been sustained by the fact that the demand, particularly in the 
domestic market, for dairy products, poultry products, and fruits has 
continued to be vigorous and has forged ahead in spite of depressions as 
severe as those of 1932 and 1938. The combined income from these 
three most prosperous major groups of farm products is shown in the 
middle part of Chart 24. It stands in marked contrast to the situation 



revealed by the major divisions, which seem to be broadly in retreat. 
When, therefore, we refer to the agricultural trend, we must keep in 
mind these diversities. 

The principal diflSiculties of agriculture in recent years represent a 
slow and painful process of postwar deflation affecting mainly the small 
grains, the raising of hogs, and, to a somewhat lesser degree, the growing 
of cotton, products urgently in demand after the outbreak of World 
War I. The cotton problem will probably become one of our most 
vserious national problems within a few years, in view of the fact that 
World War II may accentuate the decline of export possibilities, at the 
same time resulting in the shrinkage of a temporarily strong domestic 
demand. Along with this there is the trend toward mechanization in 
cotton production, which will mean large displacement of labor, such as 
has been seen in the migration from the Southeast toward the Pacific 



From the preceding analysis of the dynamics of agriculture, we have 
seen that variations in total farm income tend to be much more closely 
geared to changes in 'prices than to changes in production. We found 
reason to believe that conditions accompanying major wars encourage 
moderate expansion in the physical aspects of agricultural enterprise but 
very large additions to long-term financing and mortgage indebtedness. 
Price inflation appears to be responsible for excessive speculation in farm 
land and wide variations in farm-property values. We found also, in the 
case of animal products, that cyclical movements in production of rather 
extended duration exist, probably as the result of the relatively long 
periods required by production and the tardy adjustment of supply to 
changes in demand. A number of these points were emphasized, not 
merely because they round out the discussion of agricultural cycles and 
trends but because they will be found repeated with minor peculiarities 
in other important phases of economic activity. 

The use of large amounts of borrowed capital to invest (or speculate) 
in land is by no means limited to agriculture. Urban and suburban real- 
estate development represents an even more important cyclical element 
capable of contributing to general economic instability. It forms the 
intensely variable atmosphere within which one of the most important 
of all our industries has functioned — the building industry. The heart 
and core of the construction industry is residential building. This phase 
of activity is characterized by long-term cyclical movements having some 
degree of resemblance to the long livestock cycles. 

There are some characteristics of speculative promotion in the creation 
of housing facilities that do not apply to other types of construction 
enterprise. Nonresidential building, however, is indirectly affected by 
the sweeping dynamic forces involved in the activities of land subdividers 
and speculative home builders, particularly in urban and suburban 
areas. These activities, as in agriculture, involve the use of considerable 
quantities of borrowed capital. For many years — in fact, until recent 
financial reforms modified the process — they have been productive of 
far more general financial abuse and instability than anything that has 
occurred in the field of agriculture. These powerful tidal waves of con- 
struction activity, followed by prolonged periods of decline and inactivity, 




stamp their pattern upon a broad segment of our manufacturing and 
fabricating industries and hence the income of their personnel. These 
lines of production tend to be caught in the same wide swings of feast 
and famine as the result of circumstances over which they have no direct 
control. If we wish to understand why industrial production and trade 
vibrate constantly in a cyclical pattern, it is necessary to understand the 
dynamics of urban real estate. Following our analysis of this field, we 
shall give attention to the somewhat similar gyrations to be found in 
transportation development. 


Since houses are built on land and since the cost of land is a considera- 
ble component in the final cost of building, land suitable for urban housing 
development has long been a very important object of investment, 
speculation, and promotional manipulation. We can go back in the 
historical records virtually to the beginning of the American Colonies 
and observe how important a place dealings in land formed in the 
activities of prominent men. Underlying these activities is the familiar 
factor of the growth of population and changes in the rate of this growth 
in particular areas. The development of villages into towns, towns into 
cities, and cities into great metropolitan areas has come about as the 
result of three distinct tendencies: (1) the natural increase in population 
in a given area, (2) the migration of families and individuals from one 
part of the country to another, and (3) migration from the Old World 
and the tendency of many of these immigrants to concentrate by national 
groups in particular sections. Probably most important is the internal 
migration. It has been stimulated by developments in transportation, 
the opening up of new territories through national acquisition, and the 
adoption of legislation tending to stimulate the agricultural development 
of new areas, with resulting development of urban commercial and 
transportation centers, sometimes with astonishing rapidity. While, as 
we have already seen, the growth of our total population has proceeded 
along a very regular course, with a minimum of intermediate fluctuations, 
the expansion of individual communities, especially along the frontier 
as it has shifted from east to west, has been marked by pronounced 
variations in rate of growth and in many cases by long-term wavelike 
tendencies. To these marked variations in growth, immigration from 
abroad has, until recent decades, contributed conspicuously, although it is 
difficult to obtain exact detailed statistical evidence to illustrate this for 
particular urban areas. The growth rate of a typical city may also be 
affected, occasionally to a marked extent, by the location in or near the 
community of industries capable of affording a strong inducement to 
workers drawn from surrounding rural areas or even from foreign coun- 



tries. Each new industry as it developed has fostered such concentration 
of people. 

From the standpoint of demand for housing accommodations, two 
relatively minor factors also contribute some influence. First, some 
acceleration of a rising rate of growth, especially in urban communities, 
may result from the fact that component parts of families separate into 
distinct household units rather than living together. Thus the number 
of family units increases when employment in industry is high. Second, 
there may be variation in the marriage rate, which also tends to fluctuate 
rather closely in harmony with general business activity, with the result 
that under favorable conditions the number of families tends to increase. 
Opposite tendencies might under certain circumstances reinforce declining 
rates of local growth produced by emigration. 

The major fluctuations in the residential building industry and in 
related real-estate development have been associated with waves of 
migration and settlement, which from time to time have been accelerated 
by major improvements in transportation, opening up new areas of 
virgin territory in one of the most richly endowed continental areas 
of the earth^s surface. It was not long after the United States became 
an independent nation that great highway enterprises, such as the 
Cumberland Road, were undertaken, and steamboats began to carry 
people along the rivers into the new West. Then followed the era of 
canal enterprises, particularly the very successful Erie Canal and the 
state-financed waterway systems of Pennsylvania, which by the 1820^s 
were vastly stimulating the Western movement. In 1820 the induce- 
ments to settle new land was heightened by lowering the cash price of 
public land to settlers and reducing the minimum size of tracts available 
to individual purchasers. Again, in 1830, the general preemption land 
law further enhanced these movements by giving settlers priority rights. 
Although much of this land settlement was in agricultural sections, the 
development of new commercial centers was also exceedingly rapid. 
With the coming of the railroad in the early Thirties, such centers devel- 
oped with astonishing rapidity. The political principles of Andrew 
Jackson, who entered the Presidency in 1829, proved more favorable 
than otherwise to the opening up of limitless opportunities for individual 
enterprise, promotion, and speculation but tended toward discouragement 
of financial, transportation, and business enterprise being conducted in 
large units or along lines of well-planned and orderly development. The 
country was suddenly thrown wide open to reckless banking, conducted 
by small and ill-equipped individuals, many of them essentially land 
speculators. Railway building from its very inception was colored by the 
excessively reckless competitive atmosphere of Jacksonian democracy. 
By 1837 there came the first harvest of ruined banks and financial involve- 



ment of the army of promotional speculators that the political system 
had unwittingly encouraged. But the Cumberland Road was being 
extended as far west as Illinois, and steamships were beginning to bring 
droves of immigrants from Europe. Then, in the ^forties, more large 
areas of land were added to the national domain; a gold rush to the West 
Coast followed, and there came the enormously important expansion 
of the railroad network, aided by newly developed Bessemer steel rails 
and a fast-growing export market for farm products. To all these forces 
of continental expansion the building industry responded with all the 
intensity of its own speculative characteristics. 


Early in the nineteenth century, towns and cities at strategic com- 
mercial and industrial crossroads were being actively developed by 
promoters whose interest was primarily in acquiring profit through 
enhancement of land values as expanding numbers were attracted to these 
communities. Many of these new communities were poorly planned; 
others failed to develop, since the promoters paid more attention to 
quick profit than to matters of wise location or the planning of urban 
facilities and lots on a sound long-term basis. As population moved 
west of the Alleghenies, town jobbing became one of the great preoccupa- 
tions of individual capitalists. At this point, the emphasis upon indi- 
viduals is important, because both real-estate development and urban 
housing represent fields of activity quite unlike those organized enter- 
prises that take the form of farms, factories, mercantile establishments, 
or transportation enterprises. The subdividing of rural acreage into 
suburban lots, the disposing of these lots to those who make up an urban 
community, and the building of the houses by speculative or semi- 
speculative enterprises all represent a field of small-unit business. Here 
are represented constantly shifting groups, the participation as a side 
venture by persons engaged in some trade or profession, and, on the whole, 
a high degree of reckless competition among many thousands of amateur 
entrepreneurs, seeking the profits of turnover, primarily motivated by 
the profit opportunities in the purchase of cheap land to be sold at higher 

The activities of the typical speculative builder occupy an important 
place in the field of venture capital, which we call “real-estate develop- 
ment.^' Naturally, the speculative builder has not been responsible for 
more than a part of all housing construction. Many home builders use 
their own capital and engage builders to do the work according to plans 
and specifications. Such properties are usually to be found in the higher 
value range. But in the construction of the lower priced small properties 
destined for urban wage earners and clerical workers, the general Ameri- 



can tendency has been to provide ready-made housing in connection with 
promotional development of new subdivisions. The builders under- 
taking such ventures have rarely been organized as large units; in most 
cases they have been individual contractors, hiring a few laborers in good 
times and none at all in poor times, working usually on one plot of land at a 
time and turning the property as fast as possible but operating frequently 
in conjunction with land syndicates and subdividing organizations. 

These land-subdividing groups have characteristically consisted of 
men of substantial capital, often working with banking groups and real- 
estate brokerage enterprises. The subdividing groups have usually 
grown in size and number while the boom periods lasted and have quickly 
melted away or shifted to other areas after a given expansion reached its 
limits. The activities of the subdividers, creating building lots from 
farm land and endowing them with glamor and more or less of the com- 
munity facilities, such as streets, water and sewer connections, have again 
and again assumed spectacular momentum. They thereby contributed 
to the incentive motivating thousands of speculative ready-made builders 
and to the tenuous financing devices whereby prospective home owners 
were able, at least temporarily, to possess a home. Prior to the organiza- 
tion of the National Banking System, a good deal cf the activity of banks 
and bankers originated in the flamboyant operations of land development, 
both rural and urban. Even the Second Bank of the United States ^^did 
a large business in granting loans secured by mortgages on land. At one 
time it had under pledge almost all the area of Cincinnati. In 1823 
defaulted real estate loans in that city alone exceeded two million and a 
half dollars.’^ ^ 

Even foreign capitalists, particularly in England, maintained close 
relations with the activities of those in this country who participated in 
systematic operations in real estate. Wealthy merchants in the larger, 
rapidly growing cities of the United States found boundless opportunity 
for the investment of their surplus wealth in land. Much of this repre- 
sented shrewd, long-term investment in commercial property capable of 
enhancement in value with the growth of an urban center, but a sub- 
stantial part of the wealth overflowed into the suburban ventures of 
subdividing and speculative building. The building of the railroads 
represented much the same motive to gain from appreciation in the value 
of urban land adjacent to or served by the new transport facilities. 
Large landowners were intimately associated with railroad projects. 

1 A. M. Sakolski, “The Great American Land Bubble,*^ New York, 1932. This 
book contains well-documented information and many interesting ancedotes con- 
cerning the various forms of land speculation throughout a long period of American 
history. This is a field of activity that has largely escaped the notice of economists 
who have persistently sought the reasons for economic instability in the wrong places. 



As land speculation was repeatedly and vastly overdone, so too was the 
building of railroads, undertaken by bold and vigorous promoters, with 
results that will appear statistically in a later chapter. 

We do not have more than a sketchy factual record of urban real- 
estate activity during most of the nineteenth century, but recent investi- 
gations have pieced together the broad outlines of the process whereby 
suburban and even rural land was usually brought to the stage of sub- 
divided units. The county records of many localities have afforded 
amazing statistical pictures of the cyclical gyrations of subdividing 
operations. Measured in the terms of the number of lots subdivided 
per capita of local population, these numbers in repeated cases have risen 
to peaks 50, 150, 200, or 300 per cent above the long-time trends of urban 
growth. After reaching these dizzy peaks, when the number of lots 
might be suflScient to care for population growth perhaps fifty or a 
hundred years ahead, the additions have quickly ceased, and the number 
of lots for many years thereafter has declined until it became a small 
fraction of the trend. A few of these records go back to the middle of 
the nineteenth century or even beyond. As between one community 
and another, the major peaks and troughs of these great cycles in land 
development rarely coincide exactly, but nevertheless there is a tendency 
toward a rough sort of synchronization. The duration of the long 
cycles is between fifteen and twenty years from peak to peak and trough 
to trough. 

During the past century the most important operations have been 
in the undeveloped areas just beyond the settled section of established 
communities. Relatively little promotional enterprise of this sort has 
taken the form of developing entire communities de novo from the wilder- 
ness, although this formed occasionally a rather important type of project 
in the preceding century. Activity in converting acreage to building lots 
has ordinarily not been the forerunner of a major expansion in building 
itself; usually the fundamental population and other demand influences 
have first indicated a rising market for housing accommodations before 
systematic enterprise in subdividing occurred. But once the latter 
was under way, it tended to reinforce very powerfully all those types of 
ready-made buildings that travel upon the momentum of optimistic 
interpretation of future prospects for demand and for property values.^ 
Frequently the actual subdividing of suburban plots has been undertaken 
by individuals and groups after the land had been acquired or controlled 
in substantial parcels by land syndicates, or even a series of syndicates. 
There has thus been a cumulation of turnover profits even before the 
land has reached the subdividers or final owners. The activity of land 

^ This is the interpretation arrived at by Homer Hoyt in his valuable study *‘One 
Hundred Years of Land Values in Chicago,’’ University of Chicago Press, 1933. 



syndicates in disposing of properties has usually been most evident as 
the realty boom reached close to its extreme height. The price of land 
has been known in some cases to advance on a single turnover as much 
as 100 per cent.^ 

A considerable amount of this turnover in land has been financed with 
borrowed capital, some of it by short-term credit extension. Since sooner 
or later the more speculative types of subdividing activity resulted in 
lots being laid out far beyond what the local population increment could 
possibly absorb, taxes would accumulate rapidly, and delinquency in tax 
and capital payments would ensue. The commercial banks, which 
frequently financed the larger syndicates and subdividers, found the 
recoil of these speculative adventures falling upon themselves and their 
depositors. Since the country has not had until very recently a strong 
specialized financing system, operated under careful regulation and 
devoted to real-estate and property-mortgage financing, the banks 
(as in the case of farm loans) have from time to time been involved to a 
dangerous extent in operations where commercial banking has no proper 
place. Herbert D. Simpson goes so far as to say in retrospect that 

. . . real estate interests dominated the policies of many banks, and thousands 
of new banks were organized and chartered for the specific purpose of providing 
th(} credit facilities for proposed real estate promotions. The greater proportion 
of these were state banks and trust companies, many of them located in the 
outlying sections of the larger cities or in suburban regions not fully occupied by 
older and more established banking institutions. In the extent to which their 
deposits and resources were devoted to the exploitation of real estate promotions 
being carried on by controlling or associated interests, these banks commonly 
stopped short of nothing but the criminal law — and sometimes not short of that.* 

During the course of typical real-estate booms, some of which have 
lasted for a full decade, the activity of property turnover is also evident 

1 Ernest M. Fisher, Speculation in Suburban Land, American Economic Review^ 
Supplement, March, 1933, p. 154. This article is an excellent summary of the specula- 
tive and cyclical aspects of urban land speculation in the United States. See also 
E. M. Fisher, Real Estate Subdividing Activity and Population Growth in Nine 
Urban Areas, Michigan Business Studies, Vol. I, No. 9, July, 1928, and E. M. Fisher 
and R. F. Smith, Land Subdividing and the Rate of Utilization, Michigan Business 
Studies, Vol. IV, No. 5, 1932. See the statistical studies of land subdivision and real- 
estate cycles in several California metropolitan communities by Lewis Maverick, 
Journal of Land and Public Utility Economics, May, 1932, and February, 1933; also, 
Helen Monchow, ‘‘Seventy Years of Real Estate Subdividing in the Region of 
Chicago,” Evanston, 1939. One of the most interesting measures of fluctuation in 
the number of lots subdivided per capita pertains to Allegheny County, Pennsylvania, 
beginning in 1830; see reproduction of a chart prepared by S. Keyes, in Warren and 
Pearson, “ World Prices and the Building Industry,” p. 107, New York, 1937. 

* Real Estate Speculation and the Depression, American Economic Review Supple’- 
ment, March, 1933, p. 164. Further comment on the banking phases of speculative 
activity will be found in Chapter 11. 



in the number of deeds recorded or the number and value of mortgages 
executed. Naturally, many of the transfers recorded with county clerks 
involve not merely land but improvements, and some of the activity in 
transfer of real estate has to do with older properties that begin to 
change hands more readily in the very early stage of an incipient rising 
cycle. Increasing local population, in terms of family units, first brings 
about a stiffening of rentals and a rise in the prices of existing improved 
properties. Then new building gets under way, and the enthusiasm to 
participate in the rising values spreads throughout the field of land 
development. It is an interesting fact that for many communities whose 
records have been examined, the broad swings in the activity of property 
transfers, recordings of mortgages or of deeds, despite the inclusion of 
some irrelevant entries, correlate very closely with the changes in sub- 
dividing activity, as measured by number of lots per capita. The great 
waves of these real-estate movements have local peculiarities in pattern 
and timing, but the major cyclical swings show up in many communities 
at about the same time, although conspicuous departures will be found. ^ 


Two interesting examples of urban realty cycles in comparison with 
construction activity are shown in Charts 25 and 26. The first relates 
to the number of lots subdivided annually in Cook County (Chicago 
area), Illinois, from 1875 to 1940, and the number of buildings constructed 
over the same period in Chicago. Observe the remarkable amplitude 
of variation as well as the degree of similarity in pattern of these data. 
Hoyt says: 

Recurring land booms in Chicago . . . have generally been sustained and 
carried to their peaks partly by a sudden and extraordinary rate of increase in 
actual population growth which persisted for a few years, helped to foment 
speculative excitement, and led to even more extravagant hopes for future 
population increase. This increase in the rate of population growth was one of 
the factors that led to an increase in rents, building activity, and subdivision 
activity, each of which in turn was carried to speculative excess, and each of 
which interacted upon the other and upon land values to generate and maintain 
the boom psychology. There is thus a chain of events communicating with each 

1 Chart entitled '^One Hundred Fifty Years of Real Estate Experience,” published 
by Roy Wenzlick, Real Estate Analysts, Inc., St. Louis, 1939. Mr. Wenzlick and his 
associates have gathered together property-turnover records of numerous cities, 
some of these records extending back to 1870. See also files of the Real Estate Analyst , 
a service devoted to real-estate economics and forecasts, prepared by this organization. 
Recent study of the recording of deeds in various localities has been undertaken by 
the Division of Economics and Statistics, Federal Housing Administration, Washing- 
ton, D.C. The results show instances of astonishingly wide swings, rising far above 
the trend and falling to extremely low levels, approaching close to zero in some cases. 



Chart 26. — Building and subdivision activity in the Chicago area, 1875-1940. Sub- 
division activity has experienced extraordinarily violent fluctuations during the course of 
the major building cycle. 

Chart 26. — Building and real-estate activity in the Los Angeles area, 1880-1940. 
The above measures are in the form of deviations from long-term trends in order to show 
clearly the nature of the major cyclical movements and the fairly close similarity in the 
cycles of the three phases of activity. 



other which quickened or retarded the pace of all the activities connected with 
real estate.^ 

The second illustration relates to the number of subdivision maps and 
deeds recorded in Los Angeles County and the amount of building under- 
taken in Los Angeles during the past sixty years. These are shown in 
the form of cyclical variations about the respective long-term trends. 
Here again the fairly high correlation and extremely high range of varia- 
tion are apparent. Of the great realty boom of the 1880^s, when the rail- 
roads were pouring thousands of homesteaders into southern California at 
cutthroat fares, Maverick says, ^^Professional boosters and promoters 
arrived and laid out subdivisions in such quantities and in such unfavora- 
ble locations that many of them (had) not yet been occupied in 


The subdividing of land for urban property developments is thus a 
powerful amplifier, tending to accentuate the momentum of a group of 
activities having to do with housing construction, particularly that 
portion undertaken for speculative disposal or for rental purposes. The 
underlying forces, however, that originally give rise to the sweeping 
cyclical movements in real-estate transactions and residential building 
alike are found in population changes. This is shown in a comparison 
of building activity and the estimated annual rate of growth in population 

^ Homer Hoyt, ‘‘One Hundred Years of Land Values in Chicago,'^ p. 369, Univer- 
sity of Chicago Press, Chicago. The data of Chart 26 were taken from Hoyt's book, 
and Mr. Hoyt kindly supplied additional data to bring the record down to 1940. 
Hoyt further states (p. 391): “In 1836, in 1856, in 1872, in 1890, and in 1925 the same 
story was repeated with some variations in the mode of transportation to the subdivi- 
sion and of communication with the prospect but with little change in the nature of 
the sales arguments. The assumption at all such times is that population and new 
building will continue to grow indefinitely at the same rapid rate and that vacant land 
will continue to be absorbed at least as rapidly in the future as it has been in the 
immediate past. Close or careful calculations are not even made on the basis of the 
prevailing rapid rate of absorption, and the territory subdivided into lots exceeds any 
possible demand for years to come." 

2 Maverick, op. cit, February, 1933. The subdivision map data used for Chart 26 
were supplied to the writer by Dr. Maverick and by H. A. Harris, Deputy County 
Surveyor of Los Angeles. The cycles for building activity, 1889-1940, adjusted for 
building costs, are based upon permit data for the city of Los Angeles down to 1928 
and county data for later years. They were made available to the writer by Elden 
Smith, of the Security First National Bank of Los Angeles. The index of real-estate 
activity is based upon all deeds (except Torrens deeds) filed 1880-1927; thereafter 
upon totals, excluding deeds of partition and conveyance, road, cemetery, tax, 
and other instruments not representative of actual real-estate activity. These data 
expressed on a per family basis and adjusted for trend were also supplied by Mr. 
Smith, whose work on this subject, as manager of the research department of his 
institution, has done much to illuminate the workings of the property cycle in southern 



in 17 cities in Chart 27, based on the work of William H. Newman.* 
It will be seen that the broad variations of the two series describe similar 
patterns, whereas the index of population changes tends to precede that 
of building activity. 

Chart 27. — Urban building activity and population increments, 1875-1929. The 
building data represent permits, in a considerable number of cities, while population incre- 
ment estimates represent a limited number of large cities. The relationship throughout 
the period between the smoothed trends is highly significant. {Data prepared by William 
H. Newm^iJi, “ The Building Industry and Building Cycles,^' 1935.) 

The problem of securing a reasonably accurate general measure of the 
fluctuations in residential building throughout the United States is a 
difficult one. Building, like real estate, represents one of those fields 
of enterprise about which statistical data have accumulated more or less 
by accident rather than by deliberate interest and design. For recent 
years we have good records of building contracts and awards for many 
parts of the country (east of the Rocky Mountains), prepared by the 
F. W. Dodge Corporation as a part of their statistical services on behalf 

^“The Building Industry and Business Cycles,'^ University of Chicago, 1935. 
The estimates of annual growth in the population of these cities was derived by New- 
man from data relating to school enrollment, which tends to respond to movements 
resulting from migration during short periods of time. The building figures used by 
Newman represent building permits which although largely responsive to activity in 
residential construction, contain other elements as well and may, therefore, slightly 
distort the degree of correlation with population change. 



of those interested in building plans and construction.^ These contract 
statistics on building activity extend back, however, only a few decades. 
As we go back into the nineteenth century reliance must be placed upon 
the records of city-building inspectors, and these are principally in the 
form of the recorded value of permits granted for construction in order 
to enforce compliance with local ordinances. These figures do not give 
us actual volume data, but when the permit statistics are carefully 
compiled and deflated by an index of estimated changes in building costs, 
the result provides a tolerably good picture of the changes in the amount 
of building planned. 


Probably the best available long-term index of building activity in 
representative cities, in which residential is not segregatefl from other 
building, but use is made of building-permit figures that tend to vary 
mainly with residential work, is that prepared by John R. Riggleman.^ 
Extending back as far as 1830, Riggleman^s building index represents 
but a small scattering of cities in the early years, but these are con- 
sidered fairly typical of the spirited and contagious realty booms of 
the early nineteenth century. Rigglcman converted his index to per- 
centages of the long-term trend and also removed most of the influence 
of changing prices and costs by using an index of building-material prices 
as a deflator. The building cycle index pattern from 1845 to 1940, 
based mainly on Riggleman, is shown in Chart 28 (middle curve). ^ 
Observe particularly the intensity of the cyclical movements and the 
tendency of building to describe cyclical waves widely separated in 
time. The average period of these major cyclical movements is between 
17 and 20 years. The relation of these cycles to the very much shorter 
minor business cycles will be considered at a later point. ^ 

1 The complete F. W. Dodge figures are prepared as a subscription services rather 
than in readily available published form, although summary data may be found in the 
Survey of Current Business of the U.S. Department of Commerce, the Statistical 
Abstract of the United States^ and in various investment service publications. 

2 In its preliminary form, extending back to 1875, Riggleman's index is illustrated 
in the Journal of the American Statistical Association, June, 1933, p. 181. Since then 
the index has been revised and extended backward to 1830, and the writer has been 
given permission, through the courtesy of Mr. Riggleman, to utilize his revised data 
extending to recent years. See Appendix 6 for the use made of these data. 

3 Riggleman index 1845-1920, spliced to the writer's deflated permits index 1921- 
1940. See Appendix 6 for further details. 

^ Another series of American building indexes has been developed by Clarence D. 
Long, Jr. See “Building Cycles and the Theory of Investment," Princeton Univer- 
sity Press, 1940. Ix)ng, like Riggleman, utilized building-permit figures for a varying 
number of cities, but he segregated residential from other types so far as number of 
structures is concerned. There are two indexes of value of building permits, one 



In Chart 28 the building index is shown in comparison with two other 
series, the lowest curve being a smoothing of the ratio of immigration 
to annual population.^ It is obvious that there is a striking degree of 
relationship between the waves of immigration and the waves of urban 
building activity. Throughout the period there is also a tendency for 
the waves of immigration to anticipate the turning points in the building 
index. During the period following 1020, with a marked falling off in 
immigration due mainly to the legal restrictions already considered in 
Chapter 2, the degree of correlation between the two series becomes much 
less marked. It must be kept in mind, however, that during the 1920's 
and the major building cycle that came to a peak at about 1925, there was 
a considerable amount of internal migration produced by the shifting of 
industrial operations. Much of this was connected with the rate of 
development of automobile transportation, which rapidly created and 
expanded manufacturing centers about the Great Lakes. It also pro- 
moted the shifting of American families from crowded metropolitan areas 
into suburbs and stimulated suburban property development. The 
striking degree of relationship shown between immigration and building 
tends to support the evidence of Chart 27 in suggesting that the movement 
of people is a primary factor in generating the major building cycles. ^ 

The relation between mortgage solvency (measured by inverting an 
index of foreclosure rate) and the volume of residential building has been 

(‘xtondinf!; from 1868 to 1935 for a group of cities ultimately 14 in number, and the 
(»tlier with a somewhat different classification of building type covering ultimately 
27 cities for the same period. Ix)ng also has an index of the number of buildings with 
t hrc(‘ comprehensive classifications, extending from 1856 to 1936, and an index of the 
iiuiiiher of families accommodated in 16 localities from 1871 to 1935. The index most 
closely corresponding to the Riggleman series shows no marked deviations from that 
index, and it was decided to use Riggleman^s series for the period prior to 1921. 

^ Figures for gross immigration were used, inasmuch as there is no good reason to 
believe that the net immigration, even if the figures were available during the entire 
period, would correlate any closer than gross immigration with building activity. 
The gross immigration ratio in annual form was smoothed by a five-year moving 
average centered at the middle of each period. 

2 Some careful study has been made of international migration as related to busi- 
ness cycles in the United States and to business and social conditions in Europe. See, 
for example, Harry Jerome, ^‘Migration and Business Cycles,” National Bureau of 
Economic Research, New York, 1926. In this study it was found that the minor 
cyclical fluctuations of migration into the United States and domestic business condi- 
tions were very closely related. But although this suggests that the immigration 
movement was at least in large measure responsive to the minor changes in industrial 
conditions and employment opportunities in the United States, the bioad, major wave- 
like movements, with which Jerome was not concerned but which are shown in Chart 
28, primarily represent the influence of conditions in foreign countries and constitute 
movements that clearly precede the building cycles. They appear to be in large 
measure originating forces in the strict sense. 



determined with considerable accuracy for St. Louis as the result of the 
combined studies of Roy Wenzlick and Charles F. Roos. In Chart 29 
the building curve is shown in terms of the number of housing units 
added each year; the broad cyclical movements are preceded in each 
instance by the mortgage-solvency index. The latter has both a more 

Chart 28o. — B uilding, immigration, and mortgage solvency, 1845-1895. A significant 
similarity in broad cyclical movement exists among these factors. The index of mortgage 
solvency represents the reciprocals of per capita urban foreclosures; the immigration index 
is the five-year smoothing of the ratio of gross immigration to estimated annual total 

sensitive relation to building construction and a more similar pattern 
of amplitude than are reflected in either of the supplementary indexes, 
rental-cost ratio or local housing rental rates adjusted for occupancy 
rates and for tax payments.^ 

Let us turn now to an examination of the building cycle in terms of 
the various motivating forces and financial processes involved in this 

^See Charles F, Koos, “Dynamic Economics, “ Chapter 4, Bloomington, Ind., 



field of activity. When we speak of the building industry in this connec- 
tion, we have in mind primarily the operations of speculative house 
builders and also of builders erecting houses to order on a contract basis. 
We are not directly concerned with the many phases of the building 
materials or equipment industries, although our conclusions will have 
important bearings upon these lines and their cyclical instability. 

Chart 286. — Continuation of Chart 28a, 1895-1940. 

As a surging wave of demand for housing accommodations begins to 
develop, it follows a relatively long period of decline, the nature of which 
we shall discuss presently. During this long period of inactivity and 
declining real-estate values, the excessive supply of housing accommoda- 
tion carried over from the preceding boom continues to weigh upon the 
market. Population factors do not for some time resume a tendency 
favorable to revival of operations.^ Since the building industry is 

^ The values of both vacant land readily available for building and the existing 
structures tend to move through cycles essentially similar to those described by the 
number of transfers and the subdivision activities. Although property does not 
change hands frequently and the records of transfers are not easy to obtain in many 



primarily one of very small operating units consisting of entrepreneurs, 
subcontractors, and varying numbers of hired craftsmen, these organiza- 
tions mushroom and then fade away. There is not the enduring struc- 
ture of a factory, plant, or merchandising establishment. During the 

Chart 29. — Factors in new residential building in St. Louis, 1890-1933. Mortgage 
solvency appears to have been a more sensitive indicator of conditions in the property 
market than the other factors illustrated. 

long downswings fewer apprentices enter the unions, which so largely 
control admittance to the building and appliance crafts. Older workers 
die off; others shift permanently to other occupations. Quite apart from 
these long downturns, there are ample reasons for the proposition that 
when demand begins to revive, the building industry is not for some time 
prepared to meet it. It takes several years of improving demand to bring 
about perceptible restoration of activity among builders and their crews, 
even before the speculative builders bestir themselves. Fundamentally, 

cities, we know that there tends to be a tremendous range of fluctuation in these 
values. This can be illustrated from Hoyt^s study of Chicago, in which he speaks of 
the value of land within the 1933 limits of Chicago at selected years of peaks and 
troughs. In 1833 these values were $168,000; 3 years later they were $10,000,000; 
in 1842 they had fallen to $1,400,000; after 14 years of appreciation, in 1856, they 
became $125,000,000; 5 years later they had been reduced one-half; by 1873 they had 
again risen to $575,000,000; but in 1879 were $250,000,000; by 1892, however, there was 
a sixfold increase to $1,500,000,000. This promptly shrank in 1897 to an even billion 
dollars; then, after a long period of 29 years of appreciation, the values rose to $5,000,- 
000,000 in 1926, which was cut in half in 1933. Despite rapid growth in the aggregate 
size of the city, it can be seen that these values fluctuate around the growth trend with 
extraordinary violence. Data from Hoyt, op, cU, 


buildings are among the most durable products of human industry. 
Existing structures can be made to serve with a little crow’ding, a little 
patching here and renovation there, for a considerable period of time 
before the need for new houses becomes sufficiently acute to push rental 
values sharply higher and definitely to stimulate the slow-moving, 
cumbersome, scattered operators into more systematic action. 

Here we have a sequence essentially similar to what we have observed 
in the livestock industry. The response to the initial stimulus tends to 
be slow, because the period during which materials will not be produced 
in adequate quantity is rather long. During inactivity material plants 
are shut down, or nearly so, and distribution facilities have disintegrated; 
it requires time to resume operations and reassemble personnel. Numer- 
ous bottlenecks result, retarding the smooth flow of construction. Once 
there is an awareness of a reversal in the cycle of demand, usually in 
response to some basic shifting in the number of people or number of 
families, the rental values of existing property and the values of new 
property and of land ready for use tend to rise, but the rise continues 
for years before the expansion in construction has reached a satiation 
point. Since the building industry, when at full steam, can provide 
employment, directly or indirectly, for between 7 and 10 million workers 
in over 60 industries, the rising cycle of activity creates a parallel major 
expansion in employment and earnings. This in itself is a basis for a 
part of the improving demand for housing. Families unscrambled^ 
and establish separate households, and from many other reinforcing 
tendencies within the business system additional demand is created for 
housing facilities. Thus the cycle pushes itself along by its own momen- 
tum. The original stimulus multiplies itself before the top of the major 
cycle is reached. The accelerating rise in activity not only is accom- 
panied by higher land values and property values, reflecting the higher 
rentals, but is projected by the optimistic far into the future. According 
to Hoyt, ^'Land values are capitalized not merely on the new basis, but 
even on the assumption that the profit margin of landlords will continue 
to increase. Taxes are levied, bank loans are made, and long-time 
commitments are entered into on this new basis, until the whole financial 
structure of society is involved in the support of the newly created land 

Let us re\dew the course of a typical major cycle in housing construc- 
tion, l)eginning in the trough of depression. For a number of years there 
has been a pronounced shrinkage, not only of new construction of houses 
but of other phases that so largely depend on the residential work. Over- 
building during the previous boom has resulted in distressed properties 

} Hoyt, op. dt.y p. 233. 



being held by financial institutions. Many of these are vacant but are 
grimly held at prices still far out of line with existing conditions. The 
average vacancy in residential property is perhaps between 7 and 12 per 
cent of the total existing capacity. Families have doubled up, but many 
are not yet beginning to feel acutely the need for better accommodations. 
Some natural or migration growth has taken place in the community, and 
one by one the better vacant properties are taken over by families with 
higher than average income. Presently vacancies are reduced to the 
point at which a few new houses are again being planned, especially in the 
higher value groups. Meanwhile, some families have left the crowded 
sections of the community and sought cheap land in the suburban fringe, 
where a little activity in lower priced housing begins as a means of afford- 
ing these families an opportunity to reduce housing costs in view of the 
slow reduction in rentals in the more congested districts. A little stir of 
activity is seen among contractors, who add a man here and there and 
create new orders for lumber, plumbing supplies, glass, and other essen- 
tials. For some little time, however, possibly for a few years, the shifting 
about of families to absorb the vacant dwellings, apartments, and flats 
prevents any considerable amount of new construction. But little by 
little there is a tapering off in the decline in rental rates, and a gradual 
upward turn can be detected by the expert. 

The more alert and enterprising owners of rental property now begin 
to hire workmen to paint and renovate. As the number of independent 
family units increases and perhaps long-deferred movement of people into 
the community revives, there begins to be a more active interest in new 
construction on the part of those contemplating investment in rental 
properties. Meantime, industrial activity is feeling some beneficial 
effect of the initial orders for materials. When the rental rates, after 
taxes and other necessary costs of construction and maintenance are 
allowed for, multiplied by occupancy rates, begin to reveal an upward 
tendency, the signal is given for cautious but vigorous casting about for 
options on parcels of land suitable for the erection of new income property. 
Along with this stirring of activity, the shrewd and relatively prosperous 
families are taking advantage of the existing moderate price of materials 
to build new houses, although for a time the old ones vacated fill much 
of the demand on the part of new families in the lower income groups 
coming into the community. As the movement develops there are 
families in the middle income group and just below it who have felt for 
a long time the need for better accommodations to provide for growing 
families. There is by now enough enhancement of employment and 
income in the community (barring offsetting persistent depression factors 
that might, of course, exist in a given area), to make possible more com- 
fortable provision for those parts of families that have been living under a 



single roof. By the time the new building, which has been done mainly 
by those interested in rental properties and those having houses built 
to their specifications and financed largely by equity capital, shows a 
definite upward movement for several years, the speculative contractors 
and the real-estate firms interested in multifamily projects begin to be 
more active in planning the subdividing of suburban plots, laying out of 
streets, and sale of these lots to prospective home owners who can be 
induced to build homes, provided that the financing terms are attractive. 

In the process of creating new areas of land, partially improved and 
ready for building operations, there are to be considered the local vacancy 
rate, the rise in rentals, and the tendencies affecting the general cost of 
living. If rentals begin to rise rapidly, if the vacancy rate descends below 
5 per cent of capacity, and if the cost of living in terms of food and cloth- 
ing and other such immediate essentials is not unduly high, the processes 
of real-estate development have an open road for rapid expansion. This 
(expansion has usually been attended by more or less fanfare and promo- 
tional effort, and in what follows we shall describe tendencies that are 
not likely to be repeated in detail in the future. In order to sell lots, 
it is necessary to offer practical financing terms to prospective buyers. 
Until very recently, this was characteristically accomplished by arranging 
loans from banks, building-loan associations, life-insurance companies,^ 
mutual savings banks, trust companies, or private individuals, the terms 
of each class of lender being somewhat at variance with another. Since 
financing arrangements for residential properties comprise many types of 
borrowers, some building for personal use, others for income property, 
and still others for quick turnover as ^‘building merchants,^^ it follows 
that no generalizations on this subject will be perfectly accurate. There 
is unfortunately a remarkable dearth of precise information, inasmuch as 
the building industry has been one of the notorious blind spots in our 
economic history. In fact, the significance of the building industry in 
economic affairs and in the dynamics of industrial fluctuations has been 
recognized only within the last few decades.- 


So long as the number of families in the community is increasing and 
there is an active interest supported by rising income, employment, and 
general prospects, the opportunity for financing lot sales and home build- 

^ Only during the last twenty years or so have life-insurance companies taken a 
substantial interest in this field. 

* When George H. Hull wrote his book on “Industrial Depressions^^ shortly before 
World War I and stated categorically that “what we call booms result almost entirely 
from the great periodic increases in the volume of construction, and what we call 
industrial depressions result almost entirely from the great falling off in the volume 
of construction,’’ his was a lone voice, virtually ignored by the economists of his day. 



ing for the middle and part of the lower income group can expand. It 
must be recognized, of course, that in the United States families in the 
lower income group (let us say, roughly below income levels of $2,000 a 
year) have been accommodated mainly by rental property or by purchase 
of property at third or fourth hand. A much larger part of the new 
building than proportionate to the size of the group has for many years 
been done to accommodate the upper middle and higher income groups.^ 
In order to make it possible for the middle and lower income groups to 
participate at all in the ownership of homes, in view of the relatively small 
equity available to these families, the promotional activity has relied 
(until recent reforms served to restrict the practice) upon the use of 
mortgages requiring no regular annual payments of principal and, in fact, 
no outlay for several years on capital account. Here we come back to 
the deeply rooted evil which has lurked more or less unnoticed in so much 
of our long-term financing — the unamortized capital loan. 

From one point of view the use of such a device is readily explained 
by the historical background of a new country chronically short of long- 
term capital and hence accustomed to interest rates well above 5 per cent. 
It is obvious that if a five, ten, or fifteen-year property loan is system- 
atically amortized so that it is paid up at the end of the period, the regular 
payments by way of amortization of the principal, added to the interest 
payment on a flat basis, appreciably raise the actual annual outlay for 
financing to the borrower. If he wishes to “ trade heavily on his equity, 
as most property buyers and farmers have done, the financing naturally 
gravitates toward a flat loan payable in its entirety at the end of the 
period, at which time the borrower takes his chances upon being able to 
accumulate the principal or relies upon his efforts to secure a renewal of 
the loan for at least one more joy ride. From the standpoint of the sub- 
divider offering parcels of semiimproved property, the financing problem 
has historically been met in part by the all too familiar device of dividing 
the land into very small lots, crowding the neighborhood unduly, and 
creating a neighborhood subject to obsolescence and depreciation risks, 
of which the borrowing home builder has rarely been conscious. He 
weighed merely the rentals or the conditions of his existing accommoda- 
tions against the interest cost of ^^his^^ new property. And he seldom 
allowed for depreciation as one of the treacherous hidden costs that the 
future would bring to light. ^ 

^ See the evidence of Dr. Isador Lubin, Commissioner of Labor Statistics, before 
the Temporary National Economic Committee, June, 1939, Report, Part II, pp. 4943J^. 

* George L. Bliss, President of the Federal Home Loan Bank of New York, in his 
Seventh Annual Report, 1940, states rather pointedly: ^^It might not be amiss to draw 
attention to the curious psychology of the average property owner, who refuses to 
make allowances for ordinary depreciation and obsolescence in valuing his own prop- 



As the building cycle in a typical large community characteristically 
reached the upper third of its course or thereabouts, it became relatively 
easy for the promoters of subdivisions and the professional builders of 
jerry-made houses to dispose of their properties by means of the existing 
mortgage system. The lenders, although representing mainly highly 
reputable and established institutions, usually recognized that loans made 
under these promotional conditions represented unusual risks. Hence 
they sought (like the lenders to agriculture) to protect themselves by 
relying upon the curious fiction of ^Tiquidity ” of their loans and stubborn 
refusal to make commitments beyond relatively short periods, even 
though the properties upon which the loans were made were likely to 
be in existence for many years and the individual borrowers (apart from 
the purely speculative and turnover enterprises) were expected to hold 
the propert}^ for relatively long periods. 

First, then, was the figment or fetish of liquidity, expressed in the 
usual practice of not extending maturities on residential mortgages 
beyond about ten years. A considerable proportion of such loans were, 
in fact, restricted to five years, and commercial banks in some com- 
munities rarely made realty loans beyond three-year terms. A second 
means whereby the lenders sought to protect their depositors and their 
capital was by restricting the amount of first-mortgage loans to amounts 
not over 50 per cent of the appraised value of each property. This 
restriction was easily overcome, however, Iw means of the se(‘ond- 
mortgage lender. Since a large proportion of the families seeking homes 
to whom the subdivision operations catered could not afford more capital 
outlay than was enough to purchase the land or a part of it, the balance 
of the capital was raised by a first mortgage plus a second and even a 
third. The first carried a rate from 6 to 8 per cent, and the second cost 
from 10 to 15 per cent. In most instances the rate of interest on the total 
capital borrowed seems to have been in the neighborhood of 7 per cent, 
since the second mortgage was usually a smaller part (and this also was 
frequently amortized). 

erty, insisting instead that it is always worth what he paid for it, and that an inability 
to sell it at the original purchase price is an indication of economic maladjustment. . . 
The competent appraiser recognizes that there is little other than sentimental value 
remaining in the average forty or fifty year old house. A person who buys a home for 
five thousand dollars, with one thousand dollars representing the value of the land, 
and four thousand dollars the value of the property, should recognize that at the end of 
ten years a depreciation of, say, twenty-five per cent has taken place in the value of 
the improvement and that its aggregate value has then been reduced to about four 
thousand dollars. Twenty years after its purchase, in the ordinary case, about fifty 
per cent depreciation has taken place. There would be less wailing and complaints 
about economic injustice, if such a home owner recognized that his property is half 
worn out.^' 



Observe now the effect of this financing system upon the building 
industry when it reached the top level of a major cycle of expansion. As 
it entered this range there was in evidence the full swing of real-estate 
activity, a very active sale of lots, busy speculative builders competing 
more or less blindly with each other and having no accurate estimates 
of the future trend of population upon which actual demand would 
largely depend. Some part of the financing operations was undertaken 
directly by the speculative and rental builders and their clients who 
acquired the properties, and this part of the mortgage lending became 
increasingly fraught with risks and dangers. The more cautious savings- 
banks and building-and-loan operators became less inclined to make new 
loans, and, what is most important, they tended to frown increasingly^ 
upon the extension of loans that had been made a few years before 
and that were coming up for renewal, which might or might not be 
granted, depending on conditions at that date. 

In the course of the expansion a point was eventually reached at 
which it became apparent that the speculative building and financing had 
been overdone. Some subdividers of land actually found themselves in 
financial difficulties, unable to pay taxes or to repay loans that had been 
taken out to provide for operations during the unsound stage of the boom. 
This immediately threw some land upon the market through distress 
sales. There followed a few cases here and there of foreclosure of loans 
representing the thinnest equities or the most reckless borrowers. The 
excesses of the boom began to show themselves in a shifting of families 
out of rental properties, thus bringing about enough wavering and hesita- 
tion in the movement of rental ratos to affect the earning power of a few 
speculative multifamily structures and therefore the loans upon these 

From this point forward a process of disintegration set in. It tended 
to travel a cumulative course, marked out by the blind character of the 
competitive overexpansion during the upswing and the unsound financing 
machinery, which resulted in many thin-equity loans at or near the peak 
of overbuilding. As the values began to suffer as the result of additional 
distress sales, the financing agencies became ultraconservative; they 
refused renewals, stepped up the cost of new loans (if granted at all), and 
new building began to feel the competition of the existing properties 
thrown on the market. Employment among the building workers and 
the producers of building materials began to feel the initial effect of what 
would prove a tragically prolonged deterioration of activity This proc- 
ess again proceeded on its own momentum. More properties became 
involved in the snares of the flat loan and the remorseless, routine oper- 
ations of financial repossession. The number of foreclosures then began 
to rise rapidly, even before building operations had actually turned the 
comer downward. 




This acceleration in housing foreclosures may be considered, in the 
light of statistical evidence, to be probably the best single indication that 
a change in the tide is at hand. Referring again to Chart 28, observe the 
upper curve, which shows, in inverted form and thus as an index of 
mortgage solvency , an index of property foreclosures (per capita) in a num- 
ber of American cities.^ The chart clearly reveals how well the index 
of mortgage solvency has preceded the broad swings of the building cycle 
itself. It summarizes, in effect, all the complex factors that make up that 
cycle. In the rising phase of realty development, we find declining diffi- 
culty in financing; in the declining phase there are increasing involvement, 
distress selling, and addition to the ownership of property by financing 
institutions. Most important, from our present standpoint, has been 
the cumulative effect of this shrinkage upon employment in the building 
trades and in that vast group of durable-goods industries that is mainly 
dependent upon the construction market. As employment and wage 
income and entrepreneur income drawn from these sources have moved 
downward, the income factor entering into demand for housing itself has 
shrunk and produced additional foreclosures, lower values, lower rentals, 
more vacancies, etc., down the years to the bitter end in a long, deep 
trough of building (and general business) prostration. ^ 

During the course of this contraction there naturally occurred a fold- 
ing up of speculative operations, and the number of acres of land sub- 
divided in a community might actually decline to zero. During this 
period there was a tendency to shift loans and refinance. Three- and 
five-year loans made by commercial banks were taken over by building- 
and-loan associations; others, by life-insurance companies, which became 
active in this field after World War 1. It is difficult to say just what has 
been the typical maturity of loans that were finally kept outstanding 
during the storm, but the evidence appears to suggest that an average or 

^ The data of mortgage foreclosures were kindly supplied by Roy Wenzlick, who 
has probably done more than any other research worker in the statistical investigation 
of this phase of the American economy. Beginning at 1938 Wenzlick’s series was 
spliced to similar data which have become available through the studies of the Home 
Loan Bank Board and published in their monthly Review, 

* Charles F. Roos has also noted the importance of foreclosures as a sensitive 
barometer of the realty situation. He finds a threefold significance in them. “First, 
foreclosed houses are additions to the supply, so that prospective buyers may purchase 
a foreclosed house instead of building. Second, foreclosures affect the general value 
of buildings in the community in which they take place, and impair the equities and 
mortgages. Third, foreclosures are a measure of the state of the investment market, 
of the willingness of bankers to loan or to refrain from pressing debtors, of the very 
availability of credit itself from either banks or long-term investors. This line has a 
distinct forecasting quality/^ From “Dynamic Economics,*^ p. 78, Bloomington, 
Ind.. 1034. 



modal maturity of about ten years was the common practice. This would 
suggest that about ten years from the bottom of a building cycle a fairly 
large fraction of mortgage loans reaching maturity date either failed to 
pay out or were refinanced under conditions that made the terms more 
onerous and created further obstacles to paying out some years later. 

The entire process strongly suggests, as previously stated, the historic 
background of capital scarcity, the impracticability of housing ventures 
for families of modest income that could pay interest but not principal. 
Mortgage loans were made on what seemed to the individual lender to be 
a safe proportion of the value of a property and for what seemed at the 
time to be conservative maturity, insuring, so it was thought, the liquidity 
of the loan. But as in so many cases where the general is confused with the 
particular y the over-all result of all this narrowly conceived caution was 
unfortunate for the entire system and for many banks that dabbled in it. 

The large insurance companies in the last great depression carrying 
only a part of their investments in urban mortgages, strong enough to 
weather the storm of deflation, were holding billions of foreclosed prop- 
erty, patiently waiting to dispose of it in a better period. In contrast, 
the commercial banks in some areas of excessive promotion, as in parts 
of Michigan, in Cleveland, and in other areas of very rapid growth, did 
not fare so well.^ The mutual savings banks appear, as a whole, to 
have been sufficiently conservative in their loans and sagacious in the 
selection of their risks to come through these difficult periods with fair 
success. The building-and-loan associations had varying results; many 
of them were outstandingly conservative and successful, and they avoided 
the unsound features of unamortized loans and encouraged payment loans 
long before other financial institutions had adopted them. But in some 
localities, particularly on the Pacific Coast, some building-and-loan 
associations became involved in speculative building and apartment 
construction at the top of the last cycle of building in 1923 to 1926 and 

1 Robert G. Rodkey has shown in his study. State Bank Failures in Michipian, 
Michigan Business Studies, Vol. VII, No. 2, University of Michigan, 1935, that ‘‘little 
attention has been given to the ability of the borrower to meet his interest payments 
and to amortize the principal periodically.^^ He points out that the failed State 
Banks in the great banking crisis of 1933 had invested 37.5 per cent of their savings 
deposits directly in loans secured by real estate; they had also invested heavily in real- 
estate bonds, representing larger structures, such as apartments, hotels, and office 
buddings, which for the first time were financed to an important extent through bond 
issues following World War I. The re^al-estate loans of these banks were almost twice 
as large as those of all country National Banks. These loans were badly frozen when 
values began to collapse. The banks were unable to meet demands for withdrawal 
of deposits readily, and the demand for such withdrawals accumulated as depositors 
recognized these difficulties. This was the immediate background of the banking 
crisis of 1933, which spread like wildfire from Michigan to other metropolitan centers 
and forced the Federal Government to close all banks. 



placed themselves and their communities in serious difficulty as the cycle 
collapsed. The banking crisis of 1933 is no mystery to those acquainted 
with the building cycle and the old system of financing that that crisis 
served finally to abolish. 

During the trough of a major depression the financial institutions 
were holding large amounts of foreclosed property, which was offered on 
the market only as fast as local conditions warranted. The property was 
usually placed at rental, and this action held down rental rates for a while. 
As this overhang of foreclosed property, some of it of high quality, con- 
tinued, there was a tendency for gradual shrinkage in prices. The 
important point is that this distressed property was sufficient in the aggre- 
gate to take care of a large part of the incipient demand for housing as 
the continued revival of replacement demand for various products began 
to form the basis for recovery in general trade conditions. 

Thus in the early phase of recovery the response of actual construction 
tended to be slow and uncertain, and considerable time was required to 
get the ponderous building industry once more under way. The overhang 
of foreclosed property may be considered, therefore, to have been one 
of the most important factors in this slow response. As in the case of the 
livestock cycle, the stimulating influences do not seem to have sufficed 
at the beginning to call forth enlargement of actual supply. But when 
the productive operations began to add to the inventory, those additions 
developed a reinforcing momentum continuing well beyond the period of 
strong demand stimulus. Sales of property occurred under distress at the 
top of the cycle, just as in the livestock industry herds will be offered 
for sale when conditions become less favorable, because of either higher 
costs of maintaining the herds or acceleration of falling prices as over- 
stocked areas begin to unload and market their cattle. 

From these considerations there develops a rather fundamental 
principle to which attention has not hitherto been sufficiently directed. 
In any industry whose products are capable of extended life, in which 
production activity responds slowly following the initial stimulus of demand 
and in which supplies resulting from previous production continue to be 
marketed long after the peak of output has passed^ conditions are created 
favorable to cyclical movements of relatively long average period. 

The building industry in the past has described just such cyclical 
movements. Over a long period of history and in all countries where the 
data have been examined, the major peaks and valleys of house-building 
activity are separated by long intervals. The periods are not exactl}^ 
regular, but the tendency toward cyclical movements so much longer 
than the typical minor business cycles, yet so much shorter than the 
long-term ‘‘wave^^ movements that we examined in Chapter 4, suggest 
that population movement plus mechanical forces within the construction 



process and the miscalculations attending a bad system of speculative 
finance afford a large part of the explanation. Without ignoring the 
occasional effects upon the pattern of building activity of cyclical varia- 
tion in business conditions, there is nevertheless to be observed a dis- 
tinctive long-cycle tendency here that far transcends the minor trade 
oscillations ; in fact, it exerts a powerful influence over a large segment of 
employment and industry and logically becomes one of the originating or 
causal factors in the vibrations of the typical business cycle. We shall 
return to this phase of the matter more specifically in the following 


Among the forces tending to give rise to the characteristic building 
cycle, the element of labor costs must not be overlooked. It is a familiar 
fact that the wages of the highly organized building crafts tend to be 
relatively high. That is, they tend to be ^^high'^ in terms of daily or 
weekly rates, compared with the pay of other skilled workers in industry. 
Building workers have organized themselves, at least in the larger cities, 
into strong union organizations, partly from the powerful motive of 
ensuring these high rates of pay while they are working. This motive 
stems at bottom from the very existence of the widely varying and long- 
period building cycle. On the other hand, it tends to perpetuate these 
great cycles. Since building workers are fully employed only about once 
every fifteen or twenty years, those who remain in the industry as 
carpenters, masons, plumbers, plasterers, and painters must carry them- 
selves and their families through long periods of underemployment as 
well as through seasons of the year when building activity is naturally 
restricted. But it is the high cost, in terms of wages per unit of construc- 
tion, that directly presents itself to the home builder or the speculative 

There has, of course, been technological progress in supplying these 
workers with better equipment to economize time, although this holds 
much less true of the so-called ^‘wet processes,^' such as plastering and 
bricklaying. Carpenters are today equipped with many timesaving 
devices, and much of the work on a dwelling is prefabricated or partially 
fabricated in industrial establishments. But union rules have generally 
been in the direction of restricting the day^s output of each worker. As 
for the general layout of work, building jobs cannot be easily centralized 
unless operations are carried on on a large scale by well-financed operators 
on a broad, continuing basis. But the provision of dwellings of medium 
or low price by large-scale, well-equipped enterprise seeking continuity 
by careful planning has made but slow progress. Operations have 


remained essentially a small-scale, scattered, and ill-coordinated type of 
enterprise so far as the actual construction work on the site is concerned.^ 

Since even the speculative building has been commonly undertaken by 
relatively small-scale operators, it has meant that the labor employed on 
the job has represented essentially the belated survival of simple handi- 
craft processes only partially subject to the cost-reducing features that 
might be associated with expertly planned community or neighborhood- 
scale prop>erty development. Thus the high cost of labor, in terms of 
units of c(ynst ruction work performed per man-day, has operated as a 
limiting factor in those periods when values and net rental rates have been 
at low ebb. Not until the cycle has carried these considerably higher, 
to what might be termed the flash point,^^ above which this high cost of 
construction readily could be absorbed, was new building undertaken on a 
rapidly expanding scale. 

The high labor costs have in a sense tended to create vacuums, fol- 
lowed by eventual excessive acceleration. During the accelerating 
period, as the top level of the cycle was approached, wage rates were 
usually raised from a high level to even higher levels, along with parallel 
movements in the prices of materials of many types. Throughout the 
material industries there has been fairly generally a long-standing 
tendency to charge what the traffic will bear when times were good in 
order to make up for the long periods of inactivity. Thus a kind of 
vicious circle has been created. The high average cost of labor and 
material, arising in part from the very existence of the major cycle, has 
tended to create an excessive momentum after pressure of demand has 
finally shot values and rental returns above the temporary barrier of 
production cost. This, in turn, has produced a pinching-out effect as 
costs rise higher, but the overbuilding in relation to existing demand has 
trimmed down rentals, values, and, after a long delay, incentive. 

The circular effect of relatively high labor cost can also be seen in the 
past in the effect of interest rates. The interest rate on mortgages over a 
long period of years has shown until very recently surprisingly little 
flexibility. Different levels of rates on housing mortgages have prevailed 
in various sections of the country, usually somewhat lower in the older 
sections and much higher in the frontier and newly settled sections. 
As estimated by David L. Wickens^ in the Middle Atlantic region, 

' Out of a total of 144,396 contracting establishments enumerated in the Census 
of Construction in 1929, no less than 113,799 represented small contractors whose 
average annual volume of business was nine thousand dollars. *^The Construction 
Industry,” U.S. Department of Commerce Market Research Series Vol. I, No. 10, 
April, 1936, p. 28. 

* Developments in Home Financing, Annals of the American Academy of Political 
and Social Science^ March, 1937, p. 77. 



78 per cent of the building loans as late as the early 1930^s were straight, 
unamortized loans, whereas in the East North Central area only about 
one-fourth of the loans were of this type, and a considerable proportion 
had amortization provisions. 

Thus the amortization features also have varied geographically, and 
the actual capital cost per annum to the borrower has varied from section 
to section to a greater extent because of the amortization features and 
risk elements than because of the differences in the interest rate itself. 
But in any event, the building-mortgage rate has averaged relatively high 
when it is considered that over the country as a whole second mortgages 
were widely used, especially during the boom of the 1920\s, and the com- 
bined rates paid b}^ borrowers on unamortized realty loans represented 
much higher rates than those associated with corporation bonds, munici- 
pal bonds, or even the average rate of return on common stocks. Thus 
the lenders sought to protect themselves in part by liberal allowances for 
risk, but this in itself contributed directly to the risks of instability, 
involvement, and foreclosure. 

As of 1934,^ commercial banks and building-loan associations held 
about 30 per cent of all the mortgage loans on real estate in 61 representa- 
tive cities. It is important to observe that both these groups of institu- 
tions, particularly the commercial banks, sought deposits upon which 
interest was paid but which, although earmarked as term or time deposits 
requiring notice for withdrawal, were actually and for all practical pur- 
poses on a demand basis. Hence these suppliers of a large part of the 
urban mortgage money were all the more driven to seek an illusory 
liquidity and paradoxically a relatively high rate of return on what was 
essentially long-term investment. Capital was extended to long-term 
ventures on the assumption that they could be considered short-term 
risks, but when depositors requested withdrawals, usually at awkward 
times, the result was difficulty all along the line, particularly to the thin- 
equity borrowers who, in many cases, were still struggling with interest 
on their second mortgages. Too much reliance was placed upon asset 
security by lenders and not enough upon scrutiny of the borrower and 
his particular income prospects. This, in fact, has been an important 
characteristic of both bank credit and capital finance in this country. 
The writer has received from a Los Angeles banker interesting comment 
on the lending practices that prevailed in southern California: 

The straight loans . . . were almost invariably of three to five years^ dura- 
tion. That was true in all of the Los Angeles banks which contributed much of 
the real estate credit of the period. Moreover ... as late as 1929 and 1930 

^ David L. Wickens, ‘^Residential Real Estate,'^ National Bureau of Economic 
Research, p. 9, New York, 1941. 



lenders were commonly resisting the efforts of borrowers to reduce the principal 
of their loans. The urge to keep the money at work at 7 % was much greater in 
the mind of the lender than was the desire to see the principal reduced as time 
passed. One reason for this was the absence of any fear of a collapse in land 
values. ... Not until lenders became frightened regarding the trend of land 
values did pressure for amortization develop. 

As the result of foreclosures made by life-insurance companies on 
their real-estate mortgages, the amount of property coming into possession 
of 110 of the largest companies in the United States during the early 
1930^s is of definite significance. During the middle 1920^s the value 
of real estate owned averaged about 300 million dollars and was still less 
than half a billion as late as 1930, but these values rose rapidly as the 
amount of new mortgages declined. By 1936 they amounted to more 
than two billion dollars. During the rapid increase in foreclosures in 
1932, they were occurring at the rate of 1,000 a day. In that year the 
emergency facilities of the Home Owners^ Loan Corporation probably 
served to avert a still greater avalanche of redistribution of property, but 
the large lending institutions, particularly the life-insurance companies, 
had by that time begun to adopt policies of extension and other easement 
in the interest of avoiding further acquisition of properties. When it is 
recognized that foreclosures in urban property began to rise as early as 
1926 or 1927, it can bo seen how belated this policy was. 

In 1934, the Government \s Survey of Urban Housing disclosed that 
somewhat over 20 per cent of the residential mortgage debt represented 
loans by individuals. In view of this rather persistently large group of 
individual lenders, it is not surprising that institutional financing has so 
long held to the practice of making unamortized loans on an excessively 
short-term basis. The individual lender usually does not wish his 
capital to be constantly returning by way of principal payments. To the 
institutional lender this is acceptable, but in meeting the competition of 
individual lenders, it has been difficult to avoid the immediate competi- 
tive advantage that the small individual local lender ostensibly provided 
to the unthinking borrower — a somewhat higher average appraisal rate 
and higher proportion of loan to appraised value. It is probable that 
rates charged by individual lenders were somewhat lower in many cases, 
but these advantages were deceptive in view of the fact that individuals 
as lenders usually preferred not to amortize. 

Those who have imagined that the cyclical movements in residential 
construction have somehow resulted from variations in the so-called 
‘^general rate of interest (if this is intended to be distinct from entre- 
preneurial profits on invested capital) must not expect to find much 
factual evidence supporting their view so far, at least, as American 
experience goes. This, indeed, seriously qualifies the interest-rate 



theory that of late has been popular as a factor alleged to be a causal 
element in generating business cycles. The recent vogue of that body 
of theoretical doctrine seems to have been based more upon plausible 
argument than upon careful examination of the facts. But if we look 
at the interest rate in terms of the secular trend and recognize the marked 
decline that this trend has undergone in the past decade, one correspond- 
ing effect upon building finance seems important. This is the possibility 
of lengthening the term of systematically amortized realty mortgages. 
At a low rate, if it is assumed that it can be continued, amortization is 
much more practicable and capable of wide extension than at relatively 
high rates. In this sense the level of the rate, not its long-term cyclical 
gyrations, have an undeniable importance in this connection and also 
for all other forms of long-term property financing. 

It should also be emphasized that it is in residential building that we 
find this cyclical mechanism most pronounced and characteristic. Indus- 
trial building tends to move closely with the minor cycles of business 
activity to which further consideration will be given presently. The 
erection of social-utility structures, such as hotels, large apartment build- 
ings, etc., and also of substantial commercial structures consisting mainly 
of offices, has usually represented a kind of fantastic excrescence, pyra- 
mided on the crest of the residential cycle and deriving much of its 
motivation from the general expansion usually occurring at that stage. 
Since these elaborate structures require several years to plan and get 
under way, it has usually happened that by the time they were completed 
the housing cycle had already begun to reverse, and as the decline con- 
tinued, with its usual destructive effect upon general business and finan- 
cial conditions, these ambitious properties became involved in financial 
embarrassment. Many of them were built in the later 1920\s and were 
financed by bond issues. The impaired status of realty bonds of this 
type in the years following 1929 has been excellent evidence of the manner 
in which the incentive to build does not actually produce results until 
the conditions creating that incentive have already begun to disappear.^ 

As for public building, this depends on a variety of factors, having 
to do with the financial condition and temper of local government bodies 
and the changing policies of the Federal Government. Further features 
of this phase of building construction and the general question of utilizing 
public-building programs as a means of offsetting the influence of the 
building cycle or the business cycle generally, will be given attention in a 
later chapter. We may add at this point, however, that in the past the 

^ See the interesting chart in Warren and Pearson, World Prices and the Building 
Industry,'^ pp. Ill and 112, showing the dates at which various metropolitan sky- 
scrapers and other large buildings were built during the past hundred years. Very 
tew of them were constructed below the top third of the major building cycle. 



reckless pace of subdivision and speculative house-building activity has 
produced a prompt counterpart in local government extravagance in 
providing supplementary facilities and installations. Much of the 
municipal debt and subsequent heavy local tax burdens can be directly 
traced to the developing of utilities to serve new subdivisions, usually far 
in advance of actual demand. Mr. Hoyt, on the basis of his Chicago 
observations, states that during the typical boom 

. . . there are lavish expenditures for public improvements in some localities. 
The cost of these is financed either by bond issues, which are readily passed by 
popular vote at such times, or by special assessments payable in five or ten 
annual installments, which are fikewise cheerfully assumed by landowners in the 
belief that it will enhance the value of their land still more. Consequently, new 
bridges are built or streets are widened in old neighborhoods, and miles of pave- 
ments, sidewalks, and sewers are constructed in outlying subdivisions. Thus the 
public authorities not only do not limit the output of subdivided lots, but they 
encourage the rapid increase in their supply by enabling sewers, sidewalks, and 
pavements to be installed on vacant prairies without cost to the subdivider. 
The sight of newly installed sidewalks in a tract that would otherwise be only 
a farm or cow pasture gives the misleading impression that it is the first step in 
the growth of a new community, the other steps of which are to follow shortly.^ 

In the broad major movements of the building cycle, important warn 
naturally have important effects, since, as we have already indicated, 
wartime price inflation and the \dolent distortion of living costs tend to 
be disturbing factors rather than stimulating factors in construction 
work. We shall defer consideration of the manner in which wars have 
affected building until a later chapter, wherein the building cycle will be 
related to other major movements in the durable-goods industries and 
the relation of construction to war, price level, and the business cycle will 
be specifically analyzed. 


Let us now summarize briefly the essential features of the great cycles 
of urban real estate and housing construction. Changes in the number 
of families to be provided for appear to be the underlying causal factors 
in realty developments. Since houses are very durable it is the change in 
families not the number of families itself that produces building demand, 
and this goes far to explain why that demand can vary so widely. Once 
the construction industry has overcome its inertia and acceleration is 
fostered by speculative subdivision acti\dty, expansion in residential 
building can be carried much further than the demand on the basis of 

* Hoyt, op. cit.j p. 392. See also the interesting data presented in “Fluctuations 
in Capital Outlays of Municipalities,” U.S. Department of Commerce, 1941. 



added family units and the replacements warrants. The succeeding 
long decline carries new construction well below the level represented 
by the measure of family or population change but, of course, not below 

Although each community represents special factors and influences on 
the realty cycle, there is, nevertheless, a remarkable tendency for the 
movements to occur with a rough degree of concentration in timing in 
the important cities. The extent of the cyclical movements, however, 
will differ from locality to locality. In a few extreme cases, such as 
Miami, Fla., in the early ’twenties, there will be very extreme movements 
followed by spectacular collapse. The housing boom appears to have 
reached its last major peak on the Pacific Coast in 1923; in New England, 
the South Atlantic, and the East North Central sections, in 1925; and 
in the Middle Atlantic States, in 1928. During these great swings, broad 
movement of the index of mortgage solvency appears to have preceded 
the corresponding phases of the building cycles. Population increment 
and the status of the realty loan market thus appear to have varied 
consistently ahead of actual construction by several years. Following 
these more sensitive indicators, there were usually changes in the rental 
and vacancy indexes, the one being practically inverse with respect to the 

Building costs have tended to lag in their response to the cyclical 
movement and have appeared to be of critical importance only after the 
cycle itself extended over a long period of years and into very high ground. 
Changes in interest rates appear to have been of no important effect, 
but the willingness of lenders to make loans in consideration of the general 
solvency and foreclosure situation has been much more important. 
Exceptional activity in the subdividing of suburban land and in the turn- 
over of land and real property appear to have been characteristic of the 
realty cycle in its later phases rather than in the initial phases of recovery. 
With the tendency toward a vicious circle created by relatively high and 
rigid building costs, particularly for labor and interest charges and with 
the relatively tardy response to demand changes, the cycle has tended 
to be pushed to levels far beyond the effective demand that was capable 
of validating the expanded volume of debt, and this has brought the 
collapse of the overexpanded situations in a cumulative spiral of deflations 
and contraction, affecting broad segments of national income. Thus the 
cycle has tended to generate its own spectacular unbalance and volatility. 
But, as we shall presently see, it has been externally affected by other 
important factors, such as those emanating occasionally from war 
conditions or the disturbing effect of wide fluctuations in other segments 
of promotional capital-goods industries. Like the cycle in the livestock 
production, we have a prime mover, with internally propelling mechanism, 



but it is also subject from time to time to impulses and cycles of solvency 
in other departments of the economy.^ 

^ The factors that operate to form building and real-estate cycles will be found 
further illustrated in the following publications: Charles F. Roos, “Dynamic Eco- 
nomics/^ Chapter 4, 1934; Lowell J. Chawner, “Residential Building,” Housing 
Monograph Series 1, National Resources Committee, Washington, D.C., 1939; 
Clarence D. Long, Jr., “Building Cycles,” Princeton University Press, 1940; William 
H. Newman, “The Building Industry and Business Cycles,” University of Chicago, 
1935; Homer Hoyt, “One Hundred Years of Land Values in Chicago,” 1933; Helen 
C. Monchow, “Seventy Years of Real Estate Subdividing in the Region of Chicago,” 
Chicago, 1939; and Arthur F. Burns, Long Cycles in Residential Construction, in 
“Economic Essays in Honor of Wesley Clair Mitchell,” New York, 1935. 



The foregoing discussion of building and property financing revealed 
a distinct source of industrial and financial instability in the movements 
of large numbers of people as they affect changes in urban growth and 
generate more or less speculative and promotional development of housing 
facilities, forming patterns of long and violent cyclical oscillation in con- 
struction and land turnover. This necessarily affects a large number of 
other industries. 

In examining the nature of these building cycles, our object has been 
not merely to present their characteristics as an interesting and important 
feature of business dynamics but to establish the thesis that such extended 
and violent fluctuations form one of the basic originating and causal 
factors in the cyclical instability of industry and trade and income 
generally. We do not find here the sole explanation or perhaps even the 
most important causal factor in propagating the typical minor cycles of 
business conditions. The building cycles are much longer in period than 
the minor cycles of general business, whose average period has usually 
been between three and five years. But it is obvious that the general 
course of trade and industrial production and the flow of national income 
cannot be expected to remain stable or to pursue a smoothly ascending 
trend of growth when there are occurring within the business system such 
pronounced oscillations capable of affecting so large a segment of the 
working population and having such violent effects upon financial 
solvency and the entire credit system. Before we compare the building 
cycles with business cycles closely, it is well to examine some other 
phases of capital formation and durable-goods creation to discover if 
there may be disturbing elements of similar potency, although perhaps 
different time patterns, which, when considered in combination with the 
building cycles, may throw additional light upon the initiation of those 
persistent fluctuations known as ‘‘business cycles.^' 


It has already been pointed out that industrial construction, having to 
do with manufacturing plant, docks, warehouses, storage tanks, blast 
furnaces, and the like, also displays the wide amplitude of fluctuation 
that was found typical of the building industry. But the time pattern 



of industrial construction is not identical with that of residential building; 
it rather parallels closely the shorter movements of the general business 
cycle. It would not be difficult to show that a very substantial part of 
the additions made to factories, stores, and other business facilities arise 
from the undulating current of trade activity itself. The more active 
the flow of trade and the placing of orders for goods the more necessary 
becomes expansion and improvement of the structural facilities for 
production and distribution of these products. 

It has been demonstrated by J. M. Clark and others^ that a given 
demand for final products tends to give rise to much more violent changes 
in the increment of productive equipment used by the industry, the 
assumption being made, of course, that no usable excess capacity exists 
prior to the increase in demand. A tapering off in the rise of demand 

^See J. M. Clark, Business Acceleration and the Law of Demand, Journal of 
Political Economy y March, 1917; Economics of Overhead Costs/^ Chapter 19, 
University of Chicago Press, 1925; “Strategic Factors in Business Cycles, “ pp. 33-34, 
National Bureau of Economic Research, New York, 1934. See also the critical article 
by Simon Kuznets, Relation between Capital Goods and Finished Products in the 
Business Cycle, in “Economic Essays in Honor of Wesley Clair Mitchell, New York, 

Kuznets shows that the extent of the fluctuations in production of durable equip- 
ment or construction resulting from changes in the demand for products made there- 
with depends partly upon the amount of the stock of these capital goods per unit of 
the finished product, the extent to which this ratio is maintained throughout the 
subsequent changes in demand for finished goods, and the assumptions made as to 
replacement of the durable capital goods in any given situation. 

If capital goods are infinitely durable and no replacement is necessary and if there 
is a one-to-one ratio as between the current demand for finished products and stock of 
capital goods and building facilities, then changes in the demand for finished products 
will exactly match changes in the new capital facilities needed (if no idle capacity 
exists). The relation between the demand for finished products and the changes in 
demand for capital goods and building for their production will therefore represent 
merely the relation between changes in a total flow and changes in the increment of 
that flow. In any such relationship of aggregate change and differential change, we 
come upon the familiar principle of larger percentual changes in the differences than 
in the aggregates and the further principle that the former changes will tend to precede 
in their turning points and directions the changes in the aggregates. 

There is nothing mysterious about these statistical characteristics, but a good deal 
of difficulty has surrounded the presentation of these principles through certain more 
or less hidden assumptions as to the ratio of the stock of capital goods to the demand 
for their products, the necessity for replacement, and intermediate changes that may 
occur in these elements. In actual cases, there are so many irregularities and psycho- 
logical, financial, and other peculiarities entering into the relationship that it is 
dangerous to generalize these principles into any proposition capable of being used to 
explain the variations in the business cycle as a whole. In fact, statistical evidence 
indicates that even in particular industries the expected behavior of production of 
capital goods and structures in the face of changes in the demand for their products 
does not often verify the assumed hypotheses. 



for a product tends to bring about not merely a tapering off in the produc- 
tion of the capital goods and plants associated with that article but an 
actual reduction in the creation of new plant. Hence the cyclical move- 
ments are not only more violent but tend to be more sensitive in changing 
direction than in the case of the pattern of ultimate demand itself. In 
view of the relationship thus existing (at least in theory) between demand 
for product and demand for capital equipment, it cannot be safely argued 
that the ups and downs in the creation of equipment of this type serve 
primarily to explain the changes in demand for consumer goods and other 
finished products. To be sure, they may serve to explain why a move- 
ment in the business cycle may accelerate cumulatively for a time and 
generate still further changes in some given direction. In this special 
sense the use of complicated mechanism and elaborate industrial plant 
in making fabricated goods probably contributes occasionally to more 
instability in the flow of industrial activity as a whole than might other- 
wise be the case. It serves as an amplifier and spreader of such changes 
in general buying power as are somehow already being produced by other 
primary forces. 

We are now in search of these other “independent^^ forces. One of 
them obviously is found in the swings of residential building, depending 
upon the movement of people and major changes in rate of growth of 
population and occurring in several large areas at about the same time 
and in the same direction. It is important to distinguish between the 
long cycles of residential building and urban land development, on the one 
hand, and fluctuations in the creation of industrial plant and equipment, 
on the other. There is always the temptation, repeatedly seen in recent 
economic and political literature, to place most of the blame for business 
and industrial instability upon the manufacturing industries, especially 
in the capital-goods field. Here, to be sure, we do find wide variations 
from year to year in output and employment. The tendency is natural 
to associate these broad swings of activity, translating themselves into 
wide variations in the buying power of wage earners, with the failure of 
management in these industries to adopt a more stable course in their 
plans and operations. Unfortunately, most of these segments of industry 
are unable to adjust themselves to a stable course for the very reason 
that the things that they produce are made to order and cannot be made 
to stock; orders come to the makers of capital goods in a highly irregulai* 
cyclical pattern that exposes these industries to conditions exceedingly 
diflScult to control. It is literally a feast one year and a famine the next. 

Much misunderstanding has been created through the tendency to 
argue about this type of industrial production as though it were concerned 
with the making of staple materials or identical units of things. But 
most complex production material or mechanism is made to order, to 


fit into certain particular uses, and until these are defined and specifica- 
tions drawn up in detail, few manufacturers of capital equipment dare to 
produce for stock and thus attempt to stabilize their production. If 
they make machine tools, they must await exact specifications. Even 
if we are considering the simpler tools or materials, such as the metals, 
there is no way of knowing the proportions in which they are to be 
produced to serve future requirements in production or construction. 

In the case of the industrial plant, it is impossible for such construc- 
tion to be made speculatively very far ahead of actual need, and the usual 
tendency of business concerns is to add a little here and a little there 
as the need requires. There is, of course, always a speculative fringe of 
enterprise stumbling into difficulties through blind enthusiasm, taking 
long chances with structural expansion, but the activities of the urban 
land speculator and the speculative house builder have no real counter- 
part in the industrial field. These specialized characteristics may be 
seen even among the raw and semifabricated industrial materials. Steel, 
for example, is not just steel; the popular term applies to a wide variety 
of highly technical combinations of iron, carbon, and numerous possible 
alloys, designed for particular uses in particular places. And when 
steel is formed into semifabricated shapes, these are primarily ^Hailor- 
made^' products incapable of being made to stock. The demand for 
them is variable, for reasons lying entirely outside of the steel-making 

In order, therefore, to discover the ultimate reasons for relatively 
wide variation in the flow of demand that impinges not only upon makers 
of building material (including industrial and commercial buildings) 
and almost all the durable goods utilized in manufacturing, we must 
endeavor to locate the moving forces of an originating character — those 
that are not primarily merely resultants of changes in the industrial 
cycle, magnified through the magic glass of ‘‘rates of change.'^ 


Where shall we find other types of economic activity capable of exer- 
cising a disturbing influence upon demand and production, which are not 
merely resultants of their vagaries? It might be suggested that inven- 
tion, innovation, technological change might point the way to what we 
are seeking. Consider the infinite number of improvements resulting 
from the discovery of new methods of making things that have crowded 
one upon another in the past century of dramatic economic progress. It 
would appear almost commonplace that technological advances tend to 
be unsettling, since they involve the scrapping of old processes and 
familiar materials as new ones capture the field. 



Joseph A. Schumpeter has developed in interesting fashion the thought 
that these production innovations constitute the most important source 
of those “externar' forces that impinge upon business system and bring 
about dislocations, waves of promotion, economic excess, human failings, 
and hence an essentially irregular course in general business growth 
over the years. This seems plausible as well as fascinating as we review 
the colorful succession of these new contributions, new methods, new 
industries arising from patient experiment or adventitious discovery by 
someone impatient with old ways. But as we carefully analyze these 
innovations, we fail to see conclusive reasons why most of these technical 
changes that are important from a scientific and technological point of 
view should necessarily generate broad simultaneous cyclical disturbance 
in the entire industrial system. That system, as it has evolved in 
American experience, or, for that matter, the experience of any other 
advanced nation, is a sturdy fabric, highly resistant to disturbances that 
originate here or there within its own expanse. It requires very con- 
siderable impetus along a wide front to distort that general dynamic 
pattern. It requires the existence of changes somehow affecting the 
financial filaments in the fabric, whose strength and soundness largely 
condition the strength and evenness of the whole. 

Technical innovations appear, in fact, to be in most cases localized 
and specialized as they affect a product or a process. As improved 
machinery, for example, becomes available for the making of shoes, the 
shoe industry feels the effects, and they are transmitted throughout the 
economy, but with net results that are so diffused as to be almost imper- 
ceptible, even though in one or two localities, where shoemaking happens 
to be concentrated, there may be appreciable and long-continued effects 
of such an innovation. Occasionally an invention, such as the electric 
light, provides a basis for an important new industry whose development 
sustains and even accelerates for a time the general drift of all industry 
because of a cluster of related electrical developments associated with 
this one far-reaching improvement. Frequently such innovations stimu- 
late activity that, however, is canceled by the decay of obsolescent 
product or method. We notice the rise of the new in its engaging and 
spectacular aspects, but we forget the old and fail to take ac^count of its 
fading from the picture. Let it be granted that occasionally an innovator, 
as Schumpeter has persuasively argued, may develop some new product 
or device capable of accelerating a boom already in progress or hastening 
cyclical collapse in the early stage of a topheavy situation existing through 
a broad segment of industry.^ 

^ See his “Business Cycles: A Theoretical, Historical, and Statistical Analysis of 
the Capitalist Process, New York, 1939. Schumpeter has taken pains to explain 
that “innovations^ is a much broader term than “inventions^ and has to do with the 


Schumpeter’s hypotheses emphasize the manner in which ‘^innova- 
tions ” in industry broaden themselves by the tendency of many minds 
to copy and then rapidly exploit an original innovation, once its practical 
potentialities are apparent. Important innovations “tend to cluster, 
to come about in bunches, simply because first some, and then most, 
firms follow in the wake of successful innovation.”^ Schumpeter further 
states: “Innovations are not at any time distributed over the whole 
economic system at random, but tend to concentrate in certain sectors 
and their surroundings.”^ He recognizes the possibility that some 
innovations, particularly in the basic and durable-goods industries, may 
occasionally bring about changes of exceptional consequence by propagat- 
ing a cumulative series of new developments and adaptations all along 
the line, but the hypothesis lacks the support of convincing detail. 


It is at this point that the writer believes it desirable to venture more 
specific propositions to differentiate the really important innovations from 
those that remain localized and of no general significance as disturbing 
factors or generators of far-reaching cyclical movements in production 
and trade. The thesis is that of all the innovations bearing upon durable 
capital equipment^ those tend to be outstandingly important in their effect 
upon general economic stability and pervasive in geographic scope thdt have 
to do with methods of transportation. 

Keeping in mind that construction of transportation facilities differs 
in the matter of degree rather than in kind from other durable capital, 
let us proceed to examine why major innovations in this particular field 
of enterprise have been so important as an originating factor in general 
industrial fluctuations. Let us fully recognize at the start that there 
may be self-reinforcing tendencies in the process; that is, the impulses 
may react upon themselves and reinforce each other rather than operating 

actual development and incorporation into the economic system of new ways of doing 
things, not merely with the incident of discovery or the determination that a new 
device is workable. He shows also {op. cit.j p. 85) that inventions and innovations, 
too, may at times result from an economic situation that creates an immediate need 
for some new material or process or product. Schumpeter also regards innovation, 
in the broad sense in which he uses the term, as an internal economic factor, mainly 
operating in conjunction with existing factors of production, rather than an external 
factor impinging upon economic dynamics. In other words, innovations are part of 
the fabric and are integrally involved in the evolution of capitalistic processes. Fhey 
express the way in which evolution involves the combining of various factors in new 
ways. They are the elements that defy the ever-potential tendency toward diminish- 
ing returns from enterprise. 

1 Ibid., p. 100. 

* Ibid., p. 101. 



unilaterally. To some extent, and at various times, creation of new 
transportation equipment may be directly a function of, or resultant 
from, the oscillations of the minor business cycle itself. But there are 
good reasons for believing that basic improvements in transportation 
apparatus are likely to stand apart in their power at certain stages and 
under certain conditions to affect the course of production, trade, specula- 
tion, and finance in unmistakable and characteristic fashion. 

The wide use of mechanism to enable industry to provide an infinite 
variety and expanding quantit}'' of useful goods is but an example of the 
intricate division of labor, clearly set forth by Adam Smith in his ^‘Wealth 
of Nations/' Adam Smith pointed out that the division of labor is 
always limited by the extent of the market, which, in turn, involves the 
extent and eflSciency of the means of transport. Manufacture exists by 
virtue of the transport system that connects its manifold units. Eco- 
nomic progress is inconceivable without parallel improvement in means 
of communication. Since transportation is fundamental in expanding the 
scope of trade and the efficiency of all production, a major innovation 
likely to prove successful in a practical way has far-reaching effects and 
can produce profound and violent expansion if developed under the 
stimulus of unrestrained speculative promotion. 

It should be kept in mind that we are primarily concerned with the 
initial phases of structural development, that is, with the production 
of transportation equipment marking various stages of technical innova- 
tion. The ups and downs in demand for units of such equipment, once 
the general structure embodies the results of improvement or has adapted 
itself to the population throughout a newly settled area, will obviously 
result mainly from changes in conditions originating from many conceiva- 
ble minor causes. We shall have occasion presently to examine fluctua- 
tions in what may be called the replacement demand" for transport 
equipment, which have interesting characteristics but are not pertinent 
to this discussion. During most of the nineteenth century the outstand- 
ing ph<ase of transportation development was clearly the application of 
steam power to the railway and the construction of a vast railway network 
over an expanding domain. These occurred in response to waves of 
growth and movement in population and the local concentration of 
population that we have already seen to have been such potent factors 
in originating major building cycles. We shall presently illustrate the 
interrelation between the major cycles of building construction and those 
associated historically with the developments in transport construction. 

Using the railroad as the basis of our analysis, let us first consider 
some of the peculiarities of this type of transport that appear capable of 
making the construction phase, in conjunction with the very similar, 
although not identical ^ major waves in building activity, so potent in 


generating cyclical movements in industrial production generally. In 
its physical aspects a railroad system, representing the application of 
steam power to land movement of commodities and passengers, involves 
massive units of structures and equipment. Unlike water transport, an 
elaborate, specially prepared roadbed is necessary. Canals, supplement- 
ing rivers and lakes, whose development marked the decade prior to the 
first successful steam locomotives, were construction projects of a rela- 
tively simple type, involving no such complex fabricating operations and 
facilities as were needed for metal tracks. They were limited, too, with 
respect to the size of the carrying unit, the small canal boat. The use 
of steam locomotives afforded transportation plus speed, and speed 
required a roadbed that early took the form of iron rails laid upon stone 
and later upon tics and ballast. With increasing size of locomotives 
generating tremendous power, not only speed but tremendous carrying 
capacity per train marked a clear departure from any previous form of 
transportation. This is extremely important and has not been enough 
emphasized in connection with the railroad as a peculiar contribution 
to transportation technique. As locomotives were made more powerful, 
cars became larger, and tracks became heavier and were made of steel; 
the bridges, terminal facilities, and, of course, the engines themselves 
required new production techniques. 

These f(‘atures of the railroad meant a hundred years ago that the 
capital necessary for a railroad company was destined to be of an order 
quite out of focus with the normal capital needs of early American busi- 
ness, although naturally this was not clearly recognized at the beginning 
of the developmc'ut. It is not sufficient to say that railroads require large 
capital because of tlie massive nature of their plant requirements. Many 
industries share this feature. The precise point that is important is 
that the capital necessary to accomplish a minimum of railroad service, 
under the conti’ol of a given management, is probably larger than for any 
other type of economic effort. There is, in fact, a minimum size of rail- 
road unit that conditions the success of any given segment in the network. 
In fact, a railroad network is composed of segments that in themselves 
are units of considerable dimensions. 

In the case of large manufacturing industries there are many cases in 
which the industrial plant may be of relatively modest size. Transporta- 
tion necessarily involves space and extent, and if the roadbed supporting 
the movement of heavy equipment must be carried over a broad expanse 
of territory, over bridges, through cuts and tunnels, the material needed 
cannot be less than is sufficient to bring the line all the way from point 
of origin to point of destination. It cannot operate in small pieces. Nor 
is that all. It is necessary to develop service to adjacent ‘^feeder’' 
areas, and there is the constant temptation to expand the area served too 



rapidly. From a somewhat different point of view, this matter of area 
is of primary importance. Railroad networks were developed in many 
parts of this country more or less simultaneously as various sections 
attracted new people, and improvements in methods and design involved 
a wide extent of activity with sweeping effect upon the building industry 
and all the numerous material and equipment industries. Thus enormous 
capital requirements went hand in hand with far-flung structural promo- 
tion. This is merely another way of saying that the coming of the railroad 
was not merely the beginning of a major industry; it was a superindustry 
and was capable of stamping its own pattern of violently irregular growth 
upon the whole economy. 

The railroad and, indeed, other forms of transportation as well have 
another important characteristic. Flexibility is lacking. The railroad 
tends toward rigidity from the standpoint of diversion of plant to alter- 
native uses. A railroad line, once established, may readily equip itself 
to serve a developing community with varying proportions of freight 
and passenger transport and varying proportions among the different 
types of freight, express, etc. But it is limited in its structural facilities 
to the work of transportation. If adequate traffic does not develop, it 
is exceedingly difficult to adapt the plant to other profitable uses. If a 
railroad is successful and has been well planned and soundly financed, 
it is likely to be exceedingly successful. 

In fabricating industries and in commercial operations, there is 
usually a wide range of potential adaptation of equipment to alternative 
uses or products, but this is not true of transportation. Ships and air- 
craft admit of considerably greater flexibility than railroads, for ships and 
planes can be moved about, and even their terminals are not difficult to 
construct or relocate. Railroads have terminals that are more elaborate 
than those of ship lines or air lines. A railroad, therefore, is in a material 
sense a massive unit, spreading its plant over a wide geographic area, 
and its initial development naturally has simultaneous effect upon many 
places and many industries. The effect can be astonishingly constructive 
or, again, disastrous, since a road has little chance of success if it fails to 
tap an adequate amount of traffic within a reasonable period after its 


The foregoing peculiarities of the railroad have not been given ade- 
quate consideration in economic discussions, and we are therefore empha- 
sizing them.^ In addition to these basic and inescapable characteristics 

^ Most economic treatises on railroads are essentially discussions of rate problems 
and theories — a natural result of the preoccupation of traditional static economics 
with 'prices as the centrtd topic. 


of railroads, there are some incidental features of the development of the 
railroad network in this country. The difficulties of securing sufficient 
capital for projects of such enormous magnitude appeared at an early 
date, and they have stamped themselves upon the railroad enterprise ever 
since. These difficulties had already been experienced in the case of the 
canals, whose development was active following the conclusion of the War 
of 1812-1814. Our early corporations received charters to build turn- 
pikes and bridges and to improve roads, but the canals represented a 
larger order of enterprise that did not prove too successful under private 
control and promotion. Hence we find that the successful canals of any 
importance were those constructed by the States of New York, Penn- 
sylvania, Virginia, and Maryland. The Erie Canal, completed according 
to initial plans in 1825, was so successful that it quickly stimulated other 
State Governments to emulate it, and several ambitious state enterprises 
continued to flourish or flounder during the next two decades. 

The States played an important part in financing or subsidizing these 
forms of transportation development, because British capital could be 
readily obtained through investment in the obligations of the State 
Governments, even though most private projects were not then attractive 
to British investors.^ The marked success of the Erie Canal and the 
apparent soundness of state finances, at least as far as the 1830^s, finally 
induced some investment of British capital directly in railroad building. 
During the 1840’s, State activity in developing public works was carried 
to excess, particularly among the Southern States. This marked virtually 
the end of public enthusiasm for comprehensive transportation develop- 
ment under State Government authority. It also tended to shift foreign- 
capital investment from state obligations to the securities of the new 

The Federal Government, as early as 1806, had begun to carry out the 
policies of Jefferson and Gallatin in undertaking such projects as the 
Cumberland Road, for which large amounts of money were spent in 1819 
and in the middle Thirties. But it is a curious fact that just as the vast 
new development of railway building was getting under way, political 
considerations in the sense of the shifting toward reformism (c/. Chapter 
3) forced the Federal Government to stand aside. Andrew Jackson, as 
early as 1829, his first year as President, expressed an almost fanatical 
determination to hold the Federal Government aloof from any public 
works at the very time when wise and far-seeing policies for the super- 

1 In addition, the states received from the Federal Government a percentage of the 
receipts from sale of national land and used this income for their internal improve- 
ments. Thus public land booms directly helped to finance local government con- 
struction booms. See J. B. Sanborn, Congressional Grants of Land in Aid of Railways, 
Wtaconstn University Bulletin^ Economic Series^ Vol. II, No. 3, 1899* 



vision and coordination of the complex financial problem of railroad 
building might have averted serious difiiculties. Jackson feared, and 
there was doubtless some reason for his fear, that the National Govern- 
ment might become the unwitting source of huge subsidies and contribu- 
tions to salvage the results of reckless promotion; he was determined to 
reduce and, if possible, extinguish the national debt rather than expand 
it for such purposes. It was his conviction that if the Government was 
to be helpful along economic and financial lines its aid should be to small 
businessmen engaged in “healthy competition,’^ and particularly to the 
farmers, whose problems he thought that he especially understood. 
There was too a Constitutional aspect. Jackson was disposed to interpret 
the principle of “States’ rights” literally and narrowly. 

In 1835, therefore, at the very time that the Federal Government debt 
was being practically paid off, the States were beginning to enter upon a 
course of extravagant financial aid to all types of transportation projects, 
but in the following decade there came a shocking repudiation of State 
debt and several years of utter financial demoralization. Thereafter the 
field was wide open to private enterprise and private capital, much of it 
obtained from abroad. During the succeeding years the course of railroad 
development in the United States followed a course somewhat analogous 
to the development of the British railways, in considerable contrast to the 
more restrained and politically determined course on the Continent of 

With the field thrown open to individual promoters, it is important 
to recognize the peculiar nature of the incentive that prompted the 
venturesome to undertake railroad projects. The men who built the 
railroads were not primarily transportation experts. They represented 
in the main aggressive individuals who had amassed some wealth in 
shipping, stock speculation, or merchandising. They were men who 
shrewdly sensed the inherent characteristics of railroad transportation 
as a source of enormous gain. Steam transport over rails was soon 
accepted as sound in principle and likely in the long run to be economically 
successful. The early roads were short lines serving limited areas, but 
each little road, as it connected rapidly growing towns and cities, opened 
up brilliant and limitless prospects such as no other type of enterprise 
could possibly have done. 

The basic element in this bonanza was land — superlative oppor- 
tunities for speculation in land values certain to be created by new 
lines of communication not only in the terminal areas but along the lines 
themselves. Those who had some experience in property dealing and 
who keenly envisaged the probable course of trade, industrial, and agri- 
cultural expansion found it attractive to enter the ranks of the railroad 
builders, even though they may have been unfamiliar with the first 


principles of transportation engineering, economics, or even finance. 
Merchants in thriving cities who had been using their accumulating 
capital in real-estate ventures, town-lot subdivisions, and the like were 
instantly attracted to this new means of exploiting potential land values. 
The promoters of the Illinois Central, in the 1850^s, ‘‘placed lands which 
were likely to increase in value with the building of the railroad in their 
own name or in that of their Illinois Land Association. Station sites were 
kept secret until the Association had bought the land.^’^ It was entirely 
natural that British investors looked upon this project as a “land com- 
pany’’ rather than a railroad. Even after the Civil War, Jay Cooke was 
fully as much interested in capitalizing upon property values in Duluth 
as in the success of the Northern Pacific. Many other instances of the 
sort could be cited. 

The early railroads were fii^anced by small groups that were able 
with much effort to attract local capital and foreign capital only after 
the roads had been put into what appeared to be successful operation. 
Since the stakes were high, in view of the auxiliary attractions of land- 
value enhancement, it was natural that many more short lines would be 
built than could be financially solvent. This opened up a new field for 
those who found that they could derive advantage by purchasing small 
roads and selling them to the larger roads at a profit. Abundant oppor- 
t unity was presented to put a struggling railroad venture in a difficult 
position, then purchase it cheaply, and finally sell it to another line. 
Selling property of all kinds to railroads became one of the great sources 
of promotional wealth. Even the builders of some of the railroads, 
including the Union Pacific, formed auxiliary companies, known as 
“construction” companies, which nominally sold construction to the 
railroad — that is, to the stockholders — at inflated prices. Throughout 
the railroad-development period such methods continued virtually 
unchecked and unsupervised and were clouded in secrecy, since most of 
the promoters took the view that roads were not primarily built to 
serve the public.-^ 

1 K. T. Healy, “The Economics of Transportation in America,” p. 101, New York, 

2 “ From the moment a railroad company was formed, it fought for its existence in 
a world characteristized by anarchy and chaos. Despite the fact that transportation 
companies invited public subscriptions to their securities and were of a quasi- 
public nature, the only inviolable law was that of self-preservation. Common con- 
cepts of everyday honesty and fairness were ignored. Most of the great systems had 
been built by fraudulent construction companies, and if perchance a road had been 
honestly built, there was always an opportunity to correct this oversight by disreput- 
able, but highly profitable, manipulation of its securities. Often railway companies 
were managed, or rather mismanaged, not with an eye to fulfilling their functions as 
transportation facilities, but solely with a view to making money from speculations in 



As the railroads developed into distinct systems and their access 
to capital funds was widened, they were able to undertake bolder steps 
in constructing track far ahead of population movement or traffic require- 
ments. Unlike most ventures in merchandising or manufacturing, the 
railroad builders in the decades following the Civil War were captivated 
by the very long-term outlook for their projected lines, and plans were 
made for distinct objectives and vast growth. The tendency was to 
jump over thousands of miles, whereas the pioneers of the ’forties and 
’fifties had proceeded by hundreds. This tendency to overcapitalize the 
distant future and to invest enormous sums in the hope of remote return 
has probably been characteristic of all private railroad enterprise the 
world over. 

These tendencies toward overbuilding were accentuated by a change 
in policy of the Federal Government during the Civil War. Congress, 
beginning in 1862, approved a number of land grants to assist construction 
of the Union Pacific, the Central Pacific, and several other roads. This 
tended to overstimulate these undertakings still more, although adequate 
financing might otherwise have been difficult at the time. Thus, when 
the Federal Government did step obliquely into the picture, it contributed 
essentially nothing to eliminate excesses and financial abuses that 
flourished in most of these projects on a scale probably not to be found 
in any other segment of our industry and trade. 

The cycles of urban real-estate promotion and the cycles of railroad 
building, as well as all transportation development, have been closely 
interrelated in that both have responded to the underlying changes in 
population growth and investment. New communication facilities 
stimulated movement and the growth of new cities; the prospect of this 
growth, in turn, afforded the primary incentive for new transportation 
service and its elaborate physical equipment. The two phases of 
development are, indeed, of a single pattern.^ In this pattern we discern 
the simple truth that shelter and transport are equally basic and ele- 

their securities.'' (E. G. Campbell, '^The Reorganization of the American Railroad 
System, 1893-1900," p. 15, New York, 1938. 

^ ^^The chief ultimate importance of the canal, the lake traffic, and the plank roads 
was that they gave Chicago sufficient advantages to attract the railroads, whos(‘ 
importance in making Chicago a great wholesale and manufacturing center and in 
causing a tremendous rise in its land values far transcended any other single factor. 

. . . From 1852 to 1853 the population of Chicago increased from 38,754 to 60,600 
and half the population in the latter year was foreign born. Most of this increased 
population was poured into the city by the railroads. ... As a result of the heavy 
volume of European immigrants and homeseekers from the East coming West on the 
railroads to Chicago, the city grew rapidly in population to 80,000 in 1855, a seven-fold 
increase in the decade since 1845." (Homer Hoyt, ‘‘One Hundred Years of Land 
Values in Chicago," pp. 54, 62.) 


mental human needs. The promotional instability of house building and 
real-estate development superimposed on the high leverage arising from 
variable rates of change has in the past stemmed from the speculative 
motives and limited competence of small local enterprise. The equally 
pronounced cyclical vagaries of transportation construction have stemmed 
from the extraordinary opportunities for direct and indirect profit 
motivating pioneer capitalists and ultimately huge corporations whose 
financial structures, as the result of their historical development, have 
peculiar elements of weakness and instability. But so fundamental is 
the demand for better and faster means of transport that it is not sur- 
prising to find innovation in transportation exertirig such a profound 
effect upon manufacture of equipment and hence (as in building generally) 
upon the conditions in a wide range of manufacturing and fabricating 


Having in mind the characteristics of transportation construction, 
we are now prepared to examine the results of these alternating waves 
of boom and collapse in terms of statistical measurements extending 
over a long period of years and including several other transportation 
elements. In Chart 30, we bring together a pattern of the annual fluctua- 
tion in building construction, transportation construction, and the index 
of general business activity from 1800 to 1940. This affords an oppor- 
tunity to compare these measurements with the movements of com- 
modity prices and to observe the various relationships during war periods. 
The solid black curve in the lower portion of the chart displays primarily 
the cycles of building construction, but during the early decades, begin- 
ning at 1800, the index is based upon transactions in land only, represent- 
ing the cyclical fluctuations in the acreage sales of the public lands until 
1832, when these are averaged with the cycles of building as measured 
in the Riggl email index down to 1839. 

Thereafter the index represents urban building in terms of computed 
volume, adjusted for the long-term trend. The dashed curve is an index 
of transportation construction, including the major types of equipment. 
It is intended to measure the annual fluctuation about the groivth trend 
of railroad building throughout the course of that experience and, in 

^ It is an interesting fact that of the enterprises incorporated between 1783 and 
1800, two-thirds represented some type of transportation facility. (Joseph S. Davis, 
“Essays in the Earlier History of American Corporations,” Harvard Economic Studies 
16, Cambridge, 1917, Vol. II, p. 22.) Of all the special charters for business corpora- 
tions in Pennsylvania from 1800 to 1860, 64 per cent represented charters for trans- 
portation enterprises. (William Miller, A Note on the History of Business 
Corporations in Pennsylvania, 1800-1860, Quarterly Journal of Economics, November, 



1800 1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 

Cblvrt 30. — General business cycles, commodity prices, and indexes of building construction and transportation construction, 1800-1940. 
AU curves are drawn to uniform arithmetic scales to permit comparison of the cyclical fluctuations. For description of data see Appendix 6. For 
identification of war periods see Note 2, Chart 7. 


addition, to show the cyclical movements in production of other types of 
transportation facility, in terms of equipment, prior to the railroad era, 
and to include the development of the automobile industry after 1900. 
From 1800 to 1831, the transportation index measures the cyclical 
movements in shipbuilding only. Beginning with the railroad era, the 
shipbuilding cycles and changes in miles of railroad track laid down are 
merged together as far as 1839. During the succeeding period, until 
1899, the index traces the course of railroad development only, in terms 
of track built and new equipment ordered. From 1900 to 1940, railroad 
equipment and automobile production are combined with appropriate 
weights. Thus the index, throughout its course, portrays the history 
of transportation-development fluctuations in terms of the three most 
important types for a century and a half.^ 

In the early years of the nineteenth century, there was much road- 
work, and manufacture of wagons was an important enterprise. But 
statistical facts relating to these aspects of transportation are very 
scanty. As for early navigation of the rivers and carriage of merchandise 
by ships along the coast or abroad, shipbuilding was the dominating form 
of enterprise all along the Atlantic seaboard. Since the available data 
include canal boats, the ups and downs in activity reflect all phases of 
transportation equipment having to do with water. 

For years prior to the nineteenth century, the building of ships had 
been a leading industry in the American Colonies. ‘^The coast from 
New York harbor to Eastport, Maine, was one long row of shipyards. 
Shipbuilding was encouraged in Colonial days by British law, which long 
penalized the carrying of British trade in vessels constructed outside of 
the British Isles or the Colonies. Shipbuilding has always been pecul- 
iarly subject to the fortunes and exigencies of war. This is easily seen 
in the behavior of the transport index during the first decades of the nine- 
teenth century, when foreign trade was subject to alternating intervals 
of peace and war and embargoes arising from the long campaign of the 
British allies against the French. The index reflects the brief foreign- 
trade revival of 1805 and the drastic embargoes against European com- 
merce in 1807, 1808, and 1809. A sudden boom in 1810-1811 was 
followed by a deep depression in shipbuilding during our own conflict with 
Great Britain from 1812 to 1814. Following the return of peace in 
Europe in 1815, trade immediately became intensely active. American 
ships were in urgent demand to make up the heavy losses suffered during 
the war. ‘‘Everybody began to think of ships, and in less than a week 

‘ See Appendix 6 for more detailed explanation of the methods used in preparing 
these indexes. 

* Beory United States Census of 4880, Vol. VIII, p» 08. 



after receipt of the news shipbuilding sprang into activity and every part 
of the coast engaged in the industry/’^ 

Meanwhile, there was a burst of activity in the construction of canals, 
which had been held back by the long war and its uncertainties. By 
1823, steamboats were beginning to multiply fast on the Mississippi 
River, and were ready for Atlantic crossings. This was a great industry, 
mainly dominated by small builders, some of whom appear to have been 
speculators constructing ships for future demand. ^ Many of the sub- 
stantial merchants of the day were shipowners; Cornelius Vanderbilt 
and Daniel Drew, who played such an important part in later railroad 
ventures, built up their initial fortunes as shipowners. What is of par- 
ticular interest is the violent gyration of shipbuilding from year to year 
and the suggestion of a speculative enterprise pecularily subject to 
fitful impulses created by war conditions. Following the great ship- 
building boom of 1815, there was a substantial decline, even though 
prior to 1820 there was a significant boom in land promotion. Con- 
versely, in 1825 and 1826, with the completion of the Erie Canal and a 
vast boom in foreign trade following the opening up of Latin America 
upon gaining freedom from Spain, there was a pronounced boom in ship- 
building, and land speculation and, presumably, building activity were 
depressed. The astonishing height of the booms and depths of the 
depressions challenges attention. Compared with the very modest range 
of fluctuations in the index of general industry and trade, which is drawn 
on the same scale, transportation and building cycles are of a distinctive 

More important still is the relationship of the general business index 
to the transport and construction indexes from the standpoint of cycle 
patterns. An examination of Chart 30 discloses that after making due 
allowance for the wide difference in amplitude, the business-index 
fluctuations, in the main, indicate the combined effect of the somewhat 
dissimilar cyclical movements of the transport and building indexes.* 



The preceding analysis and that which immediately follows serve to 
support the basic proposition that the causal influences in the cyclical 

» Hall, op. cit.j p. 62. 

*See R. G. Albion, Early Nineteenth Century Shipowning, Journal of Economic 
Historyj May, 1941. 

* We refer to the building index in the earlier period, measuring speculation in 
land, as a rough gauge of the related (but not measurable) activities in urban real 
estate and building construction. A comparison of the cycles of public land sales 
with the transportation of lumber or expenditure of the Federal Government for 
various types of public buildings and with the first few decades of Riggleman^s building 
index all serve to support this interpretation. 


variation run predominantly from the transport and property cycles 
to the cyclical movements of industry and trade. This does not, however, 
exclude the possibility that there is some interaction among the factors 
and that certain phases of transportation development particularly have 
occasionally ';een given impetus, upward or downward, by fluctuations 
in general business conditions or circumstances in the credit system at 
home or abroad closely associated therewith. Another important point 
that may be drawn from this chart is that during periods of war, par- 
ticularly when a major war has directly affected the United States, the 
foregoing relationships are less clearly defined. There enter into the 
situation complex political factors and the play of price inflation, which 
independently affect all the indexes and at times produce divergent 

The effect of war disturbances in delaying plans for important struc- 
tural undertakings has a direct bearing upon the cyclical pattern. As 
has already been set forth in preceding chapters, wars of any magnitude 
or duration have always meant inflationary price trends that militate 
against long-term investment in fixed capital projects associated with 
land transportation or urban property, even though these movements 
at the same time have had a stimulating effect upon land speculation in 
agriculture. The forces that lead farmers to expand their debt during 
these wartime inflation i)eriods usually have a diametrically opposite 
effect on other forms of land and property speculation. Conversely, 
when wars end and prices begin to decline there tends to be a sudden 
dramatic release of pent-up, accumulated demand for these building 
and transportation facilities. This is capable of initiating a strong post- 
war boom in these directions, despite declining commodity prices or more 
probably because of a broad shifting of purchasing power toward the 
cities and a dilution of available capital funds carried over from the 
usually extravagant public financing accompanying any major war.^ 

* Joseph S. Davis, in his “Essays in the Earlier History of American Corpora- 
tions,” Vol. II, p. 7, has the following interesting remarks concerning the situation 
at the close of the eighteenth century, following the Revolutionary War. “Capital, 
accumulated during the War by many members of the community, was available for 
investment; fortunes in property other than real estate were undoubtedly larger than 
before the War. The disbanding of the army set free a labor supply, and throngs of 
immigrants rapidly added largely to it. The War had done much to bring into mutual 
acquaintance men of business acumen and property, had forced some experience in 
cooperative activity, and had necessitated the exercise of ingenuity in a thousand 
directions.” Another striking instance of financial resources accelerating postwar 
activities in construction was the accumulation of British capital after the Napoleonic 
Wars had been concluded and the search for investment opportunities in all directions. 
The fall of interest rates following the tight money market so characteristic of most 
wars in the past took the form in this case of conversion by the British Government of 
5 per cent obligations into 4 per cents and then into 3^ per cents, so that capital was 



Still another aspect of war conditions, looked at particularly from the 
standpoint of Europe, is the evidence that following major wars there 
has been an accentuated tendency for Europeans to emigrate to the 
New World. A considerable part of the immigration from Europe in 
the 1830^8, the 1850's, and the 1880’s resulted from political factors 
reflecting the effect of war conditions. The close relation between land 
booms and the major waves of immigration has already been illustrated. 

We may now return to Chart 30 and trace in more detail the course 
of the transport-construction indexes, beginning with the 1830^s. The 
great boom, culminating in 1836, can be imderstood only in terms of the 
vast movements of population from the Eastern section over the Alle- 
ghenies into the rich new areas opened up by the Erie Canal and the 
improved roads and turnpikes to the West. Immigration was a minor 
stimulating factor during this period. After the postwar depression 
of the 1820^8 had run its course, the movement of people accelerated. 

There began to be a serious exodus to the western country. The roads 
were filled with moving families and almost entire neighborhoods moved 
west. Fertile land at low prices^ was abundant, and speculators were 
numerous. Under this credit system men became loaded with large 
land purchases, expecting to make sale of a portion at an early date to 
incoming immigrants at an advance, and to hold the remainder for 

Andrew Jackson^s evident intention to discontinue the Second United 
States Bank was known as early as 1830, and the prospective disappear- 
ance of this moderating influence in pioneer shoestring banking created 
a most extraordinary profusion of banks, bank notes, and bank credit, 
which assisted the land promoters to capitalize upon the movement of 
people between 1830 and 1836. But in July of that year President 
Jackson dashed cold water upon the speculative orgy by suddenly 
demanding that Federal lands would henceforth be paid for only in hard 
coin. The boom immediately collapsed. But while it lasted it was 
sufficiently vigorous to have a pronounced effect upon commodity prices, 
an effect, indeed, that has never been witnessed before or since, save in 
wartime. As this boom broke it carried with it the price of cotton and a 
serious demoralization of income in the Southern States, leading, as we 
have seen, to a repudiation of state debt. This tended to obstruct the 

all the more eager to flow across the Atlantic to engage in our ventures at a much 
higher rate. 

1 After 1820, public land was sold at auction or on a cash basis at low prices. The 
Federal Government accepted the notes of the State Banks, and in return the latter 
freely accepted United States Treasury notes. War veterans were given scrip that 
was transferable and greatly assisted not only land ownership but land speculation. 

* U,S, Executive DocumenU^ 46th Congress, Third Session, p. 202. 


willingness of both domestic and British capital to supply funds for the 
new railway ventures. London became skeptical of American finance, 
but nevertheless railroad building continued to be much more active than 
property development or building as far as 1841. Between 1842 and 
1845 every phase of American business was in deep depression. 

By this time, however, a new wave of European immigration had 
begun. This was perhaps the most pronounced of all the mass move- 
ments from Europe during the century. Beginning shortly after 1845, 
the movement lasted until 1854, forming the underlying influence for a 
new major cycle of expansion in real-estate operations and building 
activity as well as construction of the railroad network.^ During the 
1850^8 railway construction was resumed in earnest in the Southern 
States, following Federal Government aid in the form of direct land 
grants to the Illinois Central. Meanwhile, the Pennsylvania Railroad 
had received important assistance from the State and by 1852 had reached 
Pittsburgh. By 1853 there was railroad connection from Buffalo to 
Chicago. The discovery of gold on the Pacific Coast in 1848 was a con- 
tributing factor to the general boom atmosphere. The brief War with 
Mexico caused but slight temporary interruption. Paralleling these 
expansive conditions here was a condition of easy credit and rapid 
financial expansion in Great Britain, l^y 1853 a great wave of real-estate 
and building promotions swept the Midwest. “ In the cities, says Hick- 
ernell, ^^speculators built large numbers of dwelling houses with borrowed 
money and were generally able to resell quickly at a handsome profit. 

Finally came the Crimean War (1854-1855), creating a temporary 
tightening of finance and signs of apprehension in the British financial 
market. There was revelation of unsavory practices in the management 
of the railroads that affected confidence. But the real collapse of the 
boom did not come until 1857, when it was accentuated by the greatly 
overextended condition of the Eastern banks and obviously excessive 
property development and railroad construction that had created many 
unsound, inflated, manipulated, and otherwise vulnerable situations. 
Each of the great booms in the basic transport-building factors has had 
this effect. Some of these ventures were soundly conceived, even includ- 
ing railroad companies, but each boom carried with it many unsound, 
dishonest, and visionary projects, and the higher it soared the more the 
imminent difficulties facing these marginal projects served as a menace to 
the rest. Each boom, in other words, tended to reach a level where 

* The principal European factors accounting for this extraordinary wave of migra- 
tion were the crop failures in Ireland and the revolutionary disturbances in many 
parts of Europe. 

* W. F. Hickernell, ** Financial and Business Forecasting,’* Vol. I, p. 248, New 
York, 1928. 



qualitative as well as quantitative aspects became important. At the top 
level the dissolution of these booms seems to have been brought about 
by the more topheavy ventures, which only boom impetus and atmos- 
phere can generate and finance. 

Conversely, in the trough of the great depressions following the boom, 
it has been the shrewd activity of the most conservative and the more 
solidly financed capitalists and promoters that came into play. They 
absorbed the properties in liquidation at absurdly low prices and initiated 
the foundations for a new wave of expansion. In the case of the railroads, 
this process is clearly evident in each of the major depressions of the last 
century. Railway properties were put together in a way that repre- 
sented in many instances sound physical assets but highly unsound 
capitalization. Those who commanded adequate funds of their own 
had extraordinary opportunities for acquiring distressed properties at a 
profit when their nominal values shrunk amazingly during the periods 
of foreclosure and receivership. And in these periods, such was the strain 
on general confidence, credit, and trade that impairment of a far- 
reaching character was inevitable. 

Following a secondary peak in railroad expansion in 1856, there 
occurred a general deterioration in capital enterprise, lasting throughout 
the Civil War period. With the exception of work done on the Union 
Pacific, the major cycle of property and railroad development remained 
at a very low ebb. General industrial conditions, however, as is to be 
expected in some war years, responded to the demands of the military 
forces. So far as building was concerned, the Civil War had the effect 
of deferring expansion and improvements. Both in this instance and 
later, during World War I, the military emergency occurred after the 
major cycle of building had already been reversing for several years. 
It is therefore not easy on the available evidence to generalize concerning 
the probable effect of a major war upon building and real-estate develop- 
ment. In view, however, of the swift recuperation in this field as soon 
as peace was restored, both in the case of the Civil War and after World 
War I, there is reason to believe that war uncertainties, the high urban 
cost of living, and the siphoning of available capital into Government 
securities all had the effect of postponing or deferring structural activity. 
But by the same token the subsequent recuperation developed a much 
more powerful and extended momentum than would otherwise have 

Following the Civil War, conditions in the South remained desperately 
bad for decades, and recuperation throughout the country was not par- 
ticularly rapid. The Civil War left a heritage of dubious political 
experimentations and meddling with the financial machinery, which 
delayed the recovery of long-term enterprise. Therefore the cycles in 


building and railroad construction that developed after 1865 were of 
relatively modest proportions. It was in this interval that the so-called 
‘^Granger railroad lines were projected and the transcontinental network 
was extended to the Pacific Coast. In 1862 the settlement of the remain- 
ing Federal lands was facilitated by the Homestead Act, but this, in turn, 
delayed the sales of the railroad land that had been obtained by Federal 
or State grants and thus somewhat slowed down the progress of railway 

During these years the smaller roads were incorporated into larger 
systems, usually with an ample amount of manipulation and financial 
sleight of hand, hidden from the public gaze by the absence of effective 
requirements as to corporate publicity. The activities of the larger pro- 
moters now shifted to efforts to control systems of considerable size. The 
builders of the Union Pacific were reaping a harvest of profits from the 
Credit Mobilier, a cleverly conceived ‘‘construction’^ company designed 
for easy and certain profits to the directors. But this period of unwhole- 
some, even though impressive, formation of railroad systems was inter- 
rupted by the Franco-German War, which temporarily restricted British 
participation in financing. There were also the impairment of many 
insurance companies by the Chicago fire of 1871 and the exposure, with 
ill effects upon the financial community, of glaring corruption and manip- 
ulation of railroad enterprises by such adventurers as Jay Cooke, James 
Fiske, Daniel Drew, and Jay Gould. ^ 

As a result of so much railway construction far ahead of the traffic 
and absorption of short segments into integrated systems, with con- 
sequent overexpansion of capitalization, some roads were beginning to 
pay their interest by new borrowings. Financial structures became 
decidedly vulnerable. With banking reserves rather short and credits 
inadequate to handle a crisis, the scene was set for the memorable panic 
of 1873, and the long-ensuing depression, especially marked in the farm- 
ing areas, naturally extended to all industry. During the uncertain years 
of the middle 1870’s British capital was frightened away from American 
investments, since it was not known whether the farmer-greenback- 
inflation element was to dominate the money system or whether the 
Civil War paper would actually be redeemed in gold. But the Resump- 
tion Act of 1875 inspired more confidence, and a successful issue of 
government bonds in London led the way to resumption of railroad 
building at a terrific pace. This was indeed one of the most spectacular 
of all the railroad booms. It culminated with the construction of 11,000 
odd miles of track in the single year 1882. In this case the railroad 

^ A very readable and substantially accurate account of railroad finance and its 
relation to our ramshackle banking system will be found in W. F. Hickerneirs “ Finan- 
cial and Business Forecasting,” Vol. I. 



boom was not closely followed in its pattern by recuperation in building 
operations, which appeared to be awaiting the stimulating effect of larger 
immigration from abroad. In due course this developed between 1878 
and 1882. 

In the meantime, railroad capital was again at work, and the devel- 
opers were active, seeking control of larger and larger systems to satisfy 
more and more grandiose ambitions. Huge stock dividends appeared 
in the early 1880’s, but at the same time savage rate wars were springing 
up between competing systems. The more reckless promoters were busy 
with all manner of schemes contributing to the overcapitalization of 
railway lines. Hence the financial strain of 1883 and 1884, rather 
acute in London, found numerous weak spots here. Meanwhile, however, 
in spite of the setbacks in 1884 and 1885, urban building conditions were 
improving, and this phase of expansion appears to have been sufficiently 
powerful and widespread to serve as a sustaining factor permitting a 
secondary railroad boom to occur in 1887, when the first Federal regula- 
tory efforts began in the establishment of the Interstate Commerce 

Building development reached its peak in 1890 or shortly thereafter, 
and the inevitable liquidation of overdeveloped properties pursued its 
dismal course for a full decade. During most of this time the depressing 
general economic effect of the construction collapse made railroad 
development exceedingly difficult, and the index reached a low point at 
1894. We now enter the period when the railroad network was becoming 
substantially complete and when all the excesses of previous speculative 
activity and efforts toward personal aggrandizement from railway land 
speculation were bearing fruit in the badly financed and poorly managed 
major roads. Railroad failures were exceedingly heavy in the early 
’nineties, and no less than 29,000 miles went into receivership in 1893, 
involving a capitalization of nearly two billion dollars. More than half 
of the capital of the important railroads at that time represented funded 
debt and a growing practice of trading heavily upon the equity by 
railroad owners and boards of directors. The high cost of construction 
and the inflated property values, layer upon layer, were mainly per- 
petuated in capitalization. Against this excessive capitalization, com- 
petitive pressures and agricultural demands for lower rates, as grain 
prices reached new lows, created a menacing situation. In addition, 
there occurred in 1890, with an impact that continued to be felt for years 
in Great Britain, the repudiation of debt by Argentina after a decade 
of flamboyant railroad and property development in that country, 
mainly with British capital. This left all financial markets highly 
vulnerable. Our own banking was vulnerable because the banks had 
begun to make heavy advances on the security of railroad collateral, and 


the community of interest between bank and railroad ownership had 
already involved large infusions of stopgap or floating bank credits. 


We now approach the end of the period of railroad development. 
What follows is much less important in terms of the 'prime movers in the 
cycles of business. More and more the railroad system becomes an 
example of a mature industry past the stage of promotion, but with the 
marks of past promotion clearly upon it. More and more the fortunes 
of the railroads came to depend upo'n business conditions made favorable 
or unfavorable by more fundamental and primary forces. But in this 
period of transition, just before one of the new prime movers — the 
automobile and its satellites — becomes important, it is interesting to 
observe a further change in the railroad financial picture brought about 
as a direct result of the reorganization of the bankrupt roads during 
the early ^nineties. ^ 

The reorganizations between 1893 and 1900 are of outstanding 
importance in giving to the railroad system its characteristic topheavy 
and oversensitized capital condition as we see it today. In other words, 
although railroads after 1890 became largely transmitters and amplifiers 
of business disturbance, they assumed this capacity by virtue of the 
excessive leverage created by their capital structures. There is no 
inherent necessity for this leverage. Had there been better control and 
a more competent type of pioneering, especially more honesty and moral 
fiber among the initial promoters, our railroads today might be of such 
sound and strong financial caliber that they would not be among the 
important transmitting and amplifying forces in the business cycle. 

What happened in the early ’nineties? Essentially there was a 
transition from the promotional period of reckless ‘trading on the 
equity” to one of banker control, in which the effort was to place as 
large a debt upon the railroad as the traffic would bear and to keep it 
there forever. The interests of stockholders became permanently sub- 
ordinated to the interests of bondholders. This change came about 

' A further point may be noted here to clarify the distinction between the con- 
struction of the railroad plant, in terms of roadbed, trackage, yards, and other terminal 
facilities, and construction of engines, rolling stock, and other equipment. The latter 
branch of fabricating industry now receives orders from the roads mainly representing 
replacement needs, rather than phases of original promotion. It seems legitimate 
for practical purposes to regard the making of equipment for the railroad as a phase 
of promotional enterprise until about 1890; thereafter the railroads were reaching 
a mature stage with little further expansion of basic structural features and an actual 
reduction in new trackage. After about 1900 the combined index represents the 
gradual fading out of the railroad factor, contrasting with the rapidly expanding and 
temporanly donuoMt motor-industry element. 



through the fact that J. P. Morgan, who assumed the role of leading 
reorganizer of the bankrupt roads, was also a commanding personal 
influence in developing the principle of railroad community of interest 
and coordination of management policy, replacing the old cutthroat 
competition and reckless mismanagement. 

But the price exacted for this excellent service was high. The 
financial principle underlying the major reorganizations, such as the 
Southern, the Erie, and the Baltimore and Ohio, was to revise the debt 
structures moderately and yet retain a very substantial portion of the 
watered capital resulting from all previous excesses and manipulations. 
By giving creditors of the roads in receivership new bonds carrying lower 
coupons, but mainly of very long-term maturity and in most cases non- 
callable, the effect was to render capital charges rigid, representing too 
large a part of the value of the properties. In addition, it became the 
practice, not only of the Morgan group but of other financing houses 
engaging in rail reorganizations, to perpetuate their control over the 
roads at the expense of the stockholders by means of voting trusts and 
other devices.^ 

The result of this process was twofold. In the first place, railroad 
financial structures, particularly those that had been reorganized, were 
made unduly sensitive to the effects of the business cycle and variations 
in traffic volume. In the second place, it was devised that the investment 
houses would continue to handle future security issues in the form of 
bonds, and as the equity shrunk to smaller and smaller proportions th(i 
roads were presently driven to new borrowings for extensions and 
improvements. In other words, the investment bankers took advantage 
of the desperate condition of the railroad systems after the crash of 1893 
to fasten upon them a virtually perpetual debt in whose profitable dis- 
tribution they hoped to participate forever. This goes a long way to 
explain the more recent status of our railroad system and the inability of 
the railroads, with only a few exceptions, to weather the storms of severe 
depressions. 2 

^ The manner in which these reorganizations contributed to maintenance of fixed 
charges and overcapitalization is well described in the study of E. G. Campbell, “The 
Reorganization of the American Railroad System, 1893-1900,^^ New York, 1938. 

* The Interstate Commerce Commission stated in its study of “ Railroad Sinking 
Funds and Funded Debt,” 1939, p. 98: “ . . . railroad policies both of indefinite 
expansion and the nonrepayment of funded debt are largely obsolete. Both have 
)>een founded upon assumptions as to the permanency of the plant investment and the 
future expansion of traffic and revenue which now appear to be erroneous. For 
example, the almost unprecedented declines in business and revenues during the 
depression as well as the comparatively low recovery since indicate little that is favor- 
able to the future growth and increase of railroad traffic. The competitive and other 
developments of the last decade by undermining the foundations of theories of a 
permanent and increasing railroad debt point to the necessity of a change of p)olicy,” 


The riotous gambling of the nineteenth century, through the necro- 
mancy of investment banking, has finally left us a heritage of financial 
unsoundness which now defies rectification. We thus have a fairly con- 
siderable segment of our industrial system highly sensitized to every wind 
that blows. The exaggerations of fluctuations in railroad revenue, when 
translated into net profits or into purchases of equipment, become 
tremendous gyrations. This became apparent in the decade from 1900 
to 1910, which happened to be a generally prosperous period, although 
largely for reasons outside the railroad sphere. During this period rail- 
road dividend payments were vastly increased, but the total debt was 
also increased, at a time when it could have been and should have been, 
by all standards of financial judgment, considerably reduced. The rail- 
road owners continued to 'Hrade on their equity” and expand their 
indebtedness by mortgages built, layer upon layer, over existing debts. 
At the same time a great boom in railway stocks was occurring on the 
New York Exchange, and presumably many of the original promoters 
were thereby able to step out of the picture and pass over their vulnerable 
equity holdings to the man in the street, to great advantage. It was the 
last decade in which the turnover of railroad stocks was the dominating 
component of the total transactions on that Exchange. 

It is not surprising, therefore, that in 1905 there was one last fair-sized 
boom in railroad-equipment activity, largely, however, the result of the 
high degree of earnings leverage and the extravagant earnings of the period 
that permitted a few further extensions and improvements. The 
Interstate Commerce Commission was now beginning to acquire increas- 
ing regulating power over rates, but the qualit}^ of service rendered ceased 
to ]jc developed on a par with progress in other directions of American 
industry. The railroads, once so powerful a factor in progress and in 
dynamics, found themselves more and more in a straitjacket from which 
they have not thus far escaped. New ideas, research in new types of 
(‘(luipment, ways of meeting the coming competition ^^ith motor vehicles 
all tended to lapse into a routine rather than an aggressive, adaptable, 
forward-looking segment of American business enterprise. 

The building boom that culminated in the period 1905-1909 was much 
more potent as an original industrial stimulant than anything in the 
railroad industry. It was supported once more by an influx of immigra- 
tion from abroad that reached a crest in 1906-1907. This was the last 
great wave of migration to this country. Just as the preceding major 
building cycle went into a decline prolonged by the disturbed inter- 
national situation of the late 1890’s and punctuated by our brief War 
with Spain, so the decline from 1909 to 1918 was intensified by war and 
preparation for war. Ominous storm clouds appeared on the European 
horizon as early as 1911, followed by the Balkan Wars and, finally, by 



the outbreak of World War I in 1914. While the War lasted there was 
a brief, although sharp, recovery in the production of railway equipment 
to serve national defense, but the urban real-estate promotions and 
building operations were suspended.^ 

Again we find, as in previous major was periods, a discrepancy 
between the behavior of the general business index and the combined 
patterns of the transport and building indexes. World War I was instru- 
mental in hastening the development of a new major factor in the 
transportation field — the internal-combustion motor. Ever since the 
beginning of the century there had been quietly developing a momentous 
new industry. It was indeed a combination of industries, clustering 
about the manufacture and use of the automobile for individual and 
commercial transportation. The culmination of this development came 
soon after the close of World War I, and the major peak was reached 
in 1929. The broad, irregular crest of the transport production cycle of 
the 1920\s was accompanied by an equally spectacular major boom in 
urban real estate and building. Demand for accommodations was 
stimulated this time, not by immigration but by the restless shifting 
about of mechanics toward and among the new industrial centers, many 
of them already enlarged by war production, others by the swift develop- 
ment of the motor industry itself. 


With the coming of the automobile and the many new industries 
that it brought into being, a new major form of transportation innovation 
passed in an astonishingly short time from its experimental stage to that 
of full development. Since automobiles have mainly been produced for 
individual ownership and operation, the making of the vehicles has 
developed as an industry distinct from that of the preparation of the 
roadbed. The latter has been undertaken at State or Federal expense, 
and a large part of the financial outlays to accommodate automobile 
transportation have been provided by Government in marked contrast to 
the railroad history. 

Automobile development (apart from trucks) has essentially repre- 
sented durable consumer goods, financed by methods as distinctively new 
as the vehicle itself. In marked contrast to the financing of the railroads 
or the manufacture of their equipment and in contrast also to the typical 
financing of urban housing, the automobile has been distributed to the 

^ During the War a Federal Priorities Circular was issued ordering that except by 
special permit no new nonwar building construction was to be undertaken involving 
an expenditure of more than five thousand dollars and no extensions costing over 
twenty-five hundred dollars. 


public by relatively short-term loans. These have represented essen- 
tially sound, self-liquidating capital financing. The manufacture of 
automobiles became rapidly concentrated in a few large corporations 
whose financial policies have contributed to ample resources and equity, 
with a minimum of long-term indebtedness. The result has been a high 
degree of efficiency, flexibility, and very rapid progress in development 
of the potentialities of the internal-combustion motor. 

Although all this is in marked contrast to what has happened in 
rail transport development or the creation of urban housing, we may 
properly consider the development of the automobile one more example 
of the powerful accelerating effect upon all industry for a decade by a 
major change in the transportation field. The motor vehicle between 
1910 and 1930 rounded out a major cycle of development to the point of 
virtual maturity, traversing this sweep in afar shorter period of time 
than was required for the full development of our railroads. In the 
course of this short but momentous evolution there occurred a more or 
less parallel development in production of new fuels, production of innum- 
erable public and private garages, service stations, and salesrooms, and a 
great expansion in industries producing glass, aluminum, tires, and acces- 
sories, all of which contributed to the population movement. 

Even more important was the contribution of this swift evolution of 
motor transport upon the building industry in suburban areas of our 
cities. The motorcar brought with it a powerful decentralizing force, 
which is still in progress. This, in turn, meant more mobility of people 
and new demands for housing, which would not have existed without the 
automobile. Lacking many of the financial excrescences and promotional 
peculiarities of the railroad and lacking also the peculiarities of ship- 
building, the automobile-development period can be considered a prime 
factor in the Inisiness system, at least during the 1920’s, and its attain- 
numt of maturity status at the end of that decade doubtless also contrib- 
uted to the deceleration in many capital lines that deprived the lean 
years of the early Thirties of a supporting cushion. Already the motor 
industry, like the railroads, has yielded its previous position as a prime 
mover and has entered the era of replacement cycles. 

It may be added that a secondary promotional capital factor also 
(contributed to the expansion phase of the late 1920T. This was the 
development of the electric-power industry and its involved corporate 
structures. In the 1920T this industry came into the hands of promo- 
tional groups that sought concentrated control over widely expanded 
properties through the device of the holding company. They followed 
much the same financial procedure that had fastened excessive rigid debt 
upon the railroads. The great financial promotions of the 1920's were 
therefore in real estate and in the electric-power industry, the latter not 



reaching its major peak until 1930.^ In order to get the complete picture 
of the financial momentum of these years of tremendous stock-market 
speculation, the existence of this third factor, representing the kind of 
large-scale innovation capital essentially similar to the railroad system, 
should be kept in mind. The electrical-industry promotions were the 
essential basis of the great 1929 stock-market boom. 

If we go one step further, we come to the latest phase of basic trans- 
port enterprise — aircraft. We cannot consider air transport and its 
fabricating phases without being struck by some analogies to shipbuilding, 
especially in the adaptability of aircraft to war purposes. (For that 
matter, the gasoline-motor vehicle is also developing swiftly as a device 
for conveying troops and as the basis of tank warfare.) But in spite of 
this close association with warfare, air-transportation development will 
probably carry forward the primary thesis that movement of goods and 
people is an outstanding phase of new capital promotions. Numerous 
industries the world over are deriving their market from the expenditures 
of governments upon motorized war equipment and military and naval 
aircraft. This has many distinctive features contrasting with the 
promotional extravagance that built our railroads, but in terms of the 
probable impact upon capital goods manufactured for a long time to 
come it is highly significant. Although up to 1940 the aviation industry 
was not yet sufficiently developed to warrant the inclusion of its produc- 
tion data in the transport index, this will certainly be appropriate in 
uture years. 

The building boom of the 1920^s culminated about 1925-1926, 
although there was divergence in timing in various localities. This 
boom had all the earmarks of financial unsoundness that had marked such 
booms in previous eras. The starting of subdivisions, the movement of 
population into suburbs, facilitated by the automobile, the growth of 
automobile centers attracting new people all contributed to make new 
suburbs and home-building enterprises urgently needed. The mortgage 
system made possible easy initial ownership and difficult ultimate pay- 
ment of debt. But once the downward slide of building began to acceler- 
ate, it marked the doom of any long-continued survival of capital-goods 
promotion in other directions. There was the familiar snowball effect 
of declining mortgage solvency and a steady contraction in building and 
in the building-material industries. While the stocks of chain mer- 
chandising companies, railroads, and particularly electric-power enter- 
prises and their related ‘investment” trusts were being shot higher on 
the New York Exchange by manipulators, surfeited with the easy credit 
of an indulgent banking system, the underpinnings of a great prosperity 

^ The indexes shown in Chart 30 do not include electric power, but its inclusion 
would alter the patterns very little. 


period were being eaten away as in previous times by the reversal of the 
primary forces. 

But there was a deeper significance in the stock-market boom of the 
late 1920^8. So long as billions of credit could be mobilized to distribute 
common stocks among small investors and speculators, those familiar 


Chart 31. — Actual and calculated business indexes (excluding war periods), 1815-1940. 
The curve in light line indicates how closely the actual index of business cycles is approxi- 
mated by a weighted combination of the building and the transportation-construction 
indexes, apart from war periods. 

with the workings of the business system were well aware that they 
probably were being favored by an exceptional opportunity to separate 
themselves permanently from positions of ownership, not only in railroads 
but in manufacturing enterprise, where the future trend was already 
implying replacement demand rather than vast new market potentials. 



In an intoxicating atmosphere of speculative frenzy, in which millions 
participated, many local governments repeated the performance of the 
1830^8 in the handling of their finances. It was little wonder that the 
acute depression of the early 1930^8 equaled in extent the depression of 
the 1830^8. In a later chapter we shall attempt to show how the vulner- 
able condition of American business, in the course of a major deflation 
of basic elements, was complicated and menaced by the financial break- 
down of Europe and the underlying weakness of the raw-material produc- 
ing countries. 

In summarizing the content of this chapter, we may illustrate statis- 
tically the consistent response of general industrial and trade conditions 
to the combined pattern of the two basic indexes shown in Chart 30. 
In Chart 31 the two basic indexes have been translated by the technique 
of multiple regression into a single computed index having the average 
range of amplitude of the business index and pertaining only to the 
nonwar periods. The result appears in the chart as the lighter of the 
two curves. This computed business index represents what the business- 
cycle fluctuations would be if they responded solely to the impulses 
impinging upon manufacturing and trade activity from the cycles of 
building and transportation construction.^ The war periods are omitted, 
since we have seen that business conditions in major wars tend to be 
subject to political and other emergency circumstances that cannot be 
brought within any statistical formula. But apart from the war periods, 
the exceedingly close relationship between the combined basic indexes 
and the business index definitely establish the logic of our analysis, 
leading to the broad conclusion that business cycles in the United States 
for well over a century have primarily represented impulses transmitted 
to manufacturing and trade from land speculation in its various forms. 

^ There is a high correlation also between the computed index and the cycles of 
steel production. This is entirely natural in view of the importance of steel as a 
material for structural purposes and the manufacture of transport equipment. 



In our discussion thus far, we have examined cyclical instability as it 
has manifested itself in fluctuations of commodity prices, in the volume of 
production, income, trade, and the major fluctuations of building and 
transport construction. We have seen that the patterns of the price 
level and of the money income of agriculture have been determined mainly 
by the effects and after-effects of war finance. The inevitable deflation 
of wartime monetary and credit circulation and reestablishment of the 
metallic money standard have contributed to prolonged periods of falling 
prices. We have found that the intermediate wavelike undulations in 
general production also appear to have their origin in political and 
economic disturbances accompanying and following major wars. As for 
the minor cyclical oscillations of business activity, we have reason to 
regard them as to a large extent the joint result of violent and long- 
extended gyrations associated with building construction and the initial 
construction phases of transportation plant and equipment. These 
waves of innovation and expansion in durable plant both have their roots 
in the changing growth rate and the movement of population. They 
have involved the utilization of capital and credit resources in ways that 
have not been consistent with continuous and orderly expansion. 

Capital in the form of accumulated savings, expressed in terms of 
money, has from time to time been mobilized and directed by promo- 
tional zeal and optimistic enthusiasm toward developments involving 
land and the exploiting of potential appreciation in land values. This 
has brought about again and again the phenomenon of badly misdirected 
investment, and the aftermath has forced the entire economy to proceed 
for long intervals at greatly reduced momentum and through troughs of 
depression during which the relations of debtors and creditors could be 
painfully readjusted to conform to sober reality. 

These prime movers in creating economic instability have involved 
the use (and misuse) of capital funds — representing the accumulated 
savings mobilized in a form available for use in costly structural enterprise 
— and also the additional purchasing power that hitherto has been 
referred to as bank credit. Wars have been financed by the hasty 
mobilization of savings into governmental obligations and through 
appropriation of both income and capital by taxation. Railway building 
and real-estate development required vast amounts of capital, mobilised 




from scattered sources by the skill and persistence of enterprisers and 
financial middlemen. We probably should have experienced fairly 
extended cyclical movements in the total amount of capital used for 
projects relating to such basic construction, even though there were no 
contributions of hank credit. The difficulties resulting from the use of 
capital savings in these developments looking toward the distant future 
have represented the repeated tendency to overcapitalize future earning 
power, the squandering of resources in blindly competitive duplication of 
durable facilities, and the waste of considerable sums through pure 
chicanery. Following each major boom there has been for a time a 
scattering or demobilizing of these sums of capital, and this has made 
necessary the slow, paralyzing processes of liquidation and reorganization 
requiring years before the financial markets were prepared once again to 
support the next wave of expansion or major technological innovation. 

We have seen that the tendency of promotion has usually been one 
of extensive “trading on the equity, with the absence of sound practice 
that would have required, in the case of borrowed capital, that repay- 
ments be made at scheduled periods to ensure amortization and to dis- 
courage the reckless. There has been a remarkable absence of legal 
safeguard to prevent the exploitation of the co-owners of structural 
wealth from being the victims of manipulation and secrecy on the part 
of the controlling interests and the mortgagees. These defects, whi(*h 
have been glaringly demonstrated by the use of savings in construction 
and transportation development, have their roots deeply embedded in the 
legal and political structure of our society. Since laws are made by men 
and since the men framing laws have at times been associated in some 
measure with promotional enterprise or personally dependent upon it, 
it follows that the legal framework itself that formed the typical proce- 
dures in using capital funds has been strangely negligent in the matter 
of safety factors and sound standards. It has already been suggested 
that these difficulties in the case of capital used in promotional structural 
development are partly due to the fact that in our earlier history and, in 
fact, well into the nineteenth century, much capital has been contributed 
by individuals rather than through the intermediary of financial middle- 
men. Hence the relations between the capitalist and the promoter have 
been so direct and so little affected by a public interest or a sense of 
fiduciary responsibility that even legislation has been slow to extend its 
regulatory influence into dealings that seemed to have so personal a 
nature. The supervision of such matters by State Governments, follow- 
ing no uniform standard and lacking full disciplinary power, has gone 
far to delay the full recognition of the problem. 

In fact, the Federal Government itself has not generally established 
precedents in the use of capital that are beyond criticism. When govern- 



ments enter the capital markets under the exigencies of war emergency or 
with the object of assisting in the development of building or transporta- 
tion projects of any magnitude, they have been negligent, reckless, and 
unobservant of the most elementary necessity of keeping the flow of 
capital moving through provisions for the regular amortization of bor- 
rowed money. Governments have used capital very much as speculative 
individuals have used it — without due allowance for the long-term conse- 
quences that inevitably follow when a debt burden is inadequately sup- 
ported by current productive income capable of retiring the obligation. 
This was precisely the situation in the 1840^s, when most of the Southern 
States and some Western States were so recklessly subsidizing road and 
canal projects and heading for the repudiation cataclysm that followed. 
National governments seek to escape these consequences through the 
various devices open to them, such as taxation, manipulation of money, 
etc. But it can be said with emphasis that governmental finance the 
world over, so far as borrowed capital is concerned, has not contributed 
in any material degree to setting up sound standards of selfdiquidating 
debt in either public or private finance. Hence it is not surprising that 
American legal codes and traditional practice, as applied to the great 
promotional projects considered in previous chapters, have been so 
ineffective in protecting both the projectors and the providers of resources 
from their miscalculations. 


Thus far we have been speaking mainly of capital in the form of 
savings, but we have had occasion from time to time to refer to the part 
that commercial bank credit has played, not only as a factor in the price 
level but also in contributing to building and transportation development. 
Our banking system has been related to these phases of major expansions 
and contractions of activity in interesting and complex ways that call 
for some further analysis. It will be assumed that the reader is already 
more or less familiar with the fundamental characteristics of banking 
institutions and the manner in which credit is made available through 
this mechanism. It will not be necessary to review the history of Ameri- 
can banking in detail or to explain all the devices whereby banks facilitate 
the financing of trade and production. We shall rather examine some of 
the ways in which the so-called commercial’^ (or demand-deposit) 
banks, as distinct from purely savings (or loaning) institutions, have 
managed to supplement financial resources by making available the 
equivalent of long-term capital for construction and plant development. 
We shall examine also the manner in which the deposit banks of the 
United States have been in a position to transmit and amplify both the 



rising and the declining phases of the business cycle, occasionally to 
the point of creating panic and trade paralysis. At many points cur 
banking system has evolved from conditions quite unlike those that have 
prevailed in other leading commercial countries. It is well to remind 
ourselves of these peculiarities and characteristics, since banking reform, 
coming tardily and being not yet complete, has not always been attentive 
to the peculiarities and characteristics of our industrial structure and the 
nature of our production problems; it has derived perhaps too much from 
foreign models and hence has failed to produce the best results. 

During most of the Colonial period, banks served mainly as facilities 
for the current deposit of funds and for making advances required by 
merchants. Foreign trade was an important part of Colonial and early 
United States business. The banks patterned themselves largely on the 
models of English commercial institutions. This was particularly true of 
banks in the port cities of New Orleans, Philadelphia, and Boston. The 
Bank of North America, organized in Philadelphia in 1782, was a good 
illustration of the larger commercial banks of the latter eighteenth cen- 
tury, making advances based on the goods bought and sold by merchants. 
It made no loans on mortgages and did not participate in the financing of 
agricultural operations other than those of a commercial nature.^ 

In a society where mobilized capital w^as scant and the individual 
businessman desired to invest as much of his surplus as povssible in land or 
expansion of his own durable equipment, the commercial banks were 
relied upon to finance the seasonal trade requirements and occasional 
temporary personal or special purposes. There are many instances of 
early banks established with inadequate cash capital, revealing no little 
irregularity in the granting of credit, but by and large it appears that the 
banks of deposit limited their operations to commercial advances. In 
this sense they conformed rather closely to the contemporary standards 
of commercial banking as set sorth (perhaps somewhat idealistically) by 
Adam Smith in his Wealth of Nations 

A bank cannot consistently with its own interest, advance to a trader the 
whole or even the greater part of the circulating capital with which he trades. 

. . . Still less could a bank afford to advance him any considerable part of his 
fixed capital; of the capital which the undertaker of an iron forge, for example, 
employs in erecting his forge and smelting-house, his workhouses and warehouses, 
the dwelling-houses of his workmen, etc.; of the capital which the undertaker of 
a mine employs in sinking his shafts, in erecting engines for drawing out the water, 
in making roads and waggon-ways, etc.; of the capital which the person who 
undertakes to improve land employs in clearing, draining, enclosing, manuring, 

^ Bray Haninioiid, Long and Short-term Credit in Early American Banking, 
Quarterly Journal of Economics^ November, 1934^ 


and ploughing waste and uncultivated fields, in building farm-houses with all 
their necessary appendages of stables, granaries, etc.^ 

He goes on to say that those who undertake fixed capital projects 
should, in justice to their creditors, make their own personal capital a 
sufficient part of their total resources, and the part that is borrowed 
ought to be borrowed upon bond or mortgage of such private people 
as propose to live upon the interest of their money without taking the 
trouble themselves to employ the capital, and who are upon that account 
willing to lend that capital to such people of good credit as are likely 
to keep it for several years.” What Smith had basically in mind was the 
remarkable success of the Scottish banks in confining themselves to 
commercial credit of a strictly amortized character; and he was also con- 
cerned to point out that unless banks functioned in this manner in serving 
trade and industry and prudently confined their advances to relatively 
short credits, they would essentially be making available to the com- 
munity funds that in the aggregate would be larger than the total of actual 
available money. The banks, in other words, would be adding to 
the total circulation of purchasing power and might thus tend to raise 
general prices and create conditions inconsistent with the maintenance 
of solvency. 

In these trenchant opinions of Adam Smith there are two essential 
points : commercial banks should restrict themselves to mercantile loans 
and grant their credit with careful attention to the qualitative aspect 
of each advance; they should not inflate the total national currency as 
the result of their lending operations. The one is a qualitative standard, 
and the other is quantitative. The quantitative aspect is important 
in view of the fact that banks of the commercial type have virtually 
the power of creating the immediate equivalent of money through the 
issue of their circulating promissory notes. But as we have previously 
explained, this is not the only way in which the commercial bank may 
extend credit considerably beyond the total cash funds deposited by 
savers. Such banks began at an early period to extend their credit to 
borrowers rather than extending cash. Advances were made that took 
the form of authorization of the borrower to draw checks upon new 
deposits created ad hoc and representing nothing more than the obliga- 
tion of the bank to honor these checks. The essential difference between 
the extension of bank credit through note issue and through the creation 
of these credit deposits lay in the fact that the notes circulated a con- 
siderable time, sometimes far distant from the point of issue, and they 
formed a part of the circulating money used by all classes. 

1 ‘‘Wealth of Nations,” Book 2, Chapter 2, 1776. 



On the other hand, the checkbook money (to use the convenient 
phrase of Irving Fisher) generally circulated for a much shorter period 
and mainly accomplished, at least in earlier days, transactions of large 
denomination among businessmen. From the standpoint of purchasing 
power over goods, property, or service, there is no essential difference 
between bank operations resulting in (credit) deposits or those resulting 
in the issue of notes. But there has long been a curious tendency of the 
law in most countries to fasten attention upon the note issues and to 
draw rather arbitrary lines of distinction between the two classes of 
bank credit. It was long considered important to regulate bank-note 
issue because of its obvious monetary significance. Hence, in our 
Colonial period and until the first decade of the nineteenth century, 
we find that bank charters were difficult to obtain; it was considered a 
high legal privilege to operate a bank and circulate credit by means of 
notes. Banks were recognized as essentially public utilities. Although 
individuals might engage in banking, both British law and American 
procedure for many years permitted nonchartcred groups to exercise 
banking functions only by special sanction. As pointed out by Shaw 
Livermore; “The long tradition of central government control over 
currency as an earmark of sovereignty made the states particularly 
jealous of letting banking corporations assume powers that were not 
carefully restricted. Charters were to be given only after inquiry, 
and were given in the spirit of delegating a sovereign power to a special 
group in the community. In the early decades of the nineteenth 
century, after it had been recognized that corporations for ordinary 
business purposes might be formed under a general law, there persisted 
powerful pressure to continue special restrictions for corporate banking 

In view of the monetary function of commercial banks, the restriction 
of their operations by law, and the circumscribed range of their lending 
activities, there early developed a struggle to supplement these banks 
with institutions specially organized to make long-term agricultural and 
real-property loans and to do away with the almost monopolistic privi- 
leges of strictly commercial banking and the limited range of its accom- 
modation. In Massachusetts, for instance, there were attempts to set 
up banks under state authority, capable of issuing notes secured by 
real estate with the specific purpose of accommodating property develop- 
ment. We have already referred in a previous chapter to the issue of 
bills of credit in the various Colonies to finance governmental projects 
and extend capital loans to enterprisers. Most of the “public-loan 
offices^' that functioned in the Colonies met with unfortunate results; 

^ Early American Land Companies,’^ p. 246, New York, 1939. 



there were inadequate sound precedents to guide their operations. Dur- 
ing the War of the Revolution and the years immediately following, the 
Bank of North America and similar chartered banks in New York and 
Massachusetts made loans to the Federal and State Governments and 
even to some favored business enterprises, although at the time these were 
regarded as rather exceptional deviations from accepted banking practice. 
But after the turn of the nineteenth century the need for much larger 
amounts of agricultural and construction capital developed growing 
pressure to break down the legalistic restrictions upon banking organiza- 
tion and banking practice. Since banks had already begun to pur- 
chase long-term public securities and had made loans to Government 
agencies on noncommercial principles, the demand emanating from 
agriculture and property development, as well as the growing need for 
industrial long-term financing, had the effect of opening the field of 
banking under provisions of general corporation law rather than special 
charter. This made rapid progress in the 1830’s, both in the United 
States and in England. 

As banking became a field easier to enter the commercial ^ standards 
cherished by Adam Smith soon ceased to limit the operations of bankers. 
The neat distinction between mercantile credit and long-term capital 
financing became increasingly blurred. While the metropolitan banks 
continued to be relatively conservative in providing commercial credit, 
the making of bank loans on security collateral and the purchase by banks 
of corporate securities developed rapidly, and in the smaller communities 
and the frontier areas banking developed into a Iree-for all, opportunistic 
game for the financing of land speculation and rural capital requirements 
generally. It was this insatiable demand for agricultural, structural, and 
promotional capital that made it impossible to continue the early Federal 
banking iastitutions, the First and Second Banks of the United States. 
The antagonism arising, particularly in the rural sections, against any 
form of restrictive monopoly ” privilege was clearly evident long before 
Andrew Jackson finally and permanently destroyed effective central 
banking and removed at least one restraining and coordinating influence 
over credit deposits and note issues. 

From the ending of the Second Bank of the United States in 1836 
to the establishment of the National Banking System during the Civil 
War, the distinction between commercial banking and capital banking 
was almost entirely obliterated. Banks made heavy loans to the State 
Governments; many states contributed to the capital of banks in order 
to obtain these loans, many of which financed permanent improve- 
ments; and the land subdividers, railroad promoters, and building 
speculators generally found ways of establishing “ banks as an 



adjunct to their promotions.^ It was thus possible to monetize the 
estimated value of a new private-capital promotion and to proceed 
without recourse to savings. Although in some states, notably New 
York and Massachusetts, there continued to be relatively conservative 
bank operation under state supervision, this was in general a ^‘wildcat” 
period. Much of the bank-note circulation represented long-term and 
more or less speculative assets that caused bank notes to circulate at 
varying rates of discount and to be extensively counterfeited. It was 
this wretched condition of the note circulation, as well as the necessity of 
widening the market for Federal bonds, which prompted the banking 
reforms of 1864. But in so intently concentrating upon the note-issue 
problem and its monetary aspects, legislators failed to include in the 
new system the credit operations of the deposit banks. The importance 
of the monetary aspect of bank-note issue was held to justify the exercise 

^ There was ample precedent for this, as may be seen from the following cases cited 
by Cleveland and Powell: 

‘^As early as 1814 Maryland chartered the Susquehanna Bank and Bridge Com- 
pany, with power to employ half its funds in the banking business. In an amendment 
to the charter of the Delaware and Hudson canal granted by New York in 1824, the 
company was given the right to exercise banking powers during a period of twenty 
years. New Jersey, the same year, granted a charter to the ‘ Morris Canal and Bank- 
ing company’ which gave the enjoyment of banking functions through a term of 
thirty-one years. Maine, which in 1823 had authorized a lottery for the benefit of the 
Cumberland and Oxford canal, chartered ‘the Canal bank’ in 1825, with authority to 
invest one-fourth of its paid subscriptions in the stock of the canal company. The 
directors of the Blackstone canal announced in 1831 that they had received a charter 
for a bank to be operated for the benefit of the company. Shareholders were privi- 
leged to duplicate their holdings of canal stock with shares in the bank; and three- 
fifths of the funds thus raised by the bank were to be exchanged for stock of the parent 
company. The same year, the ‘New Orleans Canal and Banking company’ was 
chartered by Louisiana to construct a waterway from Lake Ponchartrain to the 
Mississippi at New Orleans. . . . 

“The bank of Macomb county at Mount Clemens made no attempt to build the 
Macomb and Saginaw railroad, and in order to preserve its charter it obtained legisla- 
tive permission in 1840 to build a turnpike instead of a railroad. The bank failed in 
1858. The Ohio railroad charter of 1835 contained a provision that the funds of said 
company shall be paid out in orders drawn on the treasurer, in such manner as shall 
be pointed out by the by-laws of the company; and ‘that all such orders for the pay- 
ment of money so drawn shall, when presented to the treasurer, be by him paid and 
redeemed.’ Without collecting a dollar from the stockholders, and with an empty 
treasury, the company under authority of this clause began banking operations, and 
successfully maintained a large circulation. Laborers and contractors were paid in 
notes, and from the proceeds of the bonds of the state received as a subsidy, some of 
these notes were redeemed. When the company suspended, there had been no work 
of permanent character done on the road, and there were outstanding several hundred 
thousand dollars in worthless currency." Frederick A. Cleveland and Fred W. 
Powell, “Railroad Promotion and Capitalization in the United States,’’ pp. 167-171, 
New York, 1909. 



of Federal power, but it was held that under the Constitution the Federal 
Government could not extend its regulatory power to lending operations, 
and this was left to ^‘state” banks under state authority. Thus arose 
our dual system of banking. There developed rapidly after the Civil 
War indifferently supervised state institutions and trust companies, 
unable (after 1869) to issue notes but able to engage in what was accepted 
to be commercial banking and the extension of credit through creation 
of deposits.^ 


Within the space of a generation the commercial banks operating 
under state authority actually became more numerous than National 
l^anks, and by 1920 their total resources exceeded those of the National 
Banks. Meanwhile, bank notes had become little more than money 
certificates (representing the holding by National Banks of Federal 
bonds), and since these issues did not vary wdth the needs of trade or 
even the seasonal requirements of agriculture and merchandising, the 
variable elements in bank credit were almost entirely represented by 
the lending that generated demand deposits. As time passed, circulat- 
ing bank notes became a less and less important phase of the financing 
of business. The issuing of notes became subject to peculiar technical 
conditions relating to the outstanding Federal debt and the return 
available from Federal obligations. For all practical purposes the 
National Banking System accomplished little more than to render the 
circulating notes uniform and relatively safe and to submit at least a 
part of the banking system to regular examination and uniform super- 
vision by public authority. This tended gradually and indirectly to 
improve the regulation of banking by the states, and to eliminate some 
of the more flagrant abuses of bank management in the matter of capitali- 
zation, reserves, and exploitation of banks to further promotional 
(uiterprises of directors or favored customers. But unfortunately, this 
dividing of commercial banking supervision into political groupings 
permitted much unsound banking to continue and flourish beyond the 

1 The National Bank legislation contemplated bringing all commercial banks into 
a Federally supervised system by placing a prohibitive tax upon the circulating notes 
of State Banks. This was a futile expectation, since it overlooked entirely the growing 
importance of deposit credit and checkbook money. Had Congress fully and accur- 
ately recognized the essentially monetary characteristics of bank deposits subject to 
check, it is doubtful whether sound constitutional objections could have been raised 
against extension of Federal regulatory powers over all banking institutions. The 
extension of Federal power over the functions of note issue, previously exercised under 
state authority, was fully recognized by the Supreme Court in 1869. See Bray 
Hammond, The Banks, the States, and the Federal Government, American Economic 
Review^ December, 1933. 


range of any effective control. It is this characteristic of American 
banking in the expansive pioneering decades that warrants our special 

Although the National Banking Act, until 1913, did not authorize 
National Banks to make loans secured by real estate, they were empow- 
ered to make collateral loans with very minor restrictions, and there was 
no effective way of preventing them from making short-term loans for 
ostensibly commercial purposes but nevertheless renewable to the extent 
that they often virtually represented advances of long-term working 
capital or even fixed capital. This fact has been commonly overlooked, 
but it is important in fully appreciating the tendency of even that part of 
our system functioning under the National Banking law to become 
repeatedly embarrassed by the freezing of what seem on the surface to be 
liquid assets. Furthermore, the state-supervised banks, operating 
under much less effective and by no means uniform regulation, were able 
in most agricultural regions to extend loans liberally on agricultural 
property and intermediate-term loans on security of agricultural products. 
Thus a fairly considerable proportion of total bank lending represented 
advances well beyond the range of strictly self-liquidating commercial 
paper or the discounting of merchants’ notes and drafts. 

The United States has never utilized an appreciable part of its 
resources in foreign trade, and hence the kind of purely mercantile credit 
that so long prevailed and gave undoubtedly a high degree of liquidity 
to the British banking system has not been available to our banks, even 
in New York. A relatively large segment of our economy has been 
engaged in extractive industries, catering to construction and agriculture, 
with all their vagaries, special hazards, and wide fluctuations. These 
users of credit have infused into banking operations a conspicuous element 
of nonliquidity in the loans that in itself would have militated against 
any attempt to restrict deposit banking to purely commercial standards, 
such as those entertained by Adam Smith. ^ 

^ American practice and regulation have leaned strongly toward emphasis on the 
currency creating and formally “secured” loan in contrast to the principle of what has 
come to be called the “banking principle” — emphasizing the importance of making 
sound loans as a means of avoiding banking difficulties. This distinction between the? 
“currency” principle and the “banking” principle really developed out of British 
experience, when, during the Wars with Napoleon, the Bank of England was criticized 
by certain groups, hostile to its prerogatives and power, for overissuing its notes and 
thus inflating the currency circulation. In Parliamentary investigations, which 
finally led in 1844 to legislation restricting Bank of England note issue, it was 
repeatedly asserted by leading bankers that so long as each advance to businessmen 
was made on conservative lines with thorough knowledge of the purpose of the loan 
there could be no abuse of credit or inflation. 

Actually, these seemingly opposing principles are aspects of diverse problems. 
The currency principle is valid and of practical bearing if the banking system is placed 



From still another point of view, as a result of our banking experience 
and the sectional bias in legislation regulating it, there has been a pro- 
nounced tendency to bring essentially capital loans more or less con- 
sciously within the province of commercial banking, but at the expense of 
providing deliberately for the establishment of institutions specially 
adapted to making long-term loans for capital purposes. It is an 
astonishing fact that almost every country of importance has made far 
more progress than the United States in the development of mortgage 
banks, agricultural-loan banks, industrial-credit agencies, and savings- 
and-loan associations for capital and structural financing. What actually 
happened here was a merging under the guise of commercial banking of 
functions that actually represented substantial indirect accommodation 
to capital finance. After 1913 the National Banks were permitted to 
make loans secured by real estate up to 25 per cent of their capital and 
surplus and one-third of their time deposits, but even this concession 
(primarily to the farmers) was not in the direction of sound property 
financing, inasmuch as such loans were limited to five years and hence 
represented the typically American banking straddle — capital loans at 
short term. The financing of property, in other words, was made to 
appear as “liquid’^ financing by limiting the period, but by this very 
device the mortgages and collateral upon which much of this credit was 
extended were inherently unsound, because the many borrowers could not 
in the very nature of things liquidate the loans within the period. This 
also contributed to perpetuate the emphasis on asset security as distinct 
from the careful analysis of the personal elements in each case and the 
ultimate purpose served by each loan made. 

As for bank loans upon security collateral, these have been important 
in the larger financial centers, particularly New York. Loans of this 
type have been made by banks in the United States for at least a centur 3 ^ 
They represent a type of advance principally employed in speculative 

in the position of financing war and creating either notes or deposit credits for Govern- 
ment account. But under normal conditions, with respect to standards of business 
financing, the banking principle is important as emphasizing the qualitative aspects of 
the lending operations as these bear upon avoidance of cyclical overexpansion and the 
amplifying of depression. Much debate on this subject has confused the issue by 
implying that note circulation alone has a currency aspect or that deposit credit has no 
currency aspect, both of which contentions are fallacious. If reasonably formulated, 
there is something of value in the proposition that banks can dilute the circulation of 
means of payment by public and war loans (or excessive private loans not consistent 
with sound banking standards) and also in the proposition that sound banking practice 
in meeting business demands can go a long way (if bankers can be made to adopt such 
practice uniformly and consistently) to minimize both inflation of price level and 
encouragement to speculative promotion of capital projects, which, in turn generates 
most cyclical instability in production and trade. 



operations on the stock exchanges and to some extent the need for 
advances in distributing bond issues. These loans are either on a 
‘^demand^^ basis, subject to overnight recall of the funds, or on a 
basis, but both classes may be subject to indefinite renewal, and hence 
the loans are not inherently self-liquidating. A considerable proportion 
of such collateral lending has been done on a time basis in the financial 
centers and has thus represented a peculiar type of bank lending from the 
standpoint of liquidity and the standard of self-liquidation. Such loans 
may be considered a means whereby a commercial bank, not itself 
engaged in the purchase of common stocks or corporate capital financing, 
makes funds available to those who purchase corporate shares or bonds, 
usually on a margin. In the aggregate, such purchasers, even if mainly 
with merely speculative intent, may make up a fairly substantial volume 
of supply of industrial and mercantile or construction capital, despite the 
fact that the individual traders or speculative investors operate on a 
conditional or short-swing basis. 

There is clear evidence that the vast expansion in this kind of bank 
lending, which occurred after World War I and culminated in the great 
market inflation of 1929, was preceded in the late 1890^s and almost down 
to the beginning of that War by an almost equally conspicuous contribu- 
tion of such bank credit to the speculative market in railroad shares 
accompanying the railroad reorganizations of that period. In this sense 
the commercial banking system for a long time was frankly exploited to 
serve the needs of security ^Mistribution.^' One may go further and 
observe the manner in which many banks and trust companies in the 
1920^s went far beyond strictly banking functions in forming or acquiring 
^'aflMiates,'' engaged directly in the distribution of securities and mort- 
gages. Through these affiliates these banks found a convenient means 
of keeping a substantial volume of essentially capital loans well out of 
sight. In the hectic speculation of the late twenties some of these bank- 
ing affiliates even engaged indirectly in stock speculation. By 1930 
bank affiliates were actually sponsoring nearly 55 per cent of all new 
corporate issues.^ 

1 A. M. Allen, and others, “Commercial Banking Legislation and Control,^’ p. 427, 
London, 1938. While we are considering the manner in which banks of the commer- 
cial type actually made a large part of their loans essentially capital advances, the 
remarks of B. M. Anderson, Jr., are of interest, inasmuch as he was one of the first 
American economists to emphasize this tendency. In the Chase Economic Bulletin, 
Nov. 6, 1928, he wrote: “I would still maintain that the growth during the past thr(‘e 
or four years in bank investments and in bank loans against stock and bond collateral 
has been unduly rapid, and that a period of pause in this matter, with stock-taking 
and with a waiting for investors^ demand to take up some of the current supply of 
securities carried with bank money, is distinctly in order,” It is unfortunate that 
this warning was not widely heeded. 



The business of making loans of the installment type to facilitate 
purchase by consumers of durable equipment has been of relatively recent 
importance so far as the banks are concerned. This type of lending was 
first developed outside the banking system, but the rapid recent growth 
has been associated with a considerable volume of bank loans when we 
include those made to finance companies or others making advances to 
dealers. Such loans, although of longer term than the familiar discount 
of commercial paper, should be placed in that general category of pri- 
marily self-liquidating or systematically amortized credit of an essentially 
sound type, even though there have been abuses in matters of detail and 
unreasonably high total interest charges. But with the minor defects 
and abuses being brought under control and regulation, it seems clear 
that the principle of installment credit is thoroughly in accord with sound 
financial practice and with the operations of commercial banks, and 
we shall have occasion to comment later upon its growing significance 
as a phase of durable capital expansion in the future. 

It will have been noted in our summary of banking operations that 
American banks as a general tendency have stood ready to pay virtually 
on demand the sums owing to depositors. This includes even a sub- 
stantial fraction of what were ostensibly labeled “time^^ deposits. In 
the case of distinctly savings banks, with which we are not here con- 
cerned, the feature of deposits being subject to immediate payment has 
not been of primary importance in generating weaknesses, although in 
ccj'tain cases, particularly among some types of building-loan organiza- 
tions, the attempt to combine essentially demand deposits with long- 
term loans has been known to occur. In the face of potential deposit 
withdrawals and the many circumstances that might produce an abnor- 
mal rate of withdrawal, it has been the tendency of American banks, 
over and above regulation and legislation, to stress the element of 
liquidity among their earning assets. But this so-called ‘liquidity 
has been in large measure an illusion. The illusory element arises 
from the fact that merely because in a particular instance a security 
seems to be readily salable, it does not follow that the total of all securities 
held by all the banks would be salable without heavy losses in values 
and the unfortunate effect on those values of a simultaneous calling of 
collateral loans which would become necessary. A given flat real-estate 
loan, made for a limited period, is not necessarily solvent if the loan is 
made with the tacit expectation on the part of both banker and borrower 
that it may be renewed several times. In that event the loan is vir- 
tually a gamble on the part of the borrower that he can secure a renewal 
and that conditions will be favorable for the bank to grant a renewal. 
The same thing holds true of all capital (or working-capital) loans, 



or secured loans that are incapable of being amortized and therefore are 
not self-liquidating. 

In fact, our commercial banks have actually been in the service of 
capital finance to a surprising degree, but on a contingent and conditional 
basis. Many of the liquid commercial loans made ostensibly for a 
year have been carried along with the knowledge and assent of the 
examining authorities to five or ten or twenty years and have thus been 
of virtually the same status as long-term capital obligations of the 
borrowers. Despite surface appearance of liquidity in the earning 
assets, if the combined statements of all the so-called “commercial” 
banks were analyzed, it would disclose possession by the banks of much 
formal security against loans, which is actually merely a long-term 
unsecured debenture. 

Another distinctive feature of American banking has been the pre- 
occupation of rigid legal provisions as to reserves and the setting up of 
specific statutory requirements that minimum cash reserves be held by a 
commercial bank against its deposit liabilities. To be sure, such regula- 
tions were not of much consequence prior to the establishment of the 
National Banking System,^ but with the coming of the National 
System, legal reserves were prescribed against both deposits and out- 
standing notes, although the latter was soon eliminated in view of the 
strong Federal-bond-security setup for National Bank notes. In the 
laws of the various states, which more or less patterned themselves 
after the National Banking laws, it became a common practice to require 
state commercial banks to maintain minimum reserves as specified in 
legislation. This matter of “required reserves” against deposits is 
related closely to another peculiarity of American banking that legisla- 
tion until very recently did little to alter — the almost complete limitation 
of banking to unit control and the persistent restrictions upon large 
banks operating through branch offices. This has clearly been a result 
of the antimonopoly prejudice often revealing itself in the attitude of 
Congress, particularly the large segment of the Senate representing 
agricultural sections, where fear and distrust of moneylenders is (for 
reasons that we have already noted) proverbial. This limitation of 
banking to the unit principle has been accompanied by a tendency in 
Federal and state legislation to permit banks of the commercial type to bo 
organized with relatively small capital. Capital requirements indeed 
have been largely based upon the size of the ^particular community served 

1 In the wildcat days of the 1840^s and 1850’s, reserves were in many instances 
nonexistent. There are amusing ancedotes describing the manner in which a single 
box of coin circulated among the banks of a remote community and served to satisfy 
the examining authorities that each bank in turn had something in the nature of a 
cash reserve. 



by a bank. It has therefore been possible to organize small banks, and 
the United States has been a country of very numerous independent banks 
and all the resulting competitive tendencies and the inherent weaknesses 
due to inadequately trained personnel and local hazards. 

While banks in the larger cities grew into powerful and well-equipped 
institutions, the size of the average bank in the interior, or what we may 
call the typical country bank, has been found weaker in times of stress 
than would be true in Canada, the British Isles, or most of Europe. 
This has been an important source of instability, because so much of 
our production has been agricultural and extractive. Many banks have 
been unable to diversify their loans beyond the risks attaching to a 
particular crop, lumber area, mining operation, or industrial town, 
dependent for its prosperity upon relatively volatile conditions. In 
marked contrast to the experience of most other countries, the opposition 
in the United States to large banking companies operating through 
branches is explained historically by the unfortunate results of the various 
State Banks in the 1830^s and the 1840’s, and back of this were the 
personal bias and obstinacy of Andrew Jackson. Although failures 
among such institutions can be mainly explained by their loans to land 
speculators and the reckless State Governments of those days, there 
developed among the agricultural states and among the rural lawyers 
who dominate Congress a persistent animosity against branching systems. 
This animosity, it will be recalled, opposed the existence of any further 
Federal banking after the demise of the Second Bank of the United States 
in 1836. Thus, until the establishment of the compromise Federal 
Reserve System in 1915, the individual banks were deprived of the 
services that might have been rendered by a special institution serving 
as a bankers^ bank and capable of affording emergency assistance when 
necessary by rediscounting earning assets of the individual banks. ^ 


The essential feature of a central bank, whether it is set up as a 
publicly controlled institution or, like the Bank of England, as a private 
institution with public functions and responsibilities rooted in tradition, 

‘ A certain amount of local branching had occurred among the National Banks, 
but no important expansion along these lines was possible, because many state laws 
prohibited branch banks. The National Banking law was relaxed in some measure 
after 1927, permitting National Banks to maintain branches where state laws did not 
forbid them, but branching developments were still somewhat restricted. As late as 
1920 there were only 56 National Bank branches and 996 State Bank branches. Much 
of this expansion, such as it was, occurred within New York City and a number of 
other cities where the branching was localized in the metropolitan area rather than 
extending over a considerable territory. See J. M. Chapman and R, B, Westerfield, 
“Branch Banking,” New York, 1941. 



is to hold a major part of the actual reserves of the commercial banks 
and, by virtue of this command of reserves^ to hold always a substantial 
potential lending power inactive to be brought into use when the indi- 
vidual banks face extraordinary demands and find it necessary to supple- 
ment their own lending power. The central bank stands in relation 
to the other banks somewhat as the individual bank stands to a customer. 
The merchant who has received a shipment of goods from a manufacturer 
and who accepts’^ a draft or has given to the latter a promissory note 
for subsequent payment provides the manufacturer with the means of 
monetizing, so to speak, the goods by discounting the draft or note at 
his bank. But the banks of this country have lacked a means of thus 
quickly monetizing the advances that appear on their books as dis- 
counted commercial paper. One reason why it has been difficult for 
the banks to realize upon such assets and to turn them back into ^^cash^^ 
to support new advances has been the character of the so-called com- 
mercial paper itself. Most of this paper, with the exception of that 
originating in the transactions of fairly large corporations, was not of 
the type that could be resold or used for rediscounting outside the 
locality in which the bank was situated. 

The country, in other words, lacked a broad acceptance market, 
for many notes and drafts represented firms not widely known and 
the paper lacked sufficient endorsement to render it readily acceptable 
to banks outside the particular locality. There was, of course, a certain 
amount of resort by country banks to city correspondents, but it was 
never developed as a systematic practice and had nothing in common 
with the kind of bill market found in London, where the specialists deal- 
ing in short-term paper (known as ‘Miscount houses or “bill brokers’’) 
have long maintained a liquid market for commercial paper, relying 
upon the Bank of England for working capital and upon the large metro- 
politan commercial banks as ultimate purchasers of these instruments. 
The lack of a broad discount or acceptance market here, therefore, 
served to reinforce the characteristics of unit banking, excessively 
localized with regard to advances and to risks. The absence, during the 
period of rapid promotional development, of any kind of central bank 
capable of affording rediscount facilities in times of stress greatly rein- 
forced this rigid localization and the inability of the banks to obtain 
access to reserve lending power deliberately conserved for emergency 
conditions. Thus, when periods of liquidation and insolvency came, 
they brought with them again and again banking collapse. 

The large banks of New York and, to a certain degree, ottier metro- 
politan centers naturally developed correspondent relations with interior 
banks which were to a certain extent in the nature of central-bank 
functions. Balances were kept by country banks in New York as part 



of the routine of carrying on remittance and exchange operations. But 
over and above this routine reason for some reserve to be maintained 
in New York, there were factors that created a most unusual and danger- 
ous concentration of bank reserves in New York without formal or 
adequate responsibility for their use or provision for their immediate 
availability when interior pressures developed. It is at this point that we 
can readily see the shortcomings of the legalistic philosophy of ‘^required 
reserves,’^ as developed in American legislation and practice. 

The widespread banking difficulties of the 1840^8 had already pro- 
duced state laws establishing the principle of cash reserves to be held 
as minima against liabilities (in the early days, mainly notes). The 
National Banking System developed this further and more systematically 
in the form of statutory reserve minimum requirements for National 
Banks. These were finally worked out to provide for three distinct 
types of banks: the smaller country banks, the banks in so-called reserve 
cities, and, finally, those in New York and several other metropolitan 
areas. The principle was to require a 25 per cent minimum reserve 
against all deposits^ in the central reserve city and reserve city banks, 
but the latter might hold half of the reserves in the former banks as 
deposits, and the country banks were permitted to keep as much as three- 
fifths in other banks. Thus the minimum cash actually on hand in the 
vaults of those banks might legally be no more than perhaps 6 per cent 
of their total deposits. This system represented in part the acceptance 
of what was already banking practice. It also represented the idea that 
the essential reponsibility of a banker was to his depositors and those 
who might present checks drawn upon depositors demanding payment. 
What the law virtually said with respect to banking reserves might be 
stated in terms of reservoirs. Every detached and possibly flimsy 
house was required to keep a reservoir of water in case of fire, but the 
little houses might have a large part of their water supply in the posses- 
sion of very remote but larger structures! Instead of maintaining a 
single adequate reservoir, capable of being quickly drawn upon at strategic 
points in case of emergency, the water supply was scattered about, and 
when emergencies occurred the small local reservoirs proved utterly 
inadequate. The law failed to recognize that a credit system operates 
as a functional unit and that weaknesses in one part of the structure 
quickly spread to all other parts. 

Our curious old reserve system, sanctioned by law rather than com- 
mon sense, was rendered even more ineffective in practice because the 
banks in New York City found it very profitable to pay interest on 

1 The Comptroller of the Currency at an early date permitted banks to deduct 
from deposits owing to other banks to the extent that these amounts were covered by 
amounts due from other 



bankers^ balances and thus competed with each other for these interior 
funds. They accumulated in their vaults much larger amounts of funds 
than the legal provisions contemplated. The surplus resources of the 
interior banks, therefore, tended to be pushed toward the metropolis 
where the banks could make profitable use of this additional lending 
power but in highly unliquid extensions of credit. We say this because 
of the fact that most of these funds served as the basis for expansion of 
collateral loans to stock speculators and dealers in securities. Trusting 
again the treacherous illusion of liquidity, the New York banks were 
misled into considering that the salability of securities in the individual 
case meant also the ready salability in general; they considered their 
collateral loans essentially liquid, whereas in fact they were anything 
but liquid. The attempt to call back or refuse renewal of collateral 
loans inevitably meant severe pressure upon the Stock Exchange and 
perhaps also upon the bond market, and these pressures were capable 
at times of turning unfavorable developments into real panic situations.^ 

When these characteristics of American banking, including the 
practices under the National Banking System, are considered in relation 
to one another, it is clear that the system was full of destructive and 
dangerous illusions as to the strength of our banking mechanism. The 
character of the loans and investments, as distinct from their amountSy 
were not of primary interest to the legislators who concentrated their 
attention first upon notes and later upon minimum reserves against 
deposits. It is not surprising that lending practices and investment 
procedure among commercial banks early developed unfortunate qualita- 
tive tendencies. The banks essentially attempted to straddle two quite 
distinct fields — capital financing and commercial credit. The banks were 
always aware of the possibility of withdrawals and hence tended to place 
funds of an essentially nondeposit or savings character in capital loans 
but security lending and investment on a peculiar contingent or con- 
ditional basis. These advances had strings tied to them and were thus 
not really true investments or capital loans in the sense that the lender 

1 The Comptrollers of the Currency were not unaware of these evils. John Jay 
Knox, in his Report for 1877, made some very pointed remarks concerning this system 
of scattered reserves tending to pyramid in the hands of New York banks. He sus- 
pected that funds were sent to New York mainly because the interior banks, limited 
in the scope of their lending, frequently could not utilize to advantage all their 
resources in commercial credit. He therefore suggested that some type of Federal 
obligation should be made available to them as a means of investing surplus funds and 
obtaining a return of perhaps 4 per cent on them. He particularly suggested that 
these be in small denominations to freely enable the banks to dispose of them to the 
public, and vice versa. This policy,^' he claimed, would . . . have the effect . . . 
of retaining in their hands a considerable portion of those idle funds which are now 
sent to their correspondents in the central cities, and are loaned by the latter, upon 
call, to dealers in speculative securities.” (P. xxi.) 



was able and willing to maintain a position until the user of the capital 
had been able to recoup from his own activity the funds for repayment 
over a period long enough to permit or encourage amortization. 

As for the banks generally, the practice of making short-term loans 
that really were or soon became long-term loans through renewal tended 
to hold back the development of true capital-investment institutions, 
particularly those capable of serving the needs of the smaller business 
firms and new enterprises as distinct from large and established corpora- 
tions. This, in turn, was one factor contributing to the growth of very 
large business units, and this trend in the 1920’s was paralleled by the 
use of the security market as an important source of industrial capital 


Once the banking system (particularly in the period prior to World 
War I) was subjected to shock, it converted minor vibrations into panics. 
It became impossible for many businessmen to secure additional credit or 
even to maintain lines of credit already outstanding. When conditions 
reached the point of panic, the sudden failure of the weakest banks 
simultaneously swept away not only the savings of the poor but the 
working funds of business houses and monies to be used for payrolls. 
The tendency of the old banking system to accentuate and spread th(‘ 
\'ibration emanating from such basic factors as we have considered 
resulted to a large extent from overexpansion of speculative advances in 
New York and the difficulty of obtaining reserve funds placed in New 
York quickly enough to provide additional credit for business in the 

In order to show more specifically the functioning of our banking 
system, as it operated prior to the establishment of the Federal Reserve 
System, Chart 32 will be helpful. In the chart can be seen the relation 
between bank loans and the fluctuations of the business cycle and the 
cyclical movements of commodity prices relative to their underlying 
trend. The expansion in bank loans between 1904 and 1907 more or less 
paralleled the expansion of business activity, and the rates charged by the 
banks for discounting commercial paper (and presumably the rates on 
most other short-term loans) also rose. In general, prior to World War I 
and during the long period when the United States was primarily in a 
debtor position on international account, the variations in bank-discount 
rates reflected the cyclical movements in loans rather than independent 
changes in reserves. Occasionally there were demands upon the New 
York banks for funds to settle foreign balances, but withdrawals of gold 
in most instances were not of themselves a major cause of credit 















Chart 32. — Credit conditions, business activity, and wholesale price cycles, 1901-1914. 
All of these measures are shown in the form of indexes relative to long-term trend in 
order to portray clearly the cylical movements. The scales are uniform throughout. 



A careful study of the gold movement by months between 1880 and 
1910 would reveal that in almost all cases during those years, gold 
entered the United States when money rates were rising rather than 
falling, and gold moved out of the country when low rates here coincided 
with higher rates in European centers. At the top of Chart 32 is shown 
the cyclical course of deposits in the National Banks of New York City 
and those outside New York. If it is kept in mind that the loans and 
discount of the New York banks closely paralleled their own deposits 
(reflecting the tendency there to use balances from the interior in 
advances to the stock market), it will be seen that New York deposits 
moved inversely to outside deposits. It was the shifting of funds to meet 
interior developments and, of course, the seasonal requirements of agricul- 
ture, that mainly affected the reserves as such. In addition, however, it 
must be remembered that not only were reserve funds shifted about 
between interior and metropolis but cash funds were also shifted, as 
between the banks as a whole and the general public.^ 

During the early stages of a business boom the banks generally would 
continue expanding loans and discounts freely, but as business activity 
increased and the tempo of trade tended to affect commodity prices also, 
there began to be a demand on the part of the public for more pocket cash, 
'rhis outflow of cash from banks to people became more rapid as the 
cyclical tendency expanded, and presently it served to a perceptible 
degree to check further liberal credit advances. In conjunction with the 
faltering of business and some early insolvencies in trade or promotional 
construction, this served as the first notice of a coming storm. Loans 
began to be refused; rates rose swiftly; the New York banks called in 
speculative advances. Security prices began to decline. Merchants 
feared that credit was becoming tighter and stopped adding to inven- 
tories. Failures in industry began to multiply. Those endeavoring to 
stave off insolvency or embarrassment eagerly sought additional personal 
loans. Finally there came frantic calls from interior banks for return of 
reserve balances held in New York, with the natural result of bringing 
about grave embarrassment in New York, beset by its own difficulties. 
Time and again during these periods of acute emergency it was necessaiy 
for banks to close, and this naturally produced a spiral of panic conditions 
throughout the country. These panic phenomena were, therefore, 
definitely associated with the weaknesses of our banking system and 
should not be regarded as a necessary concomitant to business reversals or 
depressions as such. 

Chart 32 also reveals that in the particular case of the business reversal 
leading to the panic of 1907-1908, the expansion in the loans and dis- 
counts of the National Banks outside New York City, which began in 

^ We may omit for the present consideration of funds held in the national Treasury. 



1904, coincided with a declining tendency in these items in New York 
City. The New York banks were beginning to reduce accommodation 
to the stock market, and perhaps also to merchants, a considerable time 
before there was any evidence of general strain or even a significant rise 
in short-term money rates. By 1906 the outside banks had withdrawn 
considerable funds from the metropolis, and money rates began to be 
decidedly firm. Shortly thereafter stock prices began to wilt in the face 
of higher cost of speculative credit and an even faster rise in the collateral 
loan rates than in the commercial paper market. The critical point of 
strain came at the end of 1907, intensified by a rapidly collapsing stock 
market, selling of investment securities by all banks, with an accompany- 
ing decline in bond prices and demands for emergency loans by 
businessmen. ^ 

As the data used in Chart 32 relate only to National Banks, it must 
be added that in the period that we are now discussing there were further 
elements of vulnerability in New York City because of the rapid growth of 
trust companies and the shifting of loans from the banks to these even 
less conservatively managed institutions. This tended to sustain the 
loans destined for use in stock-market speculation somewhat longer than 
the data indicate. As these loans during the acute stage of the crisis were 
in part shifted back to the commercial banks and particularly to the 
metropolitan National Banks, it was necessary for these institutions to 
face a local strain in New York and also the emergency withdrawals 
of reserve balances by interior banks. The acute phase of the crisis of 
1907 revealed, as similar phases many times previously had done, the 
close association of certain banks and trust companies with those inter- 
ested in basic capital promotion. In this instance there was promotion 
of copper-mining properties by a group whose activities had begun to 
create suspicion, and from this developed the first important runs on 
banks, a long-familiar sign of approaching strain and panic. Depositors 
began to withdraw money from savings banks, and business firms reduced 
deposits in commercial banks throughout the country. Under these 
conditions the banks in the large financial centers found themselves 
greatly handicapped by the rigid character of the legal reserve require- 
ments that served as a barrier to the extension of emergency credit, where 

1 For further statistical details relating to the behavior of the assets and liabilities of 
banks during the period 1901 to 1914 see the excellent analysis by Allyn A. Young, 
“An Analysis of Bank Statistics for the United States,” Harvard University Press, 
1928, particularly Chapter 1, from which the banking data shown in Chart 32 were 

See also the detailed historical study of panics and crises during the existence of 
the National Banking System down to 1908, prepared by O. M. W. Sprague for the 
National Monetary Commission under the title “ History of Crises under the National 
Banking System,” Washington, D.C., 1910. 



it would do most good to restore confidence and allay panic. According 
to Sprague, ‘‘It was restriction in New York that inevitably precipitated 
more or less complete suspension throughout the entire country. 

The desperate situation in New York was finally relieved by resort 
to a makeshift device somewhat similar to one that had previously been 
found effective in such emergencies. This was temporary support to 
bank-lending power by the use of the local Clearing House as a source of 
temporary advances of credit. But for two months the banks of New 
York could not function on a normal basis, and money was bought and 
sold at a premium. The crisis of 1907 essentially repeated what had 
been seen in 1873 and again in 1893. In the country at large, many 
banks were forced to suspend, and there was everywhere uncertainty, 
confusion, and embarrassment to business. As in previous emergencies, 
manufacturers found it difficult to obtain funds to meet payroll, and 
many industries closed down, and their workers were idle for weeks or 

The rate of mortality in our old banking system (exclusive of savings 
banks) as the result of acute strain and panic in 1907 is revealed in the 
Reports of the Comptroller of the Currency. In the year ending June 30, 
1908, 153 National, state, and private banks were forced to suspend, 
representing a total of nearly a quarter of a billion dollars of deposits. 
This was by far the largest impairment of deposit liabilities thus far 
experienced in the United States. In the 1893 fiscal year, the number of 
failures had been 291, representing 55 millions of deposits. In 1884, 
60 banks failed, with about 21 millions of deposits. The severe impair- 
ment of business conditions in 1873 and ensuing financial diflSculties 
stretched along for several years, and the largest number of bank failures 
was not reached until 1878, when 80 banks failed, with total deposits of 
32 millions. Having in mind the close dependence of merchants and 
manufacturers upon the solvency of the banking system and their ability 
to secure accommodation continuously and readily, these failure figures 
are highly significant and are indeed a shameful aspect of our financial 

Chart 33 displays an index of business insolvency, including failures 
of banks, mercantile and manufacturing companies, and the estimated 
annual totals of fixed-charge obligations of railroads placed in receiver- 

^ Sprague, op. d(., p. 261. Sprague further says (p. 269), ** Banks with relatively 
large New York trust company deposits or numerous correspondents in the West and 
South were subject to the greatest demands for cash and for the liquidation of loans. 
When the outside banks and the trust companies called their loans, brokers, to whom 
call loans are principally made, immediately resorted to the banks carrying their reg- 
ular accounts, and the banks felt under obligation to afford them accommodation so 
far at least as it could be shown to be absolutely necessary."’ 



ship. A separate curve at the top of the chart shows the insolvency 
record in terms of real-estate mortgage foreclosures.^ The interesting 
features of this exhibit are the marked degree of volatility in financial 
impairment, the rather distinctive pattern of the cyclical movement in 
real-estate foreclosures, and (referring to the lowest curve) the evidence 

Chart 33. — Business mortality and the purchasing power of the dollar, 1870-1939. 
As the failure liabilities (partly estimated, and expressed on a per capita basis) are plotted 
to a ratio scale, the component parts of the totals should be interpreted as proportions 
rather than cumulated amounts. The purchasing power of the dollar has no very con- 
sistent relationship to business failures. See also Appendix 12, Section 1. 

that although significant increases in the purchasing power of the dollar 
were frequently related to a rise of failures, this was not uniformly true. 
This is what we expect from our previous analysis of the vital part pla3^ed 
by transportation and building construction in producing industrial 
cycles and depressions, which were intensified by the additional stresses 
arising from a vulnerable, poorly integrated banking system. ^ 

* Based upon the same data shown in Chart 28. 

*The failure experiences in the I^t^r years shown in Chart 33 will be further 
commented upon in Chapter 14 . 



Returning now to Chart 32, we can briefly summarize the financial 
sequel to the panic of 1907. It will be noted that toward the end of that 
year there was a prompt return flow of funds to New York. This was 
in some measure due to the effect of high money rates in encouraging 
imports of gold from Elurope. Gold imports in November, 1907, reached 
the highest point that had been attained in a single month for many years. 
But it cannot be claimed that the banking crisis was in any measure due 
to an outflow of gold during the business boom, for the years 1906 and 
1907 had also been years of rather large net gold imports. Conversely, 
the net outflow of gold in 1909 and 1910 did not visibly impair the 
recuperation of the banking system. During these years, when the coun- 
try was still not definitely in a creditor position internationally (save for 
very short periods of time), the tightening of money rates was almost 
entirely a matter of internal banking strain produced, first, by the rise 
in business and speculative loans and, later, by the acute pressure of 
emergency loans and shifting of loans from bank to bank. Again with 
reference to Chart 32, we see that as soon as some measure of ease was 
reestablished in the banking situation and funds again began to flow 
back to New York, with trade conditions stagnant, money rates immedi- 
ately responded. The short-term discount rate and the call rate on 
collateral loans in New York rapidly declined throughout 1908. 

This sensitive responsiveness of the short-term money rates in the 
financial center to the business cycle and occasional panic phenomena 
was for many years of practical importance. It made it possible for 
financial observers, businessmen, and security investors to determine the 
approximate time at which tension was definitely being relieved. A 
careful study of money rates revealed the approach of periods of strain, 
and thus it became a well-accepted business principle in that the state of 
the banking position in the country’s financial nerve center. New York, 
was the most reliable advance indicator of general business conditions. 
Whereas money rates always reached their highest peak during the strain 
that followed a business reversal, the peaks almost always 'preceded by a 
significant interval the turn toward recovery of manufacturing industry 
and trade activity. In other words, the basic factors tending toward 
recurring overcapitalization of long-term investment projects and impair- 
ment of mortgage solvency first registered their effects upon the banking 
mechanism, and this a little later transmitted and amplified the impulses 
as they appeared in manufacturing and merchandising. Industries 
producing raw materials and capital goods used in construction not only 
entered a period of dwindling orders as the excessive momentum in 
promotion passed its crest, but also suffered the further embarrassing 
effects of an acute impairment or shutting off of their credit facilities. A 
further extension of inactivity, closed-down factories, destruction of 



general bu3ang power, and, what is also very important, the shattering 
of investment confidence all contributed to carry the industrial recession 
even farther than its intrinsic volatility alone would have warranted. 

It is well to state this matter with care, because the writer has observed 
many cases in which economists and statisticians have seized upon the 
working of the New York money market and the peculiar sensitiveness of 
its lending rates as being virtually the motivating forces producing busi- 
ness collapse and later engineering recovery. Although undoubtedly 
money market conditions were long a useful forecasting factor (if we 
restrict ourselves to short-term cyclical forecasting), it by no means 
follows that we find in the banking system of those days more than a 
transmitting instrument or amplifier of more fundamental prime movers, 
such as our previous analysis has revealed. 

Somewhat the same comment may be made concerning the well- 
established tendency — at any rate, until recent years — for stock prices 
also to describe a cyclical turn somewhat in advance of those in the index 
of general business conditions. More will be said of this in a later 
chapter, but while we are speaking of the banking system and money 
rates we may conveniently record the fact that this sensitive property 
in the stock market was a mere reflection of the variations in mone}^ rates. 



Our banking system prior to World War I proved to be so important an 
amplifier of the stresses contributing to business instability that it is 
worth while to carry forward the analysis of subsequent changes in the 
structure and in banking policy. 

The panic of 1907 generated keen public interest in banking reform 
and considerable study of the problem, out of which emerged the Federal 
Reserve System to supplement and coordinate the operations of the com- 
mercial banks.^ The most important objectives of the Federal Reserve 
organization were, first, to introduce more flexibility into the bank-note 
circulation by permitting the central banks (operating as 12 regional 
units but with policy determined in large measure by a governing board) 
to issue Federal Reserve notes against earning assets held in the form of 
gold or commercial paper of approved character; and, second and most 
important, to provide a kind of safety factor by making available the 
rediscount of approved member bank assets in times of emergency credit 
demand. Membership was obligatory to National Banks but open to 
other commercial banks meeting specified qualifications. This supple- 
mentary lending power through rediscounting short-term notes and 
mercantile drafts arising from business rather than speculative trans- 
actions contemplated the establishment of a broad and fluid commercial 
paper or ^^bilF^ market, based upon trade instruments several times 
endorsed and thus made readily merchantable throughout the financial 
centers of the nation and widening the access of businessmen to credit 

This was essentially an attempt to transplant from London and 
Continental Europe to the United States the kind of commercial-paper 
rediscount machinery that previously had existed here to a very limited 
extent. But circumstances failed to confirm the hope of Paul M. 

^ Actually, the new system was not quite in working order when the War broke 
out in 1914, but previous legislation had provided the organization capable of affording 
a temporary device for pooling the lending power of the commercial banks, or at least 
a substantial number of them. This was developed in outline by the Aldrich-Vreeland 
Act. The banks were able under the provisions of this Act to meet the temporary 
strain occasioned by the outbreak of war, and highly disturbed foreign-exchange 
market at that juncture, and an orderly transition was facilitated to the new system 
in 1915. 




Warburg, Carter Glass, and other founders of the new system that 
American businessmen would alter their commercial practices and 
readily adopt the type of credit instruments and the dependence upon 
short-term trade credit that had been so long familiar to businessmen in 
Europe. Our business transactions continued to be mainly of domestic 
character, and the amount of accepted drafts arising from foreign-trade 
transactions was never developed to anything like the importance that 
had been attained, for example, in the London money market. Hence, 
at the very start, the system whereby ^'emergency credit’’ was to be 
available to the member banks not only was of foreign origin but repre- 
sented a narrow segment of the total earning assets of a majority of our 
commercial banks. Therefore, the plan to base the new form of note 
issue mainh' upon rediscounted mercantile and industrial notes and 
drafts rather than upon gold soon encountered obstacles. 

In order to provide the Federal Reserve bankers’ banks with real 
banking prerequisites, they were to hold in their vaults all the legally 
recognized reserves of the member banks. This was mobilization of reserve 
power. When this transfer of gold from members to Federal Reserve 
was completed in 1917, the Reserve Banks were able to extend credit 
to members within such limits as were set up by law. The gold reserves 
now supported two types of liability: the Reserve notes and the Federal 
Reserve deposits, which represented primarily deposits to the credit of 
member banks. These credits, in turn, constituted the recognized or 
legal reserve of those banks, and any additions to them created by redis- 
counting operations were therefore additions to their working reserves. 
A new concept of bank reserves was thus introduced into American 
practice. Every dollar of deposits that a member bank had to its credit 
on the books of the Federal Reserve Bank of its district represented 
available reserve. Fresh reserve could be expanded by the rediscount 
of approved paper if member banks happened to have assets in that form. 
Thus it was possible for the total reserve available to the member banks 
to be greater than all the gold held in all the Reserve Banks. We added 
a flexible expansion joint to our bank reserves but curiously enough at a 
time when inadequate gold reserve was just beginning to disappear as a 
key problem in our credit system.^ 


The exigencies of World War I not only gave this new system a 
severe test but soon necessitated changes in the relationship of member 

^ Naturally, there was a penalty attached to rediscounting. This was available at 
rates that usually would not make the practice profitable and would restrict it to 
emergency conditions as a means of avoiding the panic phase of financial stringency 
and the cumulative freezing of assets. 


banks to the central banks. The first phase was one of marked advance 
in commodity prices as we undertook to supply the Allies with urgently 
needed armaments and food. The member banks rediscounted com- 
mercial paper in large amounts during the first few years of the War. 
This process, however, may have introduced an additional inflationary 
element and even speculative element in the commodity markets, since 
the Reserve Banks could not legitimately deny rediscounts of commercial 
paper, even though that paper might actually have represented a tendency 
on the part of businessmen to increase inventories unduly or even to 
speculate in commodities. 

Soon after our entry into the War, enormous new Federal financial 
requirements had to be met. Therefore, in the autumn of 1916, the 
Reserve Act was amended to permit Reserve Banks to make advances 
directly to member banks if the latter presented promissory notes secured 
by collateral of United States Government securities. This vastly 
extended the “reserve-creating^' power from trade paper to Federal 
bonds. Although this provision contemplated only short-maturity 
advances of this type, the member banks found it possible and expedient 
to renew them. They were thus in a position to assist the Government 
very materially in carrying through its various war-loan drives but by 
an essentially inflationary operation, since many individuals and business 
firms purchasing war bonds borrowed at their banks to provide the money, 
and these banks, in turn, borrowed on the very same collateral from the 
Federal Reserve. The Federal Government virtually monetized its own 
credit in the form of circulating purchasing power. Whether the easy 
availability of credit under this new system, both for private business 
and for the War effort, had any influence in encouraging borrowing as 
against taxation is difficult to say, but the presumption is that had these 
highly flexible and expansible facilities been absent the country would 
not have endeavored, as it did, to maintain the gold standard, either at 
home or abroad. There might easily have been a repetition of the green- 
back experience in some type of outright fiat currency. At any rate, the 
advances made to the member banks on Government collateral formed 
the most important part of central-bank assistance to the commercial 
institutions during the War period. 

In addition to these tremendous bond collateral advances by the 
Federal Reserve, their rediscounting of commercial paper temporarily 
also assumed large proportions. With the Reserve Banks carrying so 
large a part of the credit load to finance the War, the member banks were 
in a position to contribute in still another direction to the mounting spiral 
of credit inflation by direct investment in Government obligations. 
Their holding of Federal securities almost quadrupled after our entry 
into the War. This momentous transition to central reserve banking 



under the abnormal and distorted conditions of war actually produced a 
threefold expansibility of total bank credit (primarily, of course, within 
the total membership of the system) by (1) concentrating reserves and 
reducing normal reserve requirements against deposits, (2) providing for 
essentially “paper” or credit reserves by regarding member bank deposits 
with the Federal Reserve Banks as legal reserves, ‘ and (3) the fortuitous 
circumstance (not anticipated in the initial legislation) of a substantial 
net inflow of gold during most of the War period and, indeed, for some 
time thereafter. Although the new system was intended to stabilize' 
credit conditions and eliminate panic stringency, all these factors were, 
in fact, contributing toward overexpansion, and the very ease of this 
emergency expansion undoubtedly created serious obstacles to inflation 
control and financing the War by a more adequate measure of taxation. 

Referring back to Chart 9, showing the net gold movement during the 
period that we are considering, we can say that the World War definitely 
marked a transition not only as to banking organization but from an era 
of recurring inadequacy (or perhaps unavailability) of reserves to a 
tendency for large, even though irregular, receipts of gold capable of 
expanding the available reserves of the banking system. The Federal 
Reserve System had been predicated upon the presumption that our gold 
position would not be radically altered by international developments, 
whereas, in fact, there soon appeared a tendency toward serious dis- 
turbance in the equilibrium of international settlements. The new sys- 
tem constituted a mechanism capable of infusing a permanently largei' 
credit superstructure per dollar of reserve on a gold foundation that itself 
was destined to expand tremendously. As events worked out, the end 
of the War did not bring about an immediate credit deflation here, for 
Europe remained in dire need of essential materials and particularly food. 
The sudden release of this additional foreign demand produced a con- 
siderable further enlargement of bank credit and rediscounting of com- 
mercial paper with the Federal Reserve Banks in 1919 and well into 1920. 

This is clearly seen in Chart 34, which illustrates the rapid rise in 
commercial money rates and commodity prices to a peak in the late 
spring of 1920. This sharp and short-lived postwar inflation was easily 
financed despite some temporary loss of gold in 1919.* In other words, 
the new system was so flexible that minor oscillations in net gold move- 
ment were no longer of consequence in their effect upon credit availability. 

* Average reserve requirements against deposits of the commercial banks prior 
to the organization of the Federal Reserve System were about 21 per cent. By the 
summer of 1917 these became less than 10 per cent. (Phillips, McManus, and Nelson, 

“ Banking and the Business Cycle,” New York, 1937.) 

* Nearly half a billion was shipped to South America and the Orient following the 
release of the embargo on foreign gold that had prevailed during the War. 


It is true the credit expansion just after the War did subject the system 
to some temporary strain, for the Reserve Banks by 1920 had expanded 
their note and deposit liabilities to a point beyond which their existing 
gold reserves would have proved inadequate according to the minimum 
legal level. Had further Federal Reserve credit been extended, it would 

Chart 34. — Commodity and stock-market inflation in relation to credit conditions, 
1915-1932. The commodity price inflation of 1916-1920 and the stock-market inflation of 
1926-1929, were both correlated with cyclical changes in credit circulation, but with differ- 
ences in the character of the credit factors in the two cases. All curves in the chart are 
drawn to uniform ratio scale, permitting comparison of proportionate fluctuations. 

have been necessary to do so under emergency conditions provided for 
in the Reserve Act, involving payment of a penalty tax. But the Reserve 
authorities, late in 1919, began to apply the brakes by raising the rate 
at which they would discount commercial paper. Since the rediscount 
rate had been below the rate prevailing in the money market, this step 
was not fully effective but did suflBce as warning that credit for speculative 
operations was to become less readily available. The rediscount rate 



was finally raised to 7 per cent in the middle of 1920 and remained at 
that level through the spring of 1921. 


But months before this point of apparent credit strain and these steps 
to curtail needless credit extension, the structure of commodity prices 
had begun to show signs of weakness. Livestock and meat prices had 
already suffered sharp declines in 1919, reflecting excessive government 
supplies and the beginnings of liquidation in farm areas. Early in 1920 
there came signs of distress in the silk industry as raw-silk prices broke 
violently in Japan. The prices of other textile products, including cotton, 
followed in the early spring as buyers refused to pay current quotations. 
Cancellation of orders, many of which had previously been duplicated 
through fear that delayed deliveries would result from the railroad-car 
shortage, further contributed to an ominous faltering and reversal of the 
commodity structure. Prices declined violently until the summer of 
1921. Industrial and mercantile demand for commodities had now to 
be readjusted to a peace basis. The United States Government began 
to dispose of huge material stocks. The needs of Europe soon passed 
from the state of acute shortage to one of more deliberate production 
recuperation and more normal trade. As in all periods of rapidly falling 
prices, business failures rapidly mounted (cf. Chart 33). And in spite 
of the supposed strengthening of the banking system, a heavy mortality 
among commercial banks marked the year 1921, even though there was 
no repetition of the historic tendency toward panic conditions. 

What happened in this instance was the folding up of banking institu- 
tions that were inherently unsound because of frozen agricultural, com- 
modity, and collateral loans. The sound banks found it possible to obtain 
ample relief and supplementary credit by rediscount almost to the end 
of 1920. But in the year 1921 (ending June 30), there were 357 failures 
among National, state, and private commercial banks, involving 161 
millions of deposits. Failures were most prevalent among the smaller 
state banks outside the Reserve System and particularly in the agri- 
cultural areas. The collapse of wartime inflation, as we have seen, usually 
exerts its most acute pressure upon farm-product prices, but the Federal 
Reserve System really did very little to attack this problem. There 
remained in existence an excessive number of small banks, facing high 
credit risks and exceedingly vulnerable to a swift deflation of commodity 
values. Nor did the Federal Reserve System eliminate the risk of the 
shrinkage in investment values that forced numerous banks to suspend 
as their assets shrank in value and loans based upon collateral of securities 
became impaired or frozen. And the Reserve Banks themselves, enlisted 


almost from the outset in the financing of the War, continued to maintain 
an easier and more lenient rediscount policy in 1919 and 1920 than an 
inflationary price tendency demanded, and they helped to build up a 
larger extension of credit — albeit secured by evidences of legitimated^ 
commodity transactions — than was consistent with a sound general 
banking condition. 

In retrospect we see clearly the weaknesses inherent in the very nature 
of our banking structure and in the processes involved in creating earn- 
ing assets, which the Reserve System, as primarily an emergency-device 
safety valve (and mechanism for war financing) utterly failed to reach. 
The old emphasis upon the crying need for emergency credit had finally 
found an answer; but in adapting to that problem the pattern of banking 
controls, the traditional disregard of the qualitative character of banking 
assets was perpetuated by formal discounting devices that did not serve 
adequately to prevent inflation; at the same time the ensuing enlargement 
of credit on Federal war loan collateral nullified any effective quantitative 
controls as they had to do with the monetary circulation aspects of 

This price inflation and the sharp deflation generated a decade of 
rather confused discussion and controversy concerning central-banking 
policy with respect to the stabilizing of prices and thereby the stabiliza- 
tion of business operations. Prices became the key to all policy. As 
business recuperation asserted itself under the compelling influence of the 
basic construction factors that we have previously considered, the 
participation of the commercial banks in building up a new mass of 
‘‘capital credit^' was given scant attention, with results that ultimately 
proved disastrous. By this intense preoccupation among economists 
and politicians with the Reserve Banks as supreme controllers of the 
money supply and providers of apparently liquid short-term credits to 
business and Government, the necessity for adequate liquidity of sound 
assets among the commercial banks, inside or outside the Reserve System, 
was almost completely ignored. Attention has fastened more and more 
upon the manipulation of money rates and the investment portfolios 
of the Reserve Banks as devices for attempting price-level stabilization 
or, perhaps, price reinflation following the 1921 collapse. It came to be 
rather generally believed that by controlling the price level we should 
attain the millenium of economic stability and never-ending prosperity. 
Meanwhile, the member banks of the Reserve System, relieved of the 
old worries over stringencies and panics and conscious of the unprece- 
dented inflow of gold, proceeded to load up their assets with paper that 
represented less and less rediscounting potentiality. This meant that 
the Reserve authorities had to resort more and more to the manipulation 
of the investment portfolios of the central banks as a means of keeping 



the system at least under nominal discipline and the monetary aspect 
of credit circulation reasonably under restraint. 

By 1923 it was already becoming evident that this country might 
never be able to develop a substantial commercial-discount market built 
upon readily marketable drafts and bills of exchange, capable, as in 
Europe, of affording delicate control by the central bank over commercial 
credit and presumably trade conditions. One further reason was that 
industry in this country chose to finance itself through nonbanking 
channels to an increasing extent. This led to the beginning of what is 
now referred to as the ^'open-market’^ policy of the Federal Reserve 
Banks. Begun experimentally in 1922, this was to become a major 
part of the mechanism of credit control. By making purchases of the 
highest grade acceptances or drafts, the Reserve Banks released funds 
to the money markets and the banks serving commerce; by reducing 
these securities funds could be taken out of the market and credit condi- 
tions tightened. This technique could readily be extended to purchase 
or sale of short-term government securities of the type that the Federal 
Government had begun to issue during the War. In fact, even long- 
term Federal securities could be used as part of this open-market regulat- 
ing system. Further encouraging the use of this new control technique 
was, of course, the change in the gold movement. We were being surfeited 
with gold, and control of credit in view of this change, although at first 
not clearly recognized, ultimately became an explicit responsibility on 
the part of the Reserve Board. This responsibility extended beyond the 
borders of the United States through attempts at collaboration with the 
central banks of other countries, particularly Great Britain. The post- 
war decade was one of general chaos in international exchange, following 
price inflations that in some countries had reached fantastic levels. The 
Federal Reserve System thus became involved in international financial 
diplomacy, which presently began to exert a perceptible influence upon 
internal credit and a course of action not well adapted to the circum- 
stances developing in the domestic economic situation. 


The 1920’s were a period of great prosperity in the United States for 
fundamental reasons that have already been discussed. Meanwhile, 
Europe struggled with the problem of internal rebuilding, restoring 
international trade relations and stabilizing currencies and exchange 
rates. By and large, the world feared deflation of prices. The raw- 
material countries, including parts of the Orient and most of Latin 
America, had enjoyed tremendous prosperity during the War, but the 
postwar collapse introduced grave difficulties and delicate problems of 
readjustment. Few countries shared the fortune of the United States in 


having ready at hand a new apparatus fortuitously designed to make 
deflations relatively painless and neatly cushioned affairs. For countries 
whose currencies had been divorced from gold and whose price levels had 
soared far higher than ours, the problems of returning to normality and 
stability were indeed complex and difficult. 

When the Swedish economist Gustav Cassel, whose writings com- 
manded wide attention in the early 1920^s, came forward with persuasive 
pleas that the deflation process be made as easy as possible, his words 
found broadly sympathetic response. Cassel accurately diagnosed the 
price inflation of most countries as immediately based upon expansion 
of war credits, and he saw no reason why a substantial part of this 
redundant credit should not remain permanently in existence. Cassel 
was inclined to be critical of our own deflationary experiences in 1920- 
1921 and insisted that our collapse of commodity prices had been harmful 
to the world. Further violent deflation, he insisted, would bring about a 
vast amount of frozen credit and liquidation throughout the world. 
The scramble to return to the gold standard as it had existed in 1914 
would be disastrous. It would be desirable, he thought, for the United 
States to refrain from attracting additional gold, but he doubted that 
even with our assistance few countries outside Britain would be in a 
position to return to anything like the prewar gold standard.^ 

Aggravating the international problem of currency rationalization 
were the particular problem of Germany and the payment of reparations, 
which could not be successful under general conditions of falling world 
prices. In such an atmosphere, reasoned words of caution against 
deflation served to cultivate a new philosophy, known as reflation.’’ 
During the 1920’s many American economists came forth in defense of 
measures for credit and monetary control,” not primarily designed to 
minimize the impact of business cycles or to prevent panics or to maintain 
a steady national income, but rather to provide a means for sustaining 
prices, averting further deflation, and incidentally providing what positive 
support could be mobilized for the prices of the products of agriculture 
and the mineral industries. To all such objectives the Federal Reserve 
System offered a most strategic instrument, to which various circum- 
stances contributed additional reflationary and expansionist elements. 

Following the brief commodity deflation of 1921, attention continued 
to be devoted throughout that decade to the distressed condition of 
agriculture. It is indeed remarkable that American agricultural prices 
were supported to the extent that they were during the 1920’s. Among 
the sustaining factors was further legislation adapting the banking system 
more particularly to the service of agriculture. The Federal Reserve 
Banks, even during the War and the crisis of 1921, served rural credit 

^ Caiael, “The World's Monetary Problems,” London, 1921, 



needs through the fact that nonmember banks in the smaller rural com- 
munities leaned upon correspondents in the larger centers who were 
members of the Reserve System and who were able to discount short- 
term farm notes with the Reserve Banks. 

In 1923 further steps were taken to recognize the normally longer 
term of agricultural marketing paper, and the Federal Reserve Banks 
were authorized to rediscount agricultural notes and drafts having 
maturities as long as nine months. In addition, there was set up a 
system of intermediate-credit institutions, particularly for the financing 
of the still longer term working capital needs of the livestock industry. 
Beyond this the Federal Land Banks came into the picture in the middle 
'twenties as a further step toward developing a type of cooperative long- 
term agricultural financing at reasonable interest rates, such as had 
already long been in existence in northern Europe. These steps were 
all indications of the previous ineffectiveness and unsoundness of the 
“renewable" short loans to agriculture made by local banks for what 
were actually capital purposes. The United States was at last beginning 
to recognize that long-term and intermediate productive credit was not a 
kind of financing that could be combined indiscriminately and safely with 
short-notice deposit banking. 

In addition to these financial steps, there came later in this decade the 
ambitious but ill-starred experiments of the Federal Farm Board to 
support the price of wheat by trying to conceal the wheat surplus and 
the forming of an articulate farm bloc in Congress dedicated to the propo- 
sition that agriculture was fundamentally in distress and should be 
granted exceptional assistance along financial lines. One of these, inci- 
dentally, was permission to National Banks to make loans (within limits) 
on property mortgages. Since these loans were limited to five-year 
maturity, the plan was inherently unsound, and it would have been very 
much better to have avoided this further potential freezing of bank assets 
by setting up distinctive institutions for long-term property financing, 
as we have previously stated. This provision for limited property loans 
by National Banks was further liberalized in 1927. In addition to 
specific measures such as these, some supporting influence in the domestic 
market for agricultural products came from the building boom and 
continuance of a high rate of industrial activity generally. But in spite 
of this, agricultural prosperity was never fully restored in the 'twenties; 
failures were heavy among farmers, and few farming groups were able 
to share the rise in income of metropolitan areas that enjoyed for their 
land and security speculations the full benefit of credit largesse provided 
by new-era banking. 

As we follow the course of events through this momentous decade and 
reflect upon the significance of the large gold imports during most of that 


period, it is difficult to avoid a feeling of astonishment at the attitude 
taken by the politicians of European countries toward resumption of the 
gold standard. Germany was experiencing fantastic inflation in the 
early ^twenties. Then came France, with almost as spectacular an 
episode of paper-money expansion. Great Britain, meanwhile, soberly 
planned resumption of the former gold standard to take effect in 1925. 
The British economist J. M. Keynes was as deeply skeptical of the possi- 
bility of resuming gold on the old basis as he had been of the success 
of the Versailles Treaty. From a baffling demoralization of currencies 
Germany finally emerged with a staggering war debt that remained a 
menace to international stability, despite all the whittling-down ^‘plans'’ 
and repeated modifications of transfer procedure. France emerged with 
a sharply devaluated franc, and so did Italy and most of the smaller 
nations of Europe. 

All this confused financial revolution contributed to two important 
tendencies in our monetary and banking policy. First, there was a 
tendency on the part of many countries, including Latin America, to base 
their currencies more or less directly upon the dollar and to use dollar 
exchange or funds deposited in New York for the redemption of their 
revised monetary standards. Foreign funds arriving in New York 
included these public deposits of gold and foreign exchange. From time 
to time there developed sizable imports of essentially ^‘refugee funds’^ 
sent to the United States for safe deposit while foreign governments were 
wrestling with the problem of just how to attain some kind of workable 
gold standard. The important point is that this gold did not represent 
trade balance or permanent deposit here, but essentially temporary and 
conditional demand deposits. Furthermore, Federal Reserve policy was 
constrained to assist the British effort to resume gold at a price that now 
represented a higher value of the pound than in the immediate postwar 
period. This assistance was rendered by maintaining money rates in 
this country as low as possible after 1924 in order that gold sh(3uld not 
be unduly drawn from London by higher short-term rates in New York. 
There was already a superabundance of gold here that in itself made it 
difficult for the Reserve authorities to enforce such a policy through either 
the rediscount rate or the open-market policy. Such control devices, as 
they were operated for many years by the Bank of England in a more 
suitable environment, presume a situation of relatively limited gold 
movements that can be delicately manipulated by credit policy to prevent 
any marked increase in or withdrawal of gold from the banking system. 
As the decade moved on, there was additional evidence that the Treasury 
was endeavoring to augment its authority over the operations of the 
Federal Reserve Board, the Secretary of the Treasury being ex officio 
A member of the Board. 




Although the rising momentum of the residential building cycle culmi- 
nated as early as 1926, general industrial activity continued to be well 
sustained for several years. Underlying this condition of remarkably 
persistent prosperity there were a number of outstanding factors. The 
building boom and its atmosphere of speculative promotion overflowed 
from the purely residential field into the building of metropolitan com- 
mercial structures, hotels, and large apartments, many of which came to 
be financed along new lines by the use of mortgage bonds. These 
securities were purchased by banks, and even trust departments of bank- 
ing institutions invested part of their portfolios in obligations representing 
structural enterprises of this type. If we leave out of account the indus- 
trial building that naturally became necessary to provide for this, as well 
as the transportation and electric-power developments of those years, the 
over-all building boom was continued well into 1929. Building was also 
proceeding apace in Europe and Latin America. Germany, despite the 
onerous burden of reparations, found in the United States a ready source 
of capital that was liberally utilized for the construction of all manner of 
public works, bridges, docks, and housing projects, and a part of the 
borrowed sums also served conveniently for indemnity payments. Dur- 
ing the 1920^8 large loans were floated in the United States to serve the 
needs of Bolivia, Brazil, Chile, Colombia, Peru, and others. Such of these 
sums as were not squandered in mere political extravagance and attempts 
to support tottering currency structures or raw-material prices went 
into railroad and building projects. It was essentially a repetition of 
what had happened in Argentina during the heyday of the British lending 
from 1880 to 1890. This was a part of our transition from a debtor 
position to a creditor position. In the five years from 1924 to 1928, 
nearly a billion and a quarter dollars a year was invested abroad. By 
the end of 1930, the total foreign investments of this country, excluding 
the nominal amounts of the inter-Allied debts, exceeded fifteen billion 
dollars. What England had slowly accumulated in a century of saving 
and foreign investment America achieved in a decade and a half.^^^ 

It was this flood of foreign investment, much of it ill-considered and 
augmented by the mildly inflationary implications of the new credit 
system, that gave a semblance of reality to the inter-Allied debt claims 
and the possibility of enormous indemnity payments being wrung from 
Germany for many years. But the United States chose to adopt trade 
policies and tariff measures that made it increasingly difficult for these 
debtor governments to discharge their obligations in goods and services. 

1 Alvin H. Hansen, ^‘Economic Stabilization in an Unbalanced World,’' p. 70, 
New York, 1932. 


The debtors merely borrowed for a while to pay interest, and it is strange 
that our bankers and investors were so easily deceived. Long-term 
financing extended to countries fighting against the tide of postwar 
dislocations and readjustments could not be expected to remain solvent. 
These foreign credits could not be promptly tested by the salutory 
provision of amortization. This was but a part of an astonishing com- 
bination of factors temporarily supporting high business activity and 
creating a psychological attitude of supreme confidence in the long-term 
future. This, in turn, supported the extravagant issues of new securities 
and startling stock-market manipulations to promote their distribution. 

The feverish prosperity of the late 1920^s reflected itself in the earnings 
of industrial corporations and the ability of well-managed companies to 
accumulate comfortable surpluses. The war years had been profitable 
to some major industries and, despite the short setback of 1921, war 
profits served as a backlog upon which the systematic plowing back of 
earnings marked a new phase of corporate financial policy. The course 
of events strongly favored a policy of retiring outstanding industrial 
debt. This was rendered all the more practicable because so many 
of the outstanding obligations of industrial companies (as distinct from 
railroads, for example) was in a form permitting the calling in of the 
securities. Despite the urge to expand plant and the temptation to 
undertake mergers and combinations, not always warranted by the facts, 
corporations did not follow the stupid policy of the railroad reorganizers 
in piling new debt on existing stale debt. The tendency rather went 
in the direction of increasing equity capital b}^ the flotation of stock, and 
this became progressively easier as the public, already rendered familiar 
with security ownership through purchase of the war loans, found it 
increasingly attractive to purchase equities with the assistance of the lush 
facilities of the banking system for making collateral loans. But the 
readiness with which the banks developed their collateral loans was itself 
furthered by the very increase in corporate solvency and financial 
solidity that pointed to a future of rising values of many shares. The 
making of commercial loans became less and less important; many large 
manufacturers were perfectly able to extend credit rather than to borrow 
in the money market. As transportation facilities improved it took 
less time to obtain inventory goods from sources of supply. Merchants 
who had gone through a trying period of price collapse and inventory 
liquidation in 1921 had learned a lesson that stood them in good stead 
now, and they bought from hand to mouth rather than far ahead. Even 
working-capital loans, which had previously been negotiated with com- 
mercial banks by manufacturing and mercantile enterprises, became less 
and less important as funds could be so readily secured by floating 
securities in a market that seemed insatiable. 



Although banks could not themselves own common stocks they were 
induced by the decline of commercial and working-capital loans to place 
their earning assets in the form of investment in promotional and vulner- 
able bonds and the obligations of electric-power holding companies, 
loaded with leverage; at the same time their advances increasingly took 
the form of collateral loans, particularly in the metropolitan centers. 
Such extension of ‘‘capital credit proceeded under the illusion that so 
long as the securities were “ marketable they were essentially liquid 
in the aggregate; and as for the loans to the stock market, were these not 
amply secured by certificates that could be sold on a moment ^s notice?^ 

As a matter of fact, there was little possibility of converting bank 
investments and collateral loans against stocks and bonds into cash 
without bringing about simultaneous liquidation capable of decimating 
the value of billions of securities — railroad bonds, “guaranteed ” mortgage 
bonds on skyscrapers in New York and hotels in Chicago, municipal 
bonds representing extravagant outlays of local governments for roads 
and schools and parks. Add to this the even more volatile common 
stocks that were beginning to reflect the high leverage of holding com- 
panies as well as the untested securities of merged enterprises and the 
various and sundry foreign bonds floated to provide new housing projects 
in Berlin or attempts to bolster the price of coffee in Sao Paolo. There 
was absolutely no direct possibility of rediscounting bank assets resting 
on such enterprise with the Federal Reserve, and reserves banking 
through rediscount died a quiet death.* 

^ Even so acute an observer as B. M. Anderson, Jr., was prone to exaggerate the 
liquidity of stock-market collateral in these years, although he recognized that th(^ 
banks were actually becoming involved in a type of credit extension serving purposes 
that in themselves were not in the nature of commercial credit. “The development 
of the modern stock market has changed the facts and provided a safe machinery 
for using the funds of commercial banks directly or indirectly for many capital pur- 
poses, still keeping them liquid. No commercial bank would lend directly on the road- 
bed, terminals, and bridges of a railroad. If the loan were not paid and the bank was 
obliged to foreclose, it would have a white elephant on its hands. No ready market 
exists for a railroad as an aggregate, or in fragments. But the bank may with entire 
safety lend money against the $100 shares or the $1,000 bonds representing the road- 
bed, terminals, and bridges of the railway, because for these bonds and shares a wide 
and active market exists. . . . When bank investments are bought at proper prices 
and are of proper quality and marketability, when collateral loans against securities 
are limited to well margined loans against readily marketable securities, and when 
growth in bank investments and in stock and bond collateral loans is moderate and 
kept reasonably in line with the growth of commercial loans, there is no occasion for 
concern about the development.^ (Chase Economic Bulletiny Nov. 8, 1926, p. 26.) 

* At this point the Federal Reserve machinery differed from some other important 
central-l)ank systems. The Bank of England, for example, had been accustomed on 
occasion to extend credit to the joint-stock banks on various types of collateral, 
including even common stock, and this gave these central banks much more direct 


Strongly contributing to this transition from commercial banking 
to capital’’ banking was the tendency of corporations to maintain larger 
cash balances in the banks. This was partly a result of experience 
following the War, when adequate cash resources were found immensely 
helpful in preserving solvency and competitive position. But there were 
features of the banking system that encouraged the piling up of these 
balances. The Federal Reserve Act permitted member banks to accept 
time deposits and pay interest on them. Although corporate balances 
were divided between demand and time deposits, a tendency developed 
in the later ’twenties to take advantage of the higher rates paid on time 
balances, but nevertheless many banks granted depositors a presump- 
tive right to withdraw funds practically on demand. Here lies one of the 
basic difficulties of banking in this period, although, as we have already 
seen, it was not really new. 

Following the War, time deposits in trust companies multiplied four- 
fold and in National Banks almost as much. Between 1924 and 1928, 
the reporting member banks of the Reserve System added two billions 
to their time deposits, while their net demand deposits remained almost 
stationary. In New York City, the reporting member banks increased 
their time deposits in the same period by nearly 50 per cent, while net 
demand deposits declined slightly. To the member banks there was a 
great advantage in time deposits, because reserve requirements for these 
were but 3 per cent as compared with a range from 7 to 13 per cent against 
demand deposits. Thus the shift from demand to time deposits meant 
a further reduction in required reserve ratios beyond all the other means 
whereby the Federal Reserve System provided for more credit per dollar 
of reserves. But it was not so much the fact of this shift as the inter- 
pretation placed by banking practice upon the legitimacy of using such 
balances that became the principal evil in the situation. As the Federal 
Reserve Board itself pointed out in 1926: 

Member banks were able to comply with legal reserve requirements with a 
considerably smaller amount of reserve than would have been necessary had the 
proportion of time and demand deposits remained unchanged, or, to put it 
another way, to add a larger amount to their loans and investments without a 
corresponding increase in their reserves. As a matter of fact, reserve balances 
of member banks have not increased since the end of 1924, while there has been 
since that time a growth of about $2,900,000,000 in the total amount of credit 
extended by these banks. 

By the middle of 1929, loans and investments of reporting member 
banks had expanded by $3,700,000,000 against an actual slight decline 

control over the situation and widened the range of possible assistance in case of 



in reserves. Considering the National Banks alone (for which statistics 
are more complete), there was an increase of about 100 per cent between 
1922 and 1928 in noncommercial loans, a like amount in investments other 
than Federal obligations, and an expansion of about 300 per cent in real- 
estate loans. We shall later examine more closely the relationship 
between money-market conditions and the issue of new corporate securi- 
ties, confining attention now to the failure of the Federal Reserve System 
to control in any effective way the mushrooming of capital expansion 
as it is clearly depicted on Chart 34.^ 


Under financial conditions such as we are now considering, the Federal 
Reserve Board, quite apart from its general attitude of timidity and 
subservience to the Treasury, found itself without adequate power to 
keep bank credit within channels assuring the true liquidity of earning 
assets. The swollen investment portfolios of the banks provided, along 
with collateral loans, adequate means of meeting periods of at least 

1 Broadly speaking, the expansion of bank investment in securities was most 
pronounced among the country banks in this period. On the other hand, the rise of 
collateral loans was naturally much more pronounced in New York City. The former 
tendency was not wholly unconnected with rediscounting operations, inasmuch as 
the smaller banks found it advantageous to rediscount such short-term paper as came 
into their hands, but the proceeds of these rediscounts were not used to expand credits 
to agriculture in view of the new Federally sponsored facilities for agricultural financ- 
ing and the lack of strength in farm prices. Hence these banks purchased securities, 
frequently on the advice of their correspondents in the larger centers. As for the 
New York banks, their active participation in collateral loans was considerably 
accelerated by the creation of “affiliates^’ directly engaged in distributing securities 
and by the extension of interlocking directorates, forming virtually giant pools of 
banking power and giving the larger investment banking firms control over an enor- 
mous amount of banking capital in the metropolis. 

According to George W. Edwards, the commercial banks generally, through their 
bond departments or affiliates, accounted for 22 per cent of the long-term capital 
issues in 1927, and by 1930 the portion rose to nearly 45 per cent. Some bank affiliates 
even resorted to speculation in the stock of the parent bank. (George W. Edwards, 
“The Evolution of Finance Capitalism,” p. 226, New York, 1938.) Mr. Edwards goes 
on to show that although this large indirect contribution of banking resources to indus- 
trial capital was occurring, it did not give the banks either individually or en masse 
any degree of control over the enterprises whose securities were involved. This was in 
marked contrast to the practice of banks in Germany, which for many years had made 
even heavier advances directly to industrial and utility enterprises but frequently 
gained control of these organizations and even domination over an entire industry. 
The growth of American investment trusts in the later years of the decade was also a 
means whereby banking and investment-distributing groups obtained very liberal 
advances of bank credit in order to accomplish the distribution of millions of shares of 
stock to the pubhc through a process that represented little more than high-priced 


moderate cyclical expansion in business requirements. Instead of resort- 
ing to the Reserve Banks for supplementary reserve, the member com- 
mercial banks merely called a few outstanding demand loans from the 
brokers or from their own customers and perhaps sold some bonds. ^ 
If the Reserve Banks resorted to their open-market policy and liquidated 
poT-t of their investment portfolio, the member banks might counter by 
rediscounting some paper, so that the total of bank credit was little 
changed. So long as the money market remained easy, primarily in 
response to the comfortable gold position, the Federal Reserve authorities 
seemed reluctant to bring about too much liquidation. They kept 
rediscount rates and rates for purchase of short-term acceptances in the 
open market more or less in line with the prevailing market level. 

All along there was a tendency on the part of Federal Reserve manage- 
ment to pay undue attention to the minor month-to-month fluctuations 
in commodity prices and business activity and to endeavor to counter- 
balance these minor movements in their rate and open-market policies. 
Little effort was made to understand or get at the reasons for these 
fluctuations. Attention was also given to the inflow and outflow of 
gold, and the authorities appeared to be committed to a policy of neu- 
tralizing^^ these movements in order to sustain a perpetual surplus of 
reserve power rather than to permit international net payments or 
receipts to have their usual or natural effect upon the size of the reserve 
surplus. This was merely another way of maintaining indefinitely a 
security market and capital-credit^’ inflation. In pursuing these 
policies on the pattern of the long-established compensating steps taken 
by the Bank of England to maintain the gold reserve on fairly even keel, 
it was entirely overlooked that London accomplished its financing 
operations on a mere handful of gold that the Bank carefully husbanded, 
at the same time preventing it from becoming an avalanche. 

In this country we were beginning to encounter the deep-seated 
problem of a permanent surplus of gold, far in excess of reasonable 
requirements. The superficial effort to compensate gold movement 
naturally led to cross purposes, since the domestic business situation 
clearly dictated the opposite policy. As early as 1927 it was clearly 
essential to have begun to apply effective brakes to the rampant security 
speculation before it assumed dangerous proportions. There was already 
beginning to be a moderate outflow of gold that the Federal Reserve 
authorities promptly endeavored to counteract by the easy-money policy. 
This was dictated only in part by the fact that in the latter part of that 
year there was a minor business recession; it was probably mainly 
explained by the desire of the Federal Reserve Bank of New York to play 

^ See Winfield Riefler, “Money Rates and Money Markets in the United States,” 
p. 31, New York, 1930. 



a directive role in helping London to retain gold after restoration of the 
gold standard under conditions that made the retention of gold uncertain 
and difficult unless (so it was thought) New York money rates were kept 
well below those of London. Thus, instead of proving an effective aid 
in restraining our own financial excesses and unwise use of credit, the 
Federal Reserve Board merely introduced spasmodic cross currents of 
influence that were confusing and contradictory in their effect and on the 
whole proved of no material consequence as stabilizing factors. 

One development in particular toward the end of the decade defied 
the efforts of the Reserve Board to deflect the roaring current of bank 
credit from these security and capital channels. This was the practice 
whereby metropolitan banks made loans on stock-market collateral with 
funds representing mainly cash balances of large corporations that were 
loaned by the banks as agents for the owners of the funds, these appearing 
in the statements as brokers’ loans for the account of others.” This 
was an extra-ordinary development that had unfortunate consequences. 
These were essentially capital loans and not bank credit, save in the sense 
that some portion of the balances thus loaned might have been indirectly 
derived from prior expansion of credit through various channels. 

Bank credit once set afloat is difficult to hold in watertight compart- 
ments, and what appears at a particular point as cash may have been 
created, at least in part, at some previous point through a credit deposit. 
These brokers’ loans for account of others rose from not much over half 
a billion dollars in the spring of 192G to a billion at the end of 1927, 
under the very nose of the Federal Reserve Board. The stock market was 
moving substantially higher. Mr. M(^llon, Secretary of the Treasury 
and ex officio member of the Federal Reserve Board, appeared very 
reluctant indeed to raise Federal Reserve rediscount rates after the turn 
of the year. He was willing to cooperate with London and the New York 
Reserve Banks as to easy-money rates here but was especially interested 
in easy money to facilitate retirement of Federal debt by refunding on 
an advantageous basis. In 1928 tardy action was taken to raise the 
official rates somewhat, but this merely provided an incentive to move 
another billion and a half dollars of outside funds into brokers’ loans. It 
was in 1928 that the volume of trading on the New York Stock Exchange 
for the first time assumed really feverish and abnormal proportions and 
the basis was laid for an inflationary advance of equity prices. 

In the face of all this, the Federal Reserve Board, more interested in 
following foreign precedents than in averting an American inflation, 
expressed mild warnings but did nothing to alter the intimate relations 
of banks to security speculation. The higher went the rates the more the 
brokers obtained outside funds. At the peak of stock prices in 1929 
these outside balances alone reached close to four billion dollars! Mean- 


while, it still seemed important that movement of gold to the United 
States be kept at a minimum in order to permit not only Great Britain 
but France and various other countries to reestablish their currencies 
on a gold standard of some sort. Temporarily, however, even foreign 
funds were attracted to New York under the stimulus of the higher rates 
for short-time balances. These actually rose rapidly during the latter 
months of 1928 and until February of 1929. This situation led to a 
larger use of the ‘^gold-exchange standard in Europe, a device that 
pegged currency to gold and at the same time provided high interest 
return on the gold balances. In a few years the sudden withdrawal of 
these balances was destined to come at a most inopportune time. 

When we add up all the contributions of credit and foreign and 
corporate balances and top the structure with the stock-market loans 
“for account of others^’ (as seen on Chart 34), the general result in 
creating inflation was fully comparable to that which was permitted to 
occur during the period following the Armistice.^ 


It may be well to interject at this point some comment with respect 
to the efforts of certain economists and legislators to force the Federal 
Reserve to adopt a mechanical procedure designed primarily to stabilize 
the price level. As was previously pointed out, this was essentially a 
carryover from the deflation days after the War. It represented 
basically the firm opposition of the farm groups and other inflationists 
to any material lowering of prices. This insistent clamor for some kind 
of automatic push-button banking device that would hold prices con- 
stant, regardless of international conditions or any changes in production 
technique, appeared in many forms. Most of them had their origin or 
received much of their publicity in the writings and statements of 
Irving Fisher. He proclaimed a plan for “stabilizing the dollar in 

^ At the peak of the stock market in 1929, there were in existence not only collateral 
loans for account of other lenders than banks, in the neighborhood of four billion 
dollars, but over one and three-quarters billions placed in the collateral market by 
banks for the account of interior banks and nearly another billion of loans made on 
collateral by the New York banks for their own account. Thus the total represented 
some seven billion dollars of essentially speculative credit, without which the stock- 
market inflationary boom never could have been carried to such absurd heights. And 
curiously enough, during 1928, the total amount of Reserve Bank credit in use reached 
the highest level that it had attained since 1920. On the whole, we can say that far 
from introducing a helpful influence into the difficult problem of reestablishing 
European currencies, the failure of credit control here, in some direct manner affecting 
the earning assets and lending practices of banks rather than tinkering with holdings of 
(Government paper and rediscount rates, seriously impaired the efforts in European 
capitals to accumulate adequate gold reserves. 



the first instance through manipulating the weight of the gold dollar and 
later by compensatory variations in the specie backing of a paper circula- 
tion. As discussion on this subject proceeded it took the form of an 
organized agitation to make Federal Reserve credit a mechanically 
compensating influence over the entire credit-currency system. It 
expressed itself in several bills before Congressional committees. The 
reflat ionist gospel also appeared in England in the writings of J. M. 
Keynes, who contributed the idea that the Bank of England should 
vary the price that it paid for gold from time to time and should utilize 
the rediscount rate to control and stabilize foreign exchange and thus, 
presumably, the price level. It came to be an accepted dogma in certain 
influential circles here and abroad that the central banks really possessed 
effective powers over the price leveF’ that was imagined, without much 
actual study of the matter, to be the leading causal factor in all industrial 
and trade cycles.^ 

Among the attempts to put this control philosophy into practice was 
the Goldsborough Bill (introduced as HR 11788 late in 1922), which 
proposed formal stabilizing of the purchasing power of money. This 
was to be accomplished primarily by varying the quantity of gold in th(^ 
dollar in accordance with an index of price changes. As an adjunct lo 
this mechanical device, Irving Fisher suggested that the Federal Reserves 
Board should be given authority to maintain total bank deposits in some 
stable relation to monetary reserves, which, in turn, would be ultimately 
controlled by the variations in the weight of the gold dollar. 

The recognition that credit control would be indispensable in any 
compensatory plan gradually brought crystallization of numerous pro- 
posals to that end, and these regulating credit devices eventually became 
the most important feature of this stabilization agenda. An example 
was the so-called Strong Amendment to the Federal Reserve Act (offered 
in 1926), proposing to force the Board to manage discount policy with 
the object in particular of ^‘promoting a stable price level for commodities 
in general. All the powers of the Federal Reserve System shall be used 
for promoting stability in the price level.” Elaborate hearings were 
held, and the views of the proponents were thus given wide circulation. 
During the hearings, Adolph C. Miller, of the Federal Reserve Boaixl, 
stated that the Board actually did not attempt to pursue any mechanical 
procedure in these matters; he was frankly doubtful that any such 
schemes for automatic stabilization would be successful in the face of 
(continually changing situations that required a flexible attitude and the 

^ See Irving Fisher, ‘^Stabilizing the Dollar,^' New York, 1920; J. M. Keynes, 
“Monetary Reform,” New York, 1924; J. S. Lawrence, “Stabilization of Prices,” 
New York, 1928; and Irving Fisher, “The Money Illusion,” New York, 1928, espe- 
cially Chapter 4. 


exercise of judgment.^ It is fair to say that the Reserve Board had not 
actually worked out a thoroughgoing philosophy of economic control 
and was frankly feeling its way along, constantly hampered by difficulties 
inherited from the War, and defects historically imbedded in our banking 
organization and never reached by the Federal Reserve Act in any 
effective manner. 

Apparently, there was a rather general acceptance by the Board of 
Dr. Miller^s viewpoint and, whenever challenged, the Board expressed 
no desire for powers and responsibilities such as were entertained by the 
mechanical stabilizing enthusiasts. But these discussions nevertheless 
did keep alive and before the public a type of thinking that continued to 
emphasize the monetary aspects of bank credit rather than getting to the 
root of banking problems, that is, to the manner in which banks were 
permitted to straddle the short-term and long-term money markets and 
to finance unbridled security market inflation. It is remarkable that so 
little attention was given to the existing inflation of security prices as 
distinct from commodity prices. On the whole, there seemed to be a 
much more realistic recognition of the complexity of the processes under- 
lying the business cycle and the movements of commodity and other 
kinds of prices on the part of Federal Reserve technical experts than 
on the part of the economic theorizers.^ The proponents of automatic 

1 This was well expressed in a later discussion of the objectives of monetary policy 
by the Board of Governors in 1937, in the light of further experience. ^'The Board is 
convinced, however, that the broader objective of maximum sustainable utilization 
of the Nation’s resources cannot be achieved by attempting to maintain a fixed level of 
prices, and that, therefore, price stability should not be the sole or principal objective 
of monetary policy. . . . 

^‘No matter what price index may be adopted as a guide, unstable economic 
conditions may develop, as they did in the 1920’s, while the price level remains stable; 
business activity can change in one direction or the other and acquire considerable 
{nomentum before the changes are reflected in the index of prices. There are situa- 
tions in which changes in the price level would work toward maintenance of stability; 
declining prices resulting from technological improvements, for example, may con- 
tribute to stability by increasing consumption. There are other situations when the 
restoration and maintenance of relatively full employment may be possible only with 
an advance in prices. Correspondence between price stability and economic stability 
is not sufficiently close, therefore, to make it desirable to restrict the objective of 
jnonetary policy to price stability.” {Federal Reserve Bulletin^ September, 1 937, p. S27.) 

2 E. A. Goldenweiser, of the Federal Reserve research staff, patiently explained 
to the House C-ommittee on Banking and Currency, during discussion of the Strong 
Bill, that so far as the wide swings in commodity prices were concerned they were 
historically attributable (as we have already seen) to war financing. He frankly 
confessed doubt that any formal money-regulating statutes would cope with such 
emergencies or could even be maintained in effect during a major war. He also 
showed that the long-term and more gradual (secular) changes in the price level 
involved causes that were by no means simple or even thoroughly understood. As for 



credit control for over-all stabilization via the price level seem to have 
been misled by the fact that during the 1920^s the general level of com- 
modity prices was relativ^ely steady, and they attributed this uncon- 
sciously to what they imagined was a systematic regulatory policy 
of the Federal Reserve. They overlooked entirely the fact that this 
stability was the result of opposing forces — a downward pressure, in a 
sense completing the postwar commodity deflation, opposed by an upward 
pressure, developing out of the speculative uses of credit and capital and 
surging upward almost throughout the period. 

It was at the Federal Reserve Bank of New York, where naturally 
the inflow and outflow of gold has its most immediate and pronounced 
effect upon the reserve position, that the doctrine of far-reaching credit 
control over prices and hence all business seems to have had its most 
vigorous adherents among the official personnel of the Reserve System. 
Benjamin Strong, Governor of that Bank until his death in 1928, admitted 
that there was no magic formula for the automatic control of prices, but 
he nevertheless lent his support to, and placed a measure of confidence in, 
manipulation of Federal Reserve control devices to stabilize the gold 
movement. He also insisted that sweeping powers to regulate prices 
as such were not wholly feasible or within the province of Federal Reserve 
management, and hence its policies could best be directed toward exercis- 
ing control within acknowledged limits and with clear recognition that 
within the general price structure there were always likely to be divergent 
forces requiring a selective regulatory policy. But far less modest in 
this regard was W. Randolph Burgess of the same bank, who repeatedly 
and confidently claimed that the country had already gone a long way 
in the technique of preventing the gold movement from being a source of 
disturbance in the financial system.' 

the ability of the Federal Reserve to neutralize the gold inflow during the 1920's, Dr. 
Goldenweiscr insisted that d(‘spite all the attempts at control, thc^re was actually a 
marked expansion in bank reserves that led to a rapid increase in credit during this 
period. He tlnai went on to display a chart of wholesale prices and called attention 
to the very diverse group mov(anents during the years 1924-1927, particularly among 
the agricultural commodities such as cotton, livestock, and grain. He showed that 
credit controls might well have the effect of intensifying the dispersion among price 
changes, and this was an aspect that the Congressional and theoretical discussion of 
the subject usually ignored. 

See the statement of E. A. Goldenweiser, Director of Research and Statistics, 
Federal Reserve Board, before the Committee on Banking and Currency, hlouse of 
Representatives, 70th Congress, First Session, on HR 11806, Mar. 19, 1928, pp. 23ff. 

^ ^‘It may safely be asserted that the Reserve System has been a powerful force 
toward business stability and toward the stability of employment. The Reserve 
System has becMi lauded for its aid in the return of Europe to the gold standard and 
monetary stability. It has been lauded for its prevention of money panics [sfc]. 
But over a long term of years it seems reasonable to expect that more important than 


Still another of this New York group was Carl Snyder, who developed 
several interesting suggestions, first offered in 1923, toward a deliberate 
and statistically controlled central-bank policy. His principal objective, 
however, was to counteract an excessive inflow of gold whose potentialities 
as to economic stability in the United States he clearly envisaged. 
Snyder^s plan contemplated the segregation or sterilization of all imported 
gold above an amount likely to serve legitimate business purposes. 
He proposed to prevent this from affecting bank reserves in either 
direction as the measurement of various sectors of economic activity 
might require. The manipulation of discount rates and open-market 
security transactions by the Federal Reserve formed a part of his scheme, 
but he saw these mainly as incidental adjuncts to an attempt to deal 
effectively with a new international financial situation. Although 
Snyder recognized the underlying fundamental factors in the business 
situation such as the building boom, foreign lending, etc., he did not 
develop detailed banking methods to extend stabilizing influence in 
those directions. Had the problem of gold been intensively studied and 
measures adapted to deal specifically with it, as Snyder urged, the results 
might have proved of definite value. 

But the enthusiasm that was currently being reflected at the time 
over what seemed to be successful Federal Reserve regulation of the 
minor financial fluctuations was entirely unjustified; it served to create 
an illusory faith in the underlying stability of a situation that by 1928 
had already entered the acute inflationary stage. In contrast to the 
cautious attitude of Governor Strong and the long-range suggestions of 
Carl Snyder as to the gold-redundancy problem, a complacent optimism 
regarding business stabilization was much more typical of the general 
feeling. It was comforting to have the assurances of the proselytize rs 
that depressions could be ended quickly, surely, painlessly. It was this 
state of mind that led speculators in stocks, commodities, real estate, 
and foreign bonds into reckless adventure. 


When a stock-market situation such as existed in 1928 and 1929 once 
develops, merely quantitative manipulation of the credit supply is wholly 
inadequate; it cannot readily be mobilized to bear upon this particular 
segment of credit circulation and speculative turnover. As H. L. Reed 
has stated it: 

either of these may be its influence toward leveling out the booms and depressions 
which in past times have brought with them so much of human unhappiness and 
distress.’^ (W. R. Burgess, A Balance Wheel of Gold, Survey Graphicy April, 1929.) 
See also his “Reserve Banks and the Money Market, “ Chapter 14, New York, 1927. 



The old guides to reserve credit policies did not seem to meet the demands of 
the situation. . . . Moderate rate increases did little to test out th© market 
thoroughly, that is to shake out purchasers who depend too largely upon 
borrowed funds; and thus the market became gradually educated to paying 
higher rates. With the failure to test out the market thoroughly in early 1928, 
a further speculative advance developed which rendered higher money rates 
ineffective in discouraging the security market demands for credit. 

In the words of B. H. Beckhart: 

It is this emphasis on the liability side of bank statements by the quantitative 
school that has precluded interest in commercial banking theory. One may 
search in vain in many of the recent works on monetary policy and theory for 
any discussion of the economic functions of commercial banks, or of the effect 
on economic fluctuations of changes in the character and composition of com- 
mercial bank assets, or of the need to relate commercial bank assets to types of 
deposit liability. This very general disregard of changes in the character and 
composition of commercial bank assets is further evidence of the attitude of this 
school of thought that credit is a homogeneous quantity. This assumption is 
implicit in the attempt to measure the credit volume by bank deposit liabilities. ^ 

' H. L. Reed, ^‘Federal Reserve Policy, 1921-1930,^’ pp. 139, 141, New York, 1930. 

^ Monetary Policy and Commercial Bank Portfolios, American Economic Review, 
March, 1940, Supplement, p. 21. This opinion is directly contrary to that main- 
tained by Lauchlin Currie. In his study ^^The Supply and Control of Money,^* 
(Chapters 4 and 5) referred to in Chapter 5, he sought to establish the proposition 
that the currency phase is the paramount consideration and was inclined to ridicule 
the allegations of those who support the banking principle, without noting that the 
two schools are arguing at cross purposes. But his contention that the policy of the 
Federal Reserve authorities has been too much identified with assets rather than 
liabilities (that is, the banking or loan aspect) seems superficial and inaccurate. 
Actually, the mistakes of the Reserve authorities in the 1920's were due fully as much 
to their inadequate emphasis upon, and inquiry into, how the member banks were 
making advances and to whom and for what purpose as they were to any undue con- 
cern about the magnitude of the demand deposits or their relation to the trend of 
total production and trade. In order formally to establish his main thesis that con- 
trol of “money,” that is, checkbook money or demand deposits, is the primary problem 
of central-bank policy, Currie erroneously minimizes the importance of the existence 
of uniform and sound standards governing extension of credit and investment of 
savings in the first instance. This is, of course, directly a result of his narrow inter- 
pretation of bank “credit” as being solely associated with demand deposits and having 
nothing to do with the banking operations that mainly generate such deposits, an 
interpretation that seems thoroughly unsound. 

The Federal Reserve management did make an effort, although a feeble one, to 
compensate for gold movements by their open-market operations. In this sense they 
were motivated essentially by the very objective that Currie considers commendable, 
“to achieve stable commodity prices, stable monetary incomes or stable business 
conditions.” They were indeed watching index numbers of commodity prices and 
index numbers of business conditions, but they were apparently not watching the 
real-estate cycle and its fateful disintegration in the late 1920’s or the giddy spiral of 


It was very largely for reasons springing from the underlying weakness 
in farm prices and overexpansion in various extractive industries that 
the 1920^8 decade was actually a period of unprecedented banking failures 
in the United States, in spite of the glamorous prosperity in the large 
cities. And even in the cities, we have previously seen that there could 
be detected under the surface, well before 1929, a stealthy rise in real- 
estate foreclosures, particularly in centers where property development 
had been most rapid during the first part of the decade. As the end 
of the decade approached, banks were also beginning to feel acutely the 
deflationary effect of tighter money rates upon their bond portfolios. 
Bank investments in foreign bonds, many overrated municipals, and the 
lush real-estate mortgage securities were depreciating, and this intensified 
the difficulties lurking in too large an clement of illiquidity among the 
loans. To take the total of reported actual failures of National Banks 
and all state banks (including savings banks and trust companies), 
there were 357 failures in 1921 and 915 in 1924. In the immediately 
succeeding years, the numbers were 542, 573, 831, 484, 549, and 640. 
The total of liabilities associated with all bank failures between 1924 and 
1929 amounted to no less than a billion and a quarter dollars. This 
compares with but 140 millions in the War period 1914-1919.^ 

Among commercial firms generally, as reported by Dun^s credit 
agency, the mortality remained fairly steady, but for the decade as a 
whole it stood at a higher level than in the prewar period or during the war 
years. When reduced to the form of percentages of the estimated number 

stock price movements. We may therefore summarize the point by saying that such 
(liialitative aspects of banking as were given attention by the Federal Reserve were 
TU)t the ones that counted most; in the meantime, the attention given to index num- 
bers measuring merely surface phenomena did not extend to the very measures of 
inflation that were important. Had the Federal Reserve authorities and bankers 
b(*en more familiar with the views of Adam Smith and had they not been confused 
by the theories of the price-level manipulators, the general economic results would 
have been very much more satisfactory. It does not necessarily follow that cither the 
level of prices or the level of general trade and national real income would have 
suffered in any material respect had commercial banks confined themselves to commer- 
cial loans and consumer installment loans. It is entirely probable that banks organ- 
ized along different lines, as to the nature of their deposit liabilities or their facilities 
to meet obligations to the public, might have been the logical supplement to the 
purely commercial banks during this period. In other words, what our banking 
system needed during the 1920’s was a qualitative segregation of functions with more 
specialized responsibility. 

1 W. E. Spahr, Bank Failures in the United States, American Economic Review^ 
March, 1932, Supplement, p. 235. The detailed figures show that failures among the 
state banks were very much more numerous than among the National Banks, and 
this applies also to the difference in habilities. If we take the period 1921-1930, 60 
per cent of the total suspensions of banks (which includes temporary as well as per- 
manent closings) occurred in places with a population of less than a thousand people. 



of active business firms, the failure figures show but a slight rise toward 
the end of the ’twenties. From 1924 to 1929, the percentage of total 
bank failures to all banks ran from two to three times as high as the 
percentage of commercial failures to the number of concerns in business. 
This was a relationship very different from that which had prevailed in 
previous years, when the percentage of bank failures was much lower 
than the percentage of mercantile failures. With respect to the earnings 
of banks, Spahr’s study showed that: ‘‘A large proportion of the banks 
outside of metropolitan centers were not earning enough to justify their 
existence. This was true even in such relatively prosperous years as 
1925, 1926, and 1927. In 1927, nearly 966 National Banks were operat- 
ing at a loss, and an additional two thousand were earning less than 
5 per cent. This constituted about 38 per cent of all the National Banks 
in the United States. The situation among the state banks was even 

It is abundantly clear, then, that while commercial banks in the large 
cities were helping to pump up a prodigious inflation in common stocks 
and fancy real estate, the position of many country banks was being 
undermined to the extent of causing actual stringency in the meeting 
of legitimate agricultural requirements and bringing about loss of capital 
and savings to thousands through failures and suspensions that can only 
be described as shameful. 

1 Op, dt.f p. 210. 



Federal Reserve stabilization policy might have met with some success 
had more attention been given to the proper use of credit and capital 
and if the distribution of gold among the financial centers of the world 
had continued to function as in the past. But with gold surging about 
and intensifying currency crises in so many parts of the world, our 
Reserve System was placed in a paradoxical position. A control policy 
primarily for neutralizing surplus gold might have done little to avert 
reckless use of speculative credit, but a total disregard of the gold problem 
and the use of stern measures merely to restrict speculative credit expan- 
sion might have been regarded as implying that direct and effective 
responsibility over bank reserves was not officially recognized. The 
basic difficulty of weak banks and unconservative banking practice was 
aggravated by the fact that world forces threatening monetary chaos 
were at work, in the face of which superficial money-market manipulations 
could not be expected to be effective. 

In order to understand more fully the background of this dynamic 
situation and the still more sweeping changes yet to come, we must survey 
international forces as they affected price levels, debts, international 
transfers, and gold. 

A striking feature of the American scene during the 'twenties was 
the brilliant performance of industrial corporations in freeing themselves 
from debt, providing ample capital resources through plowing back 
earnings and by equity financing, in perfecting the powerful technique 
of the assembly line and the automatic machine tool, in efficient use of 
labor and large-scale operations. The aggressive business corporation 
came into its own in American economic life. The earning power of 
leading corporations, particularly in manufacturing and merchandising, 
expanded sufficiently to justify a rising level of stock prices, at least until 
about 1927 or possibly early in 1928.^ Because of the accepted practice 
of permitting the commercial banks to be department stores of finance," 
with security affiliates and close relationship with the investment bankers 

' This is not intended to imply that the prices of stocks that were particularly 
lubject to reckless manipulation or that represented new mergers, tenuous holding 
companies, or other high-leverage situations were necessarily in line with either actual 
or prospective earning power. 




of New York, adequate facilities were not available for financing the 
legitimate working capital or plant requirements by small industrial 
businesses. The typical modest-sized or newly formed corporation or 
partnership, not having access to the stock market through public 
flotation of securities and unable to do business with banks that preferred 
liquidity^' of assets to the financing of industry and exacted rates 
inflated by the credit requirements of Wall Street, found itself handi- 
capped in securing capital funds. Concentration of industrial power 
into gigantic units was thus accelerated by the banking practices and 
policies of this period, with the result of greater efficiency of production, 
no doubt, but also a thwarting of investment in desirable new ventures 
having promise. In the electric-power field, integrated control was being 
achieved by the device of holding-company structures and the inter- 
connection of generating facilities. Between 1919 and 1927, the gross 
assets of 72 of the largest American corporations increased 46.7 per cent, 
and those of 36 public utilities of comparable importance increased 
157 per cent.^ 


It happens that this impressive expansion in size and producing power 
of industrial companies in the United States was also more or less paral- 
leled in Europe. By the middle Twenties, Germany had passed through 
her experience with extreme currency inflation. Despite the handicap of 
the reparation demands, she was engaged in earnest in stabilizing her 
money and planning a far-reaching policy of industrial expansion and 
rationalization.’^ In terms of the size and integration of control of 
industrial units, the Germans went far beyond any other country during 
the succeeding decade. This program of industrial rehabilitation was 
stimulated by the fact that Germany, as the result of the Versailles 
Treaty, lost 13 per cent of her area; she lost control of 16 peu* cent of 
prewar coal output, 48 per cent of her iron ore, 60 per cent of her zinc 
ore, and 26 per cent of her lead ore. It became necessary to import 
across national barriers set up by the Peace Treaty many essential raw 
materials and foodstuffs, the supply of which had been impaired by loss 
of the Eastern provinces. ^ 

Following the collapse of the mark and acute disorganization and 
depression in 1923, recovery of industrial operations developed rapidly in 
1924-1925, assisted by the availability of American loans. Cost of 
production was lowered by concentrating industrial production in the 

‘ Gardiner C. Means, The Large Corporation in American Economic Life, American 
Economic Review^ March, 1931, p. 24. 

* Carl T. Schmidt, “German Business Cycles, 1924-1933,’* pp. 5-6, National 
Bureau of Economic Research, New York, 1934. 



most suitable and eflScient plants, which operated at high capacity under 
systematic quota arrangements. Less efficient, obsolete plants were 
scrapped on a scale unprecedented in industrial history. A vast program 
of simplification and standardization of products was worked out.^ It 
was perhaps only by such sweeping measures, with close governmental 
cooperation, that the staggering payments on reparations account could 
be begun. After 1929, for the first time, their requirements had to be 
paid out of the current output of German industry without further resort 
to foreign credits. 

American lending abroad began to be restricted as early as 1928, and 
in 1929 a scaling down of the German debt payments, as previously 
stipulated under the Dawes plan, was permitted under provisions of the 
Young plan. There was then some hope, particularly after the Geneva 
Conference of 1927, that the nations would rationalize their tariff policies 
and that a broader flow of international trade might facilitate the pay- 
ment of at least a substantial part of the German war debt, which, in 
turn, would permit the British, the French, and other war debtors to 
pay what they nominally owed to the United States without unduly 
burdening their own industry to provide the means of remittance. This 
was part of the illusory and ill-informed wishful thinking of that period. 
The expectations of international-trade revival were thwarted by the 
unfortunate passage by the United States in 1930 of the Hawley-Smoot 
Tariff Act. This raised rates and further penalized the importation of 
European products. Other countries retaliated, and a tariff war, leading 
ultimately to extreme and fantastic restriction of world trade and 
demoralization of the foreign exchanges, was the outcome. 

The economic position of Great Britain in these years was less reassur- 
ing. Despite recuperation, there were a persistent drag in British indus- 
try following the War and failure to modernize industrial organization 
and plant equipment to keep step with progress abroad. Instead of 
rationalizing by concentration of authority, as in Germany, or accelerat- 
ing the development of transport and power, as in the United States, the 
British relied upon a policy of cost reduction principally through control 
of the prices of raw materials, since a large part of British industry 
depends upon imported basic commodities. The decision of the British 
Government to return to a gold standard was made as early as 1920 under 
the influence of generally high world prices (even as expressed in gold). 
The reasons for this decision are complex and not wholly clear, but apart 
from the maintenance of national honor and prestige, it was doubtless 
designed to avert the danger of further price inflation such as would 
militate against revival of British export trade. 

^ The industrial rehabilitation of Central Europe had some degree of parallel also 
in Japan, in spite of the disastrous consequences of the 1923 earthquake. 



By 1925, when restoration of the pound at the old parity of $4.86+ 
to the dollar was achieved, world prices had already fallen far enough 
below the British level that some further price deflation in England was 
necessary if the new arrangement was to hold. By making the pound 
dear, that is, adjusted to relatively high British price level, the British 
manufacturer paid fewer pounds sterling for his imported raw materials 
than he had paid when the pound was at the depreciated level below 
$4.50 early in 1924. The currencies of Argentina, Canada, and some 
other raw-material countries were stabilized at levels more or less corre- 
sponding to the British pound, but the French franc after 1926 was 
stabilized at a much lower relative level, so low, in fact, that it was 
economical for other countries to purchase French goods, and France 
therefore attracted gold. Great Britain, on the other hand, was unable 
to develop export trade to the extent that had been hoped. In contrast 
to Germany’s rapid expansion of foreign exports, the British situation 
grew distinctly unfavorable. It had frankly been the expectation in 
British financial circles during the early 1920’s that prices in the United 
States would continue high or that depreciation of the dollar would 
continue to the extent that the pound, even at the rate of $4.86, would 
be in world sense relatively cheap” and Great Britain would be able 
to expand her export trade with the United States and other nations 
without undue difficulty. But the greatest disappointment, so far as 
Britain was concerned, came about as the result of a persistent over- 
expansion in world production of foodstuffs and some other raw materials. 

The dynamic contrasts between manufacturing industry and agri- 
culture, which we have already discussed in the case of the United States, 
were now evident in the world as a whole. Quite apart from currency 
policies, gold production, or any other monetary factors, the evidence 
clearly points to a tendency of agricultural production on a scale naturally 
involving declining prices of commodities important in world trade. 
This was indeed a twofold problem. In the old consuming areas of 
Europe, the postwar period was one of deliberate encouragement of 
domestic agricultural production as part of political rehabilitation 
programs. This was true of most of Europe. Russia, which had 
ceased to be a wheat exporter during the War and for a decade thereafter, 
again became interested in the European market in 1930, when she 
shipped large quantities of wheat to Central Europe and even Great 
Britain. Central Europe being chronically forced to economize foreign 
exchange, allocated its foreign buying power to essential industrial 
commodities and strove to reduce imported food to a minimum. This 
was true also of Italy and Hungary. France encouraged agricultural 
production even though able to support her population by domestic 
food. Such policies tended to restrict the export market for the newer 



countries that before the War had made a specialty of food production 
for export. These areas included Latin America, Australia, and New 
Zealand, and in this group we must also include American farmers. It 
is unwise to generalize too far on this situation, since there are many 
peculiarities of detail, but as a general trend it is fair to say that the 
international price position of the staple raw materials of agriculture 
and in some measure also of the basic minerals was deteriorating in the 
later 1920\s. 


The large borrowings from the United States by many of these raw- 
material producers had not in all cases been wisely used or employed 
in effective diversification of products. The tendency was to continue 
along old lines and to seek again the old markets, which unfortunately 
were gradually closing. This was already evident in the raising of 
tariff rates against wheat by Germany after 1925 and the very stiff 
increases by Italy during the same period. The countries of Europe 
began to introduce all manner of minor restrictions: milling quotas, 
quality regulations, etc., as obstacles to the free movement of crop 
surpluses upon which some countries depended to maintain payments 
on their foreign borrowings. Much of the foreign-debt claim held in 
the United States during the 1920^s rested for its validation upon a 
reasonable relation of the production of these raw-material countries 
to world demand or, in other words, maintenance of stable prices in 
terms of gold. 

As these problems of disappointing export demand and raw-material 
surpluses grew ominous late in the I920\s, there were signs of a distinct 
tendency on the part of the governments concerned to subsidize their 
producers of export raw materials. This deserves careful attention 
in the light of subsequent developments. In some cases this took the 
form of export bounties or what was virtually a double-price system. 
Producers were able to cut under the market in another part of the 
world by recouping export losses from governmental bounty payments. 
Another device was purchase of a part of the crop by a government 
agency, which then disposed of its holdings through competitive prices 
made possible by foreign-exchange manipulation. Exchange manip- 
ulation became a fine art, and its complex ramifications have developed 
continuously ever since. The world was beginning to learn how to 
give government agencies the power to focus trade along particular 
channels by devices that went far to destroy the functions of international 
money and the international system of prices. When loans were no 
longer easily forthcoming from the United States in 1928 and 1929, 
many of these forced-export countries soon found themselves in a des- 



perate situation. There began to be resort to even more ruthless meas- 
ures, such as deliberate devaluation of currencies, to gain evanescent 
trade advantages. One by one the nations of Latin America resorted 
to currency manipulation and devaluation. This meant abandonment 
of the gold standard or the use of gold-exchange redemption of paper 

Once started, this course easily becomes a desperate race. The only 
advantage of debasing a money system, so far as exports are concerned, 
lies in making products cheaper to foreign buyers than similar products 
from competing sources. All such devaluation measures serve more or 
less to raise domestic prices and thus support internal debt structures, 
but they have a disastrous effect upon the service of foreign debt. In 
this case not only was it impossible to import foreign capital, even for 
such dubious uses as to pay interest, but the import of foreign goods 
had to be drastically curtailed to conserve dwindling exchange balances 
available in New York or London. Each rise in the rate of foreign 
exchange in a country depreciating its own currency meant that service 
on the foreign (gold) debt became more expensive, and when balances 
were finanlly exhausted repudiation of the debt became inescapable. 
Although this disintegration had gone but little way prior to 1929, it 
was moving in this direction perceptibly and ominously. As the heavy 
food and raw-material importing countries of Europe found their interna- 
tional trade position less favorable and reparation requirements more 
and more pressing, they raised their barriers against foreign imports 
and encouraged substitution of domestic products, including synthetics. 
Thus the world was headed for an impasse and a breakdown of trade and 
international debt service. It was this underlying economic deteriora- 
tion in the raw-material areas, associated with the fantastic artificial 
debts imposed upon Central Europe, that pi*esently contributed to a 
world-wide tidal wave of liquidation, depreciation of values, and destruc- 
tion of income on a scale never before seen and utterly beyond the lange 
of the kind of money-market tinkering in which we entertained sucli 
misplaced confidence. The world wheat market, not tlie New York 
money market, should have been the critical subject for study at that 

The heavy loans that we had made to the raw-material countries 
(paralleling the further expansion of farm debt within the United States) 
were predicated upon the supposition that there would be a continually 
expanding export outlet for all these extractive production areas. This 
is a fundamentally important point in understanding what follows. 
The industrial countries divided into two groups: the creditor nations, 
foremost of which, as the chief (nominal) beneficiary of the War, being 
the United States, with Britain and France in intermediate position as 


both debtor to the United States and creditor on war claims against 
Germany. Even after the drastic scaling down of the original reparation 
schedule, Germany was in a position in which the only possible solution 
was in developing an enormously increased export of manufactures. 
Such exports could be successfully attempted only by developing new 
markets in the raw-material areas. But Germany had been preceded 
in this exploitation through the fact that vast American capital and 
capital-goods exports had already been under way in those directions, 
and the Germans were entering too late in this race for manufactured- 
goods markets. If we turn to Britain and France, overlooking the minor 
countries, we find a large expansion occurring in internal debts, par- 
ticularly in France, where financial extravagance of the most fantastic 
sort was evident even after stabilization of the franc had been accom- 
plished in 1928. All this expansion of debt rested upon the premise that 
Germany would pay the reparations and thus permit Allied settlements 
with the United States, with something over to provide maintenance 
of adequate gold reserves and command of working capital to promote 
the recovery of home industry and public-works progress. The basic 
fact was that the burden of the debt created during these years rested 
ultimately upon the ability of the raw-material countries to find markets, 
to maintain prices and income levels, and to validate their foreign and 
domestic debts. It was the breakdown of this phase of world economy that 
mainly precipitated the ensuing catastrophic difficulties. 


The impending deterioration in the relative position of raw material 
countries could not fail to affect the debt situation within the United 
States also. Not only the fast-growing mortgage debt on American 
agriculture but an equally important local-government debt in the rural 
section rested upon the solvency of agriculture and its world-price posi- 
tion. It rested, too, upon the ability of the American farmers to con- 
tinue substantial exports to world markets, which, we have seen, did not 
materialize. Even the building debt in many of our urban areas rested 
finally upon the solvency of our agriculture, because so much of this 
construction had been done in the newer cities. Automobile manufac- 
ture was important. The sale of cars does not depend preponderantly 
upon the farm market, but disposal of used cars, wliich is essential to 
make way for new models, has depended to a large extent upon the pur- 
chasing power of farmers. Anything that brought about a material 
decline in farm income would certainly have its effect not only upon the 
automobile industry but upon employment opportunities and wage 
incomes in the great motor-production area about the Great Lakes and 
thus, in turn, upon the maintenance of the local housing-mortgage debt 



and the financing institutions there. It is in this manner that world- 
wide conditions intruded themselves into the internal-debt structure at a 
time when, as we have seen, there existed no facilities for effective 
rehypothecation of urban mortgages. In one way or another the rapidly 
increasing stresses and derangements in the world^s financial system 
brought about such internal maladjustments in almost every country. 

Chart 35a. — Agricultural prices and inventory index for agricultural products, 1913- 
1936. The inventory index is a weighted average of changes in the physical inventories 
of wheat (United States and Canada), corn, cotton (United States), coffee (world visible), 
raw sugar (United States and Cuba), dairy cows on farms, and hides (United States). 
The result is expressed as a ratio to United States population calibrated to annual data. 

The first incentives to solve the international problems of insolvency 
seem to have come about as the result of internal pressures from harassed 
or hopeless debtors carrying larger obligations than could be met out of 
current or prospective income. The steps taken with ever-increasing 
desperation by one country after another during the early 1930^s were 
primarily designed not so much to secure minor advantages in the way of 
foreign trade or to lighten external obligations but rather to prevent 
internal financial prostration or outright revolution. It was natural 


that many of those who gave attention to the raw-material markets and 
the problems of agriculture tended to associate the difficulties of declining 
prices and accumulating surpluses with monetary causes. Falling prices 
of commodities implied rising value of money, and this was interpreted 
by some influential observers as meaning that something was wrong 
with gold. Thus arose a new faction among the protagonists of money 

Chart S5h. — Nonagricultural prices and inventory index for industrial raw materials, 
1913-1936. The inventory index is a weighted average of changes in the stocks of silk 
(at United States warehouses), bituminous coal, crude petroleum, refined lead, refined 
copper, refined zinc, tin (world visible), silver (United States and Canada), finished cement, 
newsprint paper (United States) , and crude rubber (United States) . The result is expressed 
as a ratio to the intermediate trend of general production. 

juggling, and we shall presently observe how the ^'gold doctors wrote 
their prescription for American monetary reflation in 1934. 

We have already observed the characteristic postwar difficulties of 
agriculture in Chapter 7, but let us pause to comment further upon the 
remarkable situation prevailing at this juncture in the markets for some 
of the great international agricultural staples.^ In the case of wheat, 

'See V. P. Timoshenko, '‘World Agriculture and the Depression,’* Michigan 
Business Studies, Vol. V, No. 5, 1933; “Monetary Influences on Postwar Wheat 
Prices,” WhecU Studies, Food Research Institute, Stanford University, April, 1938; 



world production rose very rapidly between 1925 and 1929, far in advance 
of the rate of increase in population. Wheat prices made their postwar 
peak in the United States in 1925, and the trend was then distinctly 
downward, inverse to world production. Although wheat stocks did not 
rise rapidly, there was nevertheless some increase between 1926 and 1929. 
In 1930 there came a huge increase in world wheat acreage and produc- 
tion, and Russia suddenly reappeared with 100 million bushels of surplus. 
This precipitated a scramble to unload wheat supplies and a demoraliza- 
tion of wheat prices, contributing to the financial impairment of a large 
part of the grain areas of the British Empire. The efforts of the Federal 
Farm Board to sustain the price of wheat proved disastrously unsuc- 
cessful.^ In the middle of 1931 all pegs were removed, and the price 
collapse accelerated, Russia again exporting over 60 million bushels. 
Even in 1929 the Australian government was engaged in price-fixing 
schemes to help the wheat grower and methods to stimulate production! 

More or less paralleling the collapse of the wheat market was the 
experience in rice, tea, cocoa, jute, hemp, flax, and other basic products. 
The situation in cotton was one not so much of overstimulated produc- 
tion as of a decline in the world consumption of United States cotton. 
Beginning in 1928 and accelerating in 1929 and 1930, an impairment of 
cotton export was partly connected with the difficulty being encountered 
in British export industry to retain foreign markets. British buying of 
American cotton fell off sharply after 1925. From the peak of 35 cents a 
pound in 1923, American cotton dropped to about 12 cents following the 
large crop of 1926, and by 1932 it was selling for 5 cents. The Federal 
Farm Board in 1929 attempted to support the price of cotton at 16 cents, 
but the market continued to decline below the loan value fixed by the 
Board — an interesting and costly lesson in elementary economics. 

There was a marked international trend toward self-sufficiency with 
respect to sugar in the postwar period. A sharp rise in world sugar 
production and in stocks available occurred throughout the 1920^s, 

M. T. Copeland, Raw Material Prices and Business Conditions, Biisiness Research 
Study 2, Harvard Graduate School of Business Administration, May, 1933; by the 
same writer *^The Raw Commodity Revolution,” Business Research Study 19, March, 
1938; R. F. Martin, “International Raw Commodity Price Control,” National 
Industrial Conference Board, New York, 1937. See also the series Foreign Agricul- 
ture^ published by the U.S. Department of Agriculture, dealing with government 
policies with respect to agricultural prices and trade during the late 1920^s and the 
early 1930’s. 

^ In Canada, also, a bolstering agency, known as the “Wlieat Pool,” had been 
formed. In 1928, the Pool began for the first time to support the market by buying 
up surplus. As these stocks became unwieldy the following year, the Pool became 
insolvent, and it Was necessary to obtain the assistance of the Provincial Governments 
of the wheat-growing Provinces. 


accelerating rapidly between 1929 and 1931. Europe heavily sub- 
sidized sugar-beet growing. Even in Great Britain there were schemes 
to develop beet-sugar production. Cubans cane sugar found itself in 
competitive difficulty vitally affecting her delicate financial position. 
Various attempts at “ sugar-stabilization^’ plans here and there proved 
ineffective in preventing a severe decline in prices. The case of coffee 
in Brazil is well known, but it is not generally recognized that stocks of 
coffee in Brazil more than doubled between 1926 and 1928 and nearly 
doubled again in the next two years. From 23 cents a pound early in 1925, 
Brazilian coffee fell to less than 14 cents in 1927 and after a brief respite 
declined below 6 cents in 1931. According to Timoshenko’s figures, the 
leading agricultural commodities in the United States declined in price 
roughly 30 per cent between 1925 and the middle of 1929, and the 
available supplies increased by nearly two-thirds. It is very significant 
that this increase in unmarketed surpluses of agricultural staples was 
under way well in advance of the financial crisis of the autumn of 1929. 
Chart 35 summarizes the situation as to farm and industrial raw- 
material inventory and prices according to the writer’s index numbers. 


In the system of world trade, as it was conducted prior to the World 
War I, it appears that interchange of the manufactures of industrial 
countries for the raw materials of less developed areas was fundamental. 
For many years this was represented by the give and take between the 
great British manufacturing centers and much of the rest of the world, 
colonial and otherwise, which contributed food and raw material. It 
was this exchange that made for the smooth working of the gold standard. 
It was a standard peculiar to that system, in view of the fact that so much 
of the gold originated within the system and merely passed from its mines 
through the delicately adjusted valves of the London banks. Now, how- 
ever, the world was entering upon a new phase in which the solvency of 
the raw-material areas was being rapidly impaired because the prime 
motivating system of British manufacturing was falling somewhat 
behind, while the rest of the industrial world was failing to generate a 
corresponding demand capable of absorbing the surpluses from the 
hinterland. Without a continuing exchange capable of sustaining the 
debt load, gold tended to lose its money function. Already there was 
appearing in dim outline a reorganization of world economic structures in 
terms, not of the traditional, self-liquidating trade between complemen- 
tary areas within a great political orbit but of increasingly ruthless and 
aggressive competition between one great industrialized area and another 
on a basis becoming more and more subject to the insistent political 



demands for military self-sufl5ciency. This was the beginning of nation- 
alism, of autarchy, expressing itself in economic warfare. This economic 
war was fought for several years with the weapons of currency deprecia- 
tion and artificial allocation of trade resulting in virtually a barter basis. 
This commercial revolution was accomplished at first by imperceptible 
skirmishes, but its unfolding on the world scene in later years was an 
event stemming directly from the maladjustments that we have been 
examining. ^ 

Even as early as 1928, the agricultural countries heavily indebted 
to other nations were able to service these debts to the extent of only 
about one-half by their export surpluses, and the balance represented con- 
tinued borrowing under more and more unfavorable conditions. The net 
balance of merchandise trade of Canada, Australia, India, Argentina, the 
Union of South Africa, and New Zealand combined declined from a 
credit of 261 million dollars in 1928-1929 to a debit of 482 millions in the 
following fiscal year. The net fixed charges for interest on external 
debt alone amounted to $772 millions! This was a very sudden shift, 
capable of violent and far-reaching repercussions. In an international 
capital market already under strain, the situation became distinctly 
dangerous. 2 But the flow of loans, particularly toward Latin America, 
instead of being able to stem the situation was already contracting, 
because of the very impairment of financial prospects in those countries. 
There was more internal short-term emergency credit expansion in these 
raw-material countries, and this contributed to the credit inflation that 
shortly followed. After the middle of 1929, the Argentine peso, which 
had previously been maintained in close parity with the pound sterling, 
began to depreciate rapidly. Australia had begun even earlier to lose 
gold, and after August, 1929, these exports rose swiftly. Canada began 
to lose gold in 1928, and in 1929 her exchange market came under pres- 
sure. Argentina and Australia were forced to abandon the gold standard 
before the spring of 1930. This marked the first significant impairment 
of the gold standard, a few short years after the world had so painfully 
struggled to revive it. 

^ Of the total world imports of manufactured goods, according to Timoshenko, 
63 per cent in 1913 and 66 per cent in 1929 represented purchases by agricultural 
countries. Even the United States sold nearly three-fourths of its exports of finished 
manufactured goods in 1929 to agricultural and raw-material-producing countries, 
mostly outside Europe. (‘‘World Agriculture and the Depression, p. 575.) Timo- 
shenko also points out, and it has an interesting bearing upon the foregoing discussion, 
that in the latter 1920^8, the volume, as well as the value, of exports by industrial 
countries was increasing much more rapidly than the total exports from the raw- 
material countries. The latter apparently were unable to service their foreign debt 
adequately from sales of their staple products. 

• Timoshenko, op. cU.^ pp. 612-613. 


The darkening prospect of acute difficulty in maintaining currency 
stabilization and international solvency was now being reflected in the 
world's security markets. A growing banking stringency had already 
depressed the trend of the American bond market since the spring of 
1928. In varying degrees, this signal of tighter money manifested itself 
throughout the financial capitals of the world. In fact, in every major 
financial center except New York, the stock markets had reached their 
major tops either in 1928 or very early in 1929. The peak in London 
came in April, 1928; in Brussels, in May, 1928; in Tokyo, in midsummer, 
1928. The Swiss market reached its top in September, 1928; Paris and 
Amsterdam saw their highest prices early in 1929. In Germany stock 
prices had reached the major top long before, in the spring of 1927, and 
ever since the spring of 1928 prices on the Berlin Bourse had slipped con- 
siderably lower. New York alone of all these centers was in an almost 
continuous whirl of bullish excitement through the spring, summer, and 
early fall of 1929. But clearly the world setting, industrially and 
financially, was entirely unfavorable to the indefinite maintenance of a 
rising stock market in New York. With monetary tension and after 
ineffective warnings by the Federal Reserve authorities, the first shake- 
down of prices began early in September. Once it became apparent 
to the speculative public that thinly margined holdings for the rise could 
not be maintained, there came in October a staggering avalanche of 
liquidation quite without precedent. This great collapse inevitably 
accelerated the already declining values in foreign centers, and the 
autumn of 1929 witnessed a world- wide liquidation of securities and a 
colossal wiping out of fictitious values. 

So tremendous a financial loss meant more bank failures and the 
insolvency of brokers and investment houses around the world. From 
the highest prices of September to the lowest in November, industrial 
shares on the New York Stock Exchange lost nearly half their value, but 
even at the lowest they had barely readjusted themselves to a sane level. 

The terrific rise of stock prices in the United States in 1928 and 1929 
had all the earmarks of a manipulated inflationary phenomenon. The 
public bought shares today with the expectation that they would rise 
tomorrow, and when tomorrow came skilled professional manipulation 
saw to it that they soared considerably higher. The longer those who 
had surplus funds waited for opportunity to invest the more they seemed 
to be wrong, even by the words of noted economists. Even in Novem- 
ber, 1929, Stuart Chase was saying: ‘‘We probably have three more 
years of prosperity ahead of us before we enter the cyclic tailspin which 
has occurred in the eleventh year of each of the four great previous 
periods of commercial prosperity." Almost every day reassuring state- 
ments were issued from high places in Washington. Businessmen who 



heard the confident comments of Secretary of Commerce Lamont saw no 
reason to change their plans, predicated upon an endless rise of purchasing 
power and continuance of prosperity. Charles M. Schwab, one of the 
greatest optimists of all time, stated in October: ^‘In my long association 
with the steel industry, I have never known it to enjoy a greater stability 
or more promising outlook than it does today.'' In December Mr. 
Schwab continued to be highly hopeful, stating: Never before has 
American business been as firmly entrenched for prosperity as it is 
today." Irving Fisher contributed to this state of mind by venturing the 
thought in October: Stock prices have reached what looks like a perma- 
nently high plateau. ... I expect to see the stock market a good deal 
higher than it is today within a few months." There was, in general, a 
tendency to dilate upon the truly remarkable performance of American 
corporate enterprise without recognizing that this could not escape when 
the very foundations of the international credit structure and the capital 
mechanism itself were being undermined by the deflation of income in the 
raw-material-producing areas of the world and the beginnings of that 
shifting of world competitive forces from individual to Government 

The year 1930 began with a subdued revival in the financial markets 
of the United States, but by summer it became clear that industrial 
conditions were not really improving, and deterioration was evident in 
the mortgage and banking structures. Apart from a stir of belated dis- 
tribution of electric-power securities, capital issues were small. Abroad 
there were a generally lower trend in stock quotations and a creeping 
shrinkage in industrial production. Industrial activity in Great Britain 
had held up surprisingly well throughout 1929, but in the late spring of 
1930 a sharp decline in business occurred, probably reflecting new crises 
in the raw-material countries and new steps threatening the maintenance 
of the gold standard generally. Conditions in Germany, Belgium, Italy, 
and Japan steadily deteriorated. Not only American agricultural prod- 
ucts but also manufactured goods were finding the going more difficult 
in foreign markets, and after the Hawley-Smoot tariff export resistance 
was abruptly accentuated. 

From the very beginning of 1930, farm-product prices in the United 
States weakened and continued in a state of collapse for two to three 
years. Merchants and manufacturers found themselves confronted by 
shrinking inventory values, and bank loans were required to stave off 
insolvency. Fortunately, 1930 was a year of continuing inflow of gold, 
not a healthy movement, as we shall soon see, but along with Federal 
Reserve purchases of securities in the open market and a conscientious 
effort to help by rediscounts, the gold position was temporarily beneficial. 
Meanwhile, however, the steady deterioration in both urban and rural 



mortgage solvency made it almost impossible to secure long-term capital 
for builders or farmers. The reduction in the official discount rates 
from 43 ^ to 2 per cent during the year really had little significance other 
than to show that gold was plentiful but trade was stagnating. More 
than 760 banks failed during 1930, and the deposits of impaired banks 
reached the unprecedented figure of over 300 million dollars. 

In the semisolvent railway system of the United States, the growing 
traffic impairment brought net operating incomes dangerously close 
to fixed charges, and by the end of 1930, in some instances, fixed charges 
were not being earned. The New York Central, the Chicago and North 
Western, Wabash, Chicago, Milwaukee and St. Paul, Atlantic Coast Line, 
and Northern Pacific had all reached the point by the end of 1930 where 
net operating income barely covered fixed charges. The Erie had 
characteristically increased its fixed charges during 1930 and along with 
the New York, Chicago and St. Louis, and St. Louis Southwestern 
roads already found net operating income below fixed charges. In the 
case of the Chicago and Eastern Illinois, there was actually an operating 
deficit by the end of 1930. Almost all roads sharply curtailed mainte- 
nance outlays, thousands of employees were dismissed and joined the 
ranks of workers in the building and building-material industries who 
were beginning to walk the streets. They were soon to be joined by 
millions thrown out of work in the automotive and other industries, and 
thus the crisis gathered momentum. 


Let us turn again to the international situation. The year 1930 
brought internal political disturbances in many raw-material countries 
where prices were declining: Brazil, Cuba, Argentina, Peru, India, 
Egypt. Desperate efforts were made to bolster those prices by every 
device that political ingenuity could invent, but stopgap measures merely 
served to create new maladjustments. The political expedients to 
bolster collapsing markets were primarily designed by and for creditors 
who saw the interest and principal on contractual obligations gravely 
menaced. It is most unfortunate (but usually overlooked) that rigid 
contractual debt obligations rested to an excessive degree upon those 
very branches of production having little flexibility or ready resort to 
other means of securing capital. In other words, the debt was built 
up during the war and the postwar period of financial extravagance and 
the false confidence that inflation invariably generates. What could 
not now be accomplished by a frontal attack in adjusting debts to a new 
level of income and values (which might, indeed, have been a way of 
undermining all contractual obligations) was attempted by opportunistic 
indirection and subterfuge. The ultimate results, however, did not 



protect the structure of private capital investment from a world-wide 
intrusion of Government efforts to reflate prices and underwrite values, 
to manipulate currencies, to assume responsibility for production, and, 
in short, to build a new order of dictatorial paternalism. 

Out of this welter of expediency arose two kinds of economic sophistry. 
One was the challenging thought that debt burdens, after all, were incon- 
sequential, because it was so simple to manipulate currency and prices 
to accommodate the debt, whether it was initially sound or unsound. 
The second, in various forms, asserted the nominal validity of all out- 
standing debt to the extent of transforming old debt into new debt, 
either by mortgaging the future still more heavily or by bringing the 
combined resources of the nation^ openly or by subterfuge, to guarantee 
the validity of particular frozen debts for which the whole people were 
not responsible. In the great world revolution of the past few years, 
these ideas have developed into an articulate new economic code. They 
furnish the basis for much of the political action that economic exigency 
has called into being, not only in the United States, but in virtuall}^ 
every country. 

Let us observe a few further details. In 1930 there was rapid depre- 
ciation in the currencies of the periphery of the food-supplying hinter- 
land — Australia, New Zealand, and the Argentine. This accentuated 
the competitive effort of the major wheat-growing countries to market 
their mounting surpluses, but these efforts were obstructed by the 
industrial importing countries of Europe in the interest of protecting 
their own subsidized agriculturists from still more ruinous prices. As 
export grain from the surplus countries faced increasing resistance, these 
countries determined to combine the inflation of their paper currency 
with measures calculated to stimulate rather than contract wheat produc- 
tion. Australia, after finding loans from London unavailable, began to 
ration her supply of foreign exchange (that is, funds abroad available 
to Australians) as a means of restricting imports. The fall of wheat 
prices in terms of gold was severely felt in Canada, although the currency 
system was not yet affected. Germany resorted to stiff increases in the 
wheat tariffs, and France and Italy took similar measures. A wide 
disparity was developing between wheat-export income and the gold 
prices of industrial products in gold-standard countries, particularly 
England, where prices and costs since 1925 had held their level. The 
astonishing rise in physical inventories of selected agricultural products, 
mainly in the United States, on a per capita basis, appears in Chart 35. 
On such a basis there should have been but little rise in an index of 
available surpluses, but the actual rise, accelerating during the early 
1930's, is shown to be definitely correlated with rapidly shrinking prices 
(in gold). 


There was an almost equally marked expansion in aggregate physical 
inventory of industrial raw materials (expressed in this case as ratios of 
the index to the trend of industrial production generally), although price 
movements in this group of materials were less uniform and differed 
somewhat as to timing, when compared with the agricultural prices. 
Most of the artificial control and rationalizing measures that had been 
taken during the decade of the 1920^s to raise the price of rubber, tin, 
copper, etc., had broken down by the spring of 1930. Some of these 
efforts had already begun to give way to spontaneous enlargement of 
production before the 1929 crisis was precipitated in the United States.^ 

In the case of American copper, the industry's export control, which 
had held the price unduly high during 1929, collapsed early in 1930, 
largely as the result of clear evidence of demand curtailment that was 
making copper unsalable at 18 cents a pound. The sudden readjust- 
ment of such prices one after another created a series of shocks and 
stresses that might have been avoided had these schemes been more 
flexibly and reasonably adjusted to demand conditions. But it was in 
the grain-producing countries and especially those having close relations 
to the great British market that this commodity crisis had its primary 
significance; the currency depreciation within the British group of 
countries was the first indication of inability to maintain the gold stand- 
ard that had been so laboriously restored between 1925 and 1927. 

The situation in Great Britain itself was anything but reassuring 
in 1930. The traditionally important industries, such as coal mining, 
textile manufacturing, and shipbuilding, were all suffering acutely from 
postwar changes. Coal mining was affected by the wider use of oil for 
fuel. Textiles were meeting strong competition in the Orient, especially 
in the Indian markets, where Japan had been carefully cultivating trade 
while other nations were fighting. Shipbuilding was depressed as 
hundreds of merchant ships were tied up following the war boom in 
construction. British labor was expressing its growing power in the 
ability to hold wages steady and to incorporate unemployment insurance 
into legislation — a worthy objective, so long as it could be paralleled by 
increased production. British export trade was slipping ominously. 
Unfortunately, by 1931, the unemployment-insurance fund was found 
to be insolvent. The British had made a serious effort to promote 
economic and financial reconstruction in Europe, but too much reliance 

‘ The Stevenson plan for the restriction of rubber exports from the British East 
Indies was an outrageous example of an attempt to elevate prices. The temporary- 
success of this regulation through application of variable export quotas appears to 
have been highly profitable to the British and doubtless assisted in the restoration of 
the gold standard in 1925. In that year crude-rubber prices in New York were raised 
from about 20 cents to over a dollar a pound I 



was placed upon intermediate-term and short-term loans whose uses 
were not followed through. The European debtor countries faced an 
acute scarcity of working capital, since foreign long-term capital was no 
longer obtainable. 

This tightening of the international-capital market contrasted 
strangely with the easing of short-term money in London and New York 
and Paris. The latter phenomenon, long regarded as the harbinger 
of better industrial conditions, was now a symptom of a creeping trade 
paralysis and shrinking demand for commercial credit. The fresh 
collapse of stocks in most centers had materially lightened the demand 
for collateral lending, and hence there was a plethora of “liquid capital 
that by 1930 and 1931 was restlessly searching out some of the distressed 
industrial areas of Continental Europe, where interest rates remained 
high. London served as the funnel through which large amounts of 
French, Swiss, Belgian, and Dutch funds sought the remunerative rates 
prevailing in the rest of Europe. London banks made short-term 
working-capital loans designed to stave off acute industrial difficulties 
in Austria, Hungary, Germany, Poland, and the Balkans, but in view 
of the less favorable export and therefore industrial conditions, the loans 
quickly became frozen. Thus a situation was being created on a broad 
scale essentially similar to that which had prevailed here prior to the 
crash in New York — advances of bank credit for working capital and 
even permanent capital purposes but on a contingent basis, with funds 
that were essentially short-notice deposits and with inadequate attention 
to the means whereby such loans could be repaid. It was another case 
in which the attraction of interest-rate differentials proved a snare and a 
delusion to lenders who failed to carry their thinking far enough to 
examine the reasons for these differentials and the intricate tangle of 
political factors thereby involved. It was the money market and not 
production conditions that received all the attention. 

One reason for this growing accumulation of liquid funds or demand 
deposits was the fact that the French, in returning to the gold standard 
in 1928, had devalued the franc 80 per cent, creating a situation that 
attracted gold to Paris. ^ France received large amounts of reconstruc- 
tion material and equipment from Germany by way of war indemnity 
and was regaining a fair degree of industrial activity. By the end of 

^ When a country's financial structure has been subject to paper-money or credit 
inflation but no action has been taken with regard to a change in the metallic standard, 
speculators tend to accumulate gold (if that is the standard metal of the currency 
system) or acquire gold exchange in foreign centers and retain these balances pending 
the time when they believe there will be an opportunity to re-exchange these gold 
holdings for new currency following devaluation. This usually takes the form of 
increasing the number of money units per unit of standard metal. This operation 
may be enormously profitable, as, indeed, it proved to be in the case of France. 


1930 short-term credits extended by Paris and other centers of the 
French gold standard to London were being recalled because of appre- 
hension over the future of British conditions. The French also began 
to withdraw large balances that had been maintained for some years 
in New York, since New York money rates were now less attractive and a 
general movement toward liquidity made itself felt among the financial 
institutions of the gold group. One of the most important factors in 
accentuating this tendency in 1931 was a growing feeling that Germany 
would find ways of evading payment on reparations account, as laid 
down in the Young plan of June, 1929. Germany had done fairly well 
industrially through 1929 and even part of 1930, largely through the 
drastic curtailment of imports, which helped to balance the nation’s 
finances, even though it was harmful to the British. But the collapse 
of prices (in terms of gold) was affecting German industry and agriculture, 
and, in fact, the farm situation throughout Europe was bringing acute 
pressure upon the institutions that had made loans on farm and building 

It must be kept in mind that by 1931 European agriculture had made 
enormous strides in the direction of self-sufficiency in food. This was 
particularly true of German}^ which had been able to curtail import of 
grain from 7.5 million tons in 1927 to 1.8 million tons in 1931. Net 
import of cattle and beef practically disappeared. Behind this tendency 
were also such factors as the curtailment of emigration from Europe 
to the United States, making it necessary to find agricultural work for 
many laborers and, perhaps vStill more important, an exacting and unin- 
telligent carving up of European states into small political units insulated 
by tariff boundaries, unable to maintain their usual industrial exports 
and foiced to reduce their standards of living by becoming agricultural 
and self-sustaining. This was a far worse result of the Versailles Treaty 
than the provision for reparation payment. It arose primarily from 
the desire of the French to reduce Europe to a mass of small, weak 
states in order to preserve the security of France. 


One of the most flagrant cases of atomizing Europe was the division 
of Austria-Hungary into a number of smaller states without visible means 
of support. The situation in Austria by 1931 had become particularly 
acute. This remnant of a formerly prosperous, industrial nation had 
been living on short-term loans ever since the late 1920’s, and the efforts 
of the Austrian Government to obtain a substantial capital loan in world 
financial centers had failed. Many small industrial enterprises that had 
been started during the later 1920’s in such portions of formerly pros- 



perous nations could not avoid disaster as the agricultural population 
found its ability to purchase even local products fast shrinking. In the 
face of these growing difficulties, foreign credits were being nervously 
withdrawn, and a flow of badly frightened capital away from Austria- 
Hungary, Rumania, Yugoslavia, and similar areas began in the spring of 
1931. By summer large increases in the gold reserves in creditor Switzer- 
land, Belgium, and Holland were evident. German gold reserves had 
followed the downward path already marked out by the gold holdings 
of the agricultural periphery in the Southern Hemisphere. Gold with- 
drawals from the United States did not become important until the end 
of 1931. 

The financial weakness in Austria had become quite apparent by 1930, 
when it became necessary to merge two of the largest industrial and agri- 
cultural banks. The Kreditanstalt was left in a weakened condition, 
unable to withstand the gradual spreading world depression. In May, 
1931, the Austrian Government was forced to guarantee all deposits of 
the banks. Emergency advances were somehow obtained from the Bank 
of England. The Bank for International Settlements,^ which advanced 
100 million schillings to the National Bank of Austria. There was a 
somewhat similar crisis in Hungary, temporarily alleviated by similar 
means, Germany meanwhile had sought to make capital of the strained 
situation by proposing a Customs Union with Austria, but the French 
objected. This matter contributed to further distrust of affairs in Ger- 
many, whose financial institutions were more or less involved with those 
of Austria and Hungary. The Reichsbank had by this time used up a 
large part of its reserves and was receiving emergency help from various 
central banks and Bank for International Settlements. But heavy with- 
drawals from the Reichsbank were taking place, and in July serious com- 
mercial failures induced bank runs, and cash payments were restricted 
in mid-July. It was evident that a very serious financial crisis was in the 

President Hoover was aware of the increasingly serious situation and 
saw the grave consequences that it portended. He therefore proposed 
in June that a moratorium be arranged on all intergovernmental debts 
arising from the War, predicated upon the willingness of the Allied 
governments to accept a moratorium for one year on German payments 
of reparations. His proposal was acceptable in principle; but as usual 
the French raised objections, and their bickering led to a delay in the 
moratorium plan, although it did become effective in August. Unfor- 

‘ This had been organized as a means of superintending the transfer of German 
reparations in accordance with the Young Plan of 1929 and for a limited period per- 
formed useful services as a central bank for the various European countries involved 
in the reparations problem. 



tunately, this very fact of a moratorium proposal led to swift aggravation 
of the fears of financial collapse in Central Europe. 

It was instantly realized that, not only other banks in Austria and foreign 
countries, but virtually the whole industrial structure of Austria, and other 
Eastern European countries, would be involved. It was equally evident that 
neighbouring debtor States, and particularly Germany, would be at once exposed 
to the danger of panic withdrawals of capital. A crack had developed in the 
carefully constructed and patched facade of international finance and, through 
that crack, already timid investors and depositors caught glimpses of a weak and 
overburdened structure. It was not only a bank which threatened to collapse, 
but the whole system of over-extended financial commitments which was the 
worst legacy of the war and of subsequent credit expansion.^ 

Despite the moratorium, runs on banks continued to create havoc 
throughout Europe. The French seized the opportunity to demand 
return from London of the short-term credits previously advanced, but 
London could not extract more than a part of her advances from the 
nearly frozen mass of European obligations. The Bank of England, as 
had been customary in such cases, took vigorous action to raise its dis- 
count rate from to 4^^ per cent; but it proved impossible to retain 
gold, and the balances available were smaller than usual since Great 
Britain had not been able to build up adequate reserves under the inter- 
national trade conditions previously existing. London was in much the 
same position that the banks of New York City had frequently experi- 
enced in critical times, when their unwisely selected earning assets were 
freezing and the interior banks were demanding gold. London frantically 
secured some short advances from Paris and New York early in August 
and again at the end of August. But the drain continued. OvTr 200 
million pounds sterling were taken out of the London money market in two 
months prior to Sept. 20. On the next day the momentous decision 
was at length announced that the government had permitted the Bank of 
England to suspend the obligation to sell gold upon demand in exchange 
for paper currency. England had abandoned her effort to retain the 
gold standard. 

In this step, the British were essentially recognizing the fact that parts 
of the Empire and countries close to the British economic system had 
already permitted their currencies to depart from the gold basis, and she 
was taking steps to close the widening gap between her price level and 
those price levels prevailing in the colonial periphery. Further large 
movements of gold toward France, Switzerland, Belgium, and Holland 
occurred, and Germany, the United States, and Japan lost considerable 
amounts of gold. The departure from gold abruptly intensified the rate 

1 World Economic Survey, 1931-1932,'' pp. 72, 73, League of Nations. 



of decline in American industry, construction work, commodity and 
security prices, and the issues of new corporate capital. Had it not been 
for this blow to confidence, a turn for the better would probably have 
been negotiated early in 1932. Although there was no indication as yet 
that liquidation of urban mortgages or the impairment of activity in some 
industries had run their course, this additional shock, transmitting its 
effects immediately to the capital market and all other markets, intro- 
duced into the business situation literally a doubling of the intensity of 
the depression. 

Previous to the British suspension of gold currency, depreciation 
had already occurred in Argentina, Australia, New Zealand and Uruguay, 
Brazil, Chile, Venezuela, Paraguay, Peru, and Mexico. Following the 
British suspension, other countries joined the list: Bolivia, Denmark, 
Canada, Egypt, India, Norway, Sweden, Finland, Portugal, Colombia, 
and Japan. ^ In the countries that abandoned gold, the course of prices 
in domestic currency tended thereafter to be fairly well sustained. In 
the case of British prices, there was a mild recovery, followed by a relapse 
early in 1932 and then a fairly steady level. In the remaining gold 
countries — the United States, France, Belgium, Holland, Italy, and 
Germany — prices continued to decline. The decline of prices in terms 
of gold, due primarily to commodity factors, was accentuated by falling 
rates of exchange on the various centers which had left gold. That is, 
no country attempting to preserve a gold standard was able to resist the 
external factors whittling down its internal level of prices, whereas 
countries off gold could with some effort avoid an inflationary rise in 
internal prices, since the underlying price trend in gold was still declining. 
This was the case in Great Britain. In 1932 the British took steps 
through their Exchange Equalization Account (operated by the govern- 
ment jointly with the Bank of England) to keep sterling as depressed 
as possible through manipulative purchases of foreign exchange and 
other devices, which proved measurably successful. 

Continued pressure on (gold) prices, particularly in the United States, 
was beginning to create a very acute situation in our farm areas and in 
our extractive industries generally. This became a matter of interest 
to speculators in Paris and other gold money centers. They sensed that 
the United States might soon be constrained to follow Britain in bringing 
the dollar to a readjusted level. Speculators in New York also were 
becoming apprehensive of the same thing and were beginning to purchase 

^ J. P. Day, An Introduction to World Economic History since the Great War," 
p. 114, London, 1939. This book contains an excellent brief account of the circum- 
stances and events of this period. See also Lawrence Smith, Suspension of the 
Gk)ld Standard in Raw Material Exporting Countries, American Economic Review, 
September, 1934. 


balances in Paris and Amsterdam, feeling that this was a way of hedging 
against devaluation and probably inflation. Thus a torrent of gold 
started to flow from New York (see again Chart 9). The Federal 
Reserve Banks early in 1932 began large open-market purchases of 
Government securities, which by the end of the year reached 1,855 
million dollars. The effect of this export of gold upon money rates and 
bond prices will be examined in a later chapter, but it can be said that 
the Reserve policy did alleviate the situation to some extent, and the 
worst of the gold loss was over by spring of 1932.^ 

This evidence of a tendency to lose large amounts of gold, contrasting 
with the very comfortable gold position of the middle Twenties, served 
curiously enough to extend the influence of that type of economic think- 
ing that fastens upon gold as the root of all financial difficulties. Gold, 
it was contended, was gradually becoming ^ ^scarce’' as the result of the 
effort of the various nations to reaccumulate gold reserves (efforts that 
had really not proved very successful except in the case of France and her 
satellites) and the activities of gold hoarders in increasing the ‘‘demand^' 
for gold. During 1932 and especially 1933, this view attained wide cir- 
culation and was usually phrased in the proposition that the falling trend 
of world commodity prices was due to an ‘increased demand for gold. 
Therefore, by cheapening gold the United States could likewise accomplish 
in one step the stabilizing of prices. This meant, of course, devaluing 
the dollar or making smaller the gold content of what was called a dollar, 
a step that would retain the gold standard, but on a basis of lower pur- 
chasing power of each dollar over other goods. This was the manner 
in which that device of cheapening the money by debasement, for so 
many centuries the last resort of bankrupt kings, became theoretically 
justified. We shall return to this again presentl 3 ^ 

1 In addition to loss of gold by shipment to Europe, an even larger amount appears 
to have been withdrawn from the banks for personal hoarding, a further example of 
the double drain on reserve that always accompanies financial strain. 




The abandonment of the gold standard by Great Britain and many 
other countries had wide political repercussions as well as economic 
results. There were now unmistakable signs that a new alignment of 
national interests, new kinds of competition, and new forms of protection 
against international competition were in the making. The policies 
that had been adopted in 1929 and earlier by the raw-material-producing 
countries to force outlets for their accumulating and depreciating sur- 
pluses represented forces too powerful to be resisted, now that currcnc.y 
chaos and a baffling confusion of price levels confronted business enter- 
prise everywhere. Resort to a new kind of refuge was therefore inevi- 
table by the alignment of national interest in new groupings. One such 
group aligned itself with the pound sterling and included, in addition to 
most of the British Colonies, such countries as Argentina, the Scandina- 
vian countries, and Egypt. ^ France, Switzerland, Holland, Belgium, 
Poland, and Czechoslovakia constituted a gold bloc, with Germany 
and Italy following somewhat similar monetary policies but not coordi- 
nating economic or political affairs so closely with the other countries as 
was the case within what came to be known as Sterlingaria.^ 

Japan, meanwhile, was taking advantage of the disturbed conditions 
and the bickering among the European powers to launch her ambitious 
designs for a New Asia under her control. Late in 1931 she formally 
abandoned the gold standard and launched upon a militar^^ career 
tinged with inflation. The previous collapse of silk prices had hit tlu^ 
Japanese economy disastrously. Population and employment problems 
were becoming acute, and the invasion of Manchuria was in part a 
result of this situation. Although conquest of the area that came to 
be known as Manchukuo was ostensibly territorial aggrandizement, it 
was primarily designed to bring pressure on the Chinese to n^lax their 
^^popular boycott^^ of Japanese manufactures. The Japan('S(‘ had 
already made serious inroads in India in competition with the British 

^ Canada was somewhat apart, although commercially closely related. 

2 The Union of South Africa continued substantially on its former gold basis until 
the beginning of 1933 but may be considered in a political sense as one of the Ster- 
lingaria units. 




textiles, and they were desirous of making inroads in Chinese trade with 
the same successful results. 

But from the standpoint of our present interest, these developments 
in the Orient have their place as revealing the beginning of a rising tide 
of nationalistic political policy, the beginnings of the new groupings of 
national power to which the demoralization of the gold standard and of 
international trade conditions and the world price system directly con- 
tributed. By the summer of 1932, there were signs that political power 
in Germany was moving toward a strong nationalist direction of the 
country's affairs. The Hitler-fascist party was forging ahead in the 


In the summer of 1932 a conference at Lausanne resulted in agreement 
among the Allied nations to reduce very materially the obligations of 
Germany on reparations account and to make more flexible the means 
whereby payments would be made. This was done by the Allied coun- 
tries as a way of hedging themselves against the ominous possibility that 
Germany might soon undergo a revolution and become a collectivist 
state like Russia, whose five-year plan of industrial promotion was already 
commanding world attention, particularly since it appeared to involve 
distinct militaristic as well as proselytizing aspects. If the United States 
could be convinced of the merits of the proposal, it was expected that 
American claims upon the Allies for war-debt payments might be scaled 
down, since they had all along been delicately linked by implication with 
the reparations. But the United States, not yet fully aware of what was 
going on in the world outside, was in no political frame of mind to accept 
this proposition. The Presidential election campaign was a complicat- 
ing factor. The Democratic platform proclaimed that the United 
States would make no concessions with respect to the Allied debt, inas- 
much as we had consistently ignored (or had professed to ignore) the 
existence of any relation between the Allied debt to this country and 
German reparation payments. Since the conferees at Lausanne had 
made a secret agreement among themselves not to ratify until the United 
States should declare itself satisfied to make a war-debt settlement of a 
compensating character, the net result of it all was that an opportunity 
was given Germany to repudiate the entire reparations matter. By the 
same token our Allies relieved themselves after December, 1932, from 
making further debt payments other than a few token payments that 
were entirely suspended (except for Finland) in 1934. 

This had the immediate effect of lending support to the Hitler move- 
ment in Germany, and Hitler was able to capitalize upon his apparent 
success in defying powerful nations whose claims had been an obstacle 



to any political party that had professed willingness to accede to the 
demands of foreign creditors rather than to the immediate needs of the 
German people. Here is the crux of the political situation that has 
since developed throughout the world. It was the common people — 
farmers, artisans, the unemployed, in all countries — who were forcing 
their governments into radical policies directed primarily toward internal 
solvency, reemployment, industrial and structural revival — the direction 
of all political policy toward these ends, with no regard to foreign cred- 
itors, foreign competitors, or any combinations of foreign interests. 
Lausanne gave Germany this opportunity to declare a new position and 
to organize the planning of a new order, the results of which have since 
become abundantly clear. In January, 1933, Hitler became Chancellor. 
Later in the year, Germany stepped out of the League of Nations and 
began preparations for the use of force to restore Germany's position 
in Europe. This implied a ruthless program of combining the needed 
industrial and raw-material areas of Europe under a dominant political 
leadership, probably through the use of force. ^ 

Meanwhile the British bloc was taking shape. The British broke 
with many precedents. They began to levy emergency tariffs on a 
wide range of imports. In July, 1932, an embargo was placed on loans 
to foreign countries. The emphasis henceforth was to be placed upon 
restoration of employment and the forced lowering of interest rates to 
enable reduction of excessive accumulations of internal debt by refund- 
ing. ^ With definite abandonment of the policy of free trade, a new 
schedule of duties was imposed, covering a large proportion of the total 
imports into Great Britain. This policy toward economic protectionism 
and political nationalism was further extended as the result of the 1932 
conferences at Ottawa, whose objective was the lowering of tariffs within 
the Empire but whose final result was rather to raise the duties of coun- 
tries in the Empire orbit against nations outside Sterlingaria. Mean- 

1 The leaders of the new German totalitarian regime appear to have proceeded on 
the assumption that Germany as a nation could be preserved only by a ruthlessly 
independent course, harshly contemptuous of financially embarrassed Britain and 
America and their economic traditions, covertly hostile toward Moscow and its 
mendacious Internationale, whose alleged subtle, well-financed secret machinations 
throughout all Europe might perhaps have been given exaggerated import. On the 
whole, Hitler's fear of the growing power of the Soviets seems to have goaded him to 
developing the internal resources and economic activity of Germany, by self-worship 
and a fanatical rejuvenation, into a military state, half capitalist, half collectivist, 
designed ultimately to contest the swelling tide of armed communism. Hitler over- 
looked the fact that had Germany followed a less provocative program, Russia, 
despite its dictatorship, might also have been content to develop its socialist experi- 
ments along nonaggressive and peaceful lines. 

* The British successfully converted two billion pounds sterling of War Loan in 
1932 from a 5 to a 33^ per cent basis. 



while Russia was fast developing her intensive program of collectivization 
and forming a more or less self-contained and insulated unit of vast 
geographic proportions. 

During 1932 the United States began to feel rather unfavorably the 
effect of these gradually crystallizing new aggregations of political and 
economic interest. There was a further decline in prices, and the Ottawa 
agreement served materially to reduce our already shrinking exports 
to countries included in that understanding, particularly the British 
Isles. The effort within Sterlingaria to resort to various devices, such 
as export bounties, government purchase of surpluses, government 
guarantees of farm prices, served to confirm a world-wide trend toward 
agricultural excess and intensified pressure on prices. Evidence of the 
existence of international competition cutting across old alignments 
appeared in the difficulty of obtaining agreement upon some limitation 
of world crop production and the failure of the London Economic Con- 
ference in 1933. A new order of international competition by currency 
juggling, competitive inflation, competitive regimentation, and ulti- 
mately war, was launched. In the United States it came to be called 
the New Deal, ostensibly for internal reconstruction but in fact part of 
the new world complex of political turbulence and reorientation. 

During President Hoover^s final year in office and under the most 
trying conditions, legislative steps were taken to cope with a desperate 
situation not amenable to the usual palliatives. The decline in bond 
prices and the continuing wave of property foreclosures during 1931 
and 1932 had brought unprecedented strain upon the banking structure. 
In 1932 the wave of failures was becoming a tidal wave (see again Charts 
33 and 34) . There were in that fiscal year almost 2,400 closings of banks 
having 1.7 billions in deposits. This situation was increasing the delib- 
erate hoarding of gold. Had the banks during this period been forced 
to contend merely with the problem of writing off impaired agricultural 
and urban mortgage loans and the usual emergency demand for solvency 
credit, it is entirely possible that with the help of the Federal Reserve 
and a fairly comfortable gold position, the strain might have been sur- 
mounted. But in the face of this tremendous w^ave of suspensions and 
the beginning of nation-wide runs and gold hoarding, the banks, as we 
have seen, were loaded up with investments that were rapidly shrinking 
in value and had little that was available for rediscount. Open-market 
purchases by the Federal Reserve merely offset fresh gold withdrawal. 

Intense pressure upon the banks occurred in the Great Lakes section, 
where the building boom had been greatly overdone and where unem- 
ployment in the newly developed transportation-equipment industries 
was making impossible the validation of mushroom real-estate obliga- 
tions. Various emergency measures were hastily devised by the Federal 



Government^ late in 1931 to bolster weak institutions and prevent the 
spread of panic and embarrassment of insurance companies and savings 


In January, 1932, there came into being a new type of financial institu- 
tion known as the Reconstruction Finance Corporation. It was designed 
to afford immediate emergency assistance to banks that were finding it 
necessary to write off so much of the stated value of their outstanding 
loans that they not only had erased what surplus they had but were 
trenching upon capital and found it impossible to raise additional capital. 
According to the old-fashioned and long-since-forgotten theory of strictly 
‘‘commerciaF^ practices, banks would have found it easily possible to 
avoid marked depreciation of assets, since these would have consisted 
primarily of self-liquidating, short-term advances, and by rotation of 
maturities and caution in making new loans, serious depreciation would 
have been averted. Actually, however, the banks were unable to reduce 
a large mass of frozen capital-loan’^ assets. Loans on real estate had 
been reduced since the end of 1929 only by an insignificant amount; 
collateral loans had been reduced during the two years ending December, 
1931, by only about 25 per cent. 

With ample financial resources, the RFC was empowered, among 
other things, to make direct loans to solvent banks and financial institu- 
tions. It was also in a position to aid many railroads in view of the rapid 
disintegration of their solvency. ^ Because of the wave of mortgage 

^ In connection with the heavy withdrawal of deposits from banks between 1930 
and the spring of 1933, when the entire banking system had to be suspended, it is 
interesting to observe that a much larger percentage of reduction occurred in large 
deposits than in small deposits. A 70 per cent reduction took place in demand deposits 
amounting to $100,000 and over, and a 6 per cent reduction occurred in the case of 
balances amounting to less than $500. {Federal Reserve Bulletin^ March, 1939.) The 
reduction in interbank deposits was extremely drastic; but as might have been 
expected in view of the structure of the banking system, there was a large withdrawal 
of time deposits, only moderately exceeded by the rate of reduction in demand 
deposits. It can readily be seen that the sudden withdrawal of funds by large cor- 
porations or their local branch plants and offices from unit banks in cities and towns 
of moderate size could quickly place these banks in an extremely vulnerable position 
in view of the fact that many of them had so little in their earning assets that could 
be used as the basis of assistance from the Federal Reserve. 

* As first set up, the RFC had a capital of 500 million dollars extended by the 
United States Treasury and was authorized to issue notes, debentures, or bonds up to 
1.5 billions. 

It was also empowered to make available emergency funds to be administered by 
the Secretary of Agriculture. The RFC was essentially an outgrowth of two previous 
Federally sponsored financing institutions, the War Finance Corporation, which 
assisted in the financing of industries during the World War, and the National Credit 



foreclosures, the RFC was given authority also to assist building-loan 
associations, savings banks, insurance companies, farm-mortgage asso- 
ciations, and livestock-finance companies. It was believed the RFC 
could thus allay panic hoarding and withdrawals of bank deposits; 
by restoring confidence the banks would be able to extend loans on 
property and working-capital advances to industry, and thus the process 
of readjustment would not become an endless cumulating spiral.^ 

Thus the RFC attempted to sustain, at least for the time being, the 
existing credit and capital structure by virtual blood transfusions from 
the Treasury to private financial institutions. Thereby it pointed 
incidentally to the previous lack of development in the United States of 
institutions specifically organized for long-term capital advance, either 
by loans or equity finance, to the extractive and structural industries. 
By first bringing financial succor to banks and railroads, the Government 
was led to explore this underdeveloped phase of our financial structure 
and to recognize that what private financing had not been able to do 
(outside the insurance companies, a few of the so-called “investment 
trusts,” and the surplus investment of corporations) might perhaps 
be developed through the direct or indirect lending of Government- 
controlled capital. 

The RFC, however, in its early phase and apart from the railroads, 
did not make direct loans to industry but sought to provide emergency 
credit to support banking structures. In July, 1932, however, the RFC 
was given additional resources nearly doubling its potential loan fund 
and was authorized to advance emergency funds to states and munici- 
palities to be used for direct relief or work relief to the needy and unem- 
ployed, to provide for local construction projects of a self-liquidating 
type, to finance sales of agricultural surpluses abroad (an indication 
of our entry into the international economic war), and, finally, the making 
of advances to regional credit corporations for agriculture. 

At about the same time the Federal Government had also created a 
new system of Home Loan Banks in view of the intensified and threaten- 
ing nature of the mortgage insolvency crisis.^ These regional Banks 

(Corporation, incorporated in October, 1931, as a means of relieving banks in the more 
distressed agricultural areas. The latter institution was organized upon too restricted 
a basis and was not much of a success, but the RFC expanded its scope and general 
purpose with much larger resources and broader powers. 

1 The RFC at the close of 1934 held 426 millions of the capital notes and deben- 
tures of 2,781 banks and 776 millions of preferred stock, representing 3,913 banks. 

* The Home Loan Banks were set up by requiring the RFC to allocate to the 
Secretary of the Treasury 125 million dollars to purchase the stock of 12 regional Banks 
somewhat paralleling the Federal Reserve Banks in the commercial banking field. 
(J. Franklin Ebersole, ^‘Current Economic Policies, pp. 116-117, edited by J. B. 
Hubbard, New York, 1934.) 



were designed to afford relief to home owners who were in danger of mort- 
gage foreclosure. Receivers of closed National Banks were instructed 
to suspend foreclosure on first mortgages on sound properties until these 
Home Loan Banks could be set up. Although this was merely an 
emergency stopgap to hold back the tidal wave of foreclosures and to 
deal with the generally critical financial situation in Chicago, Cleveland, 
Detroit, and the surrounding areas, it was also clear evidence of the 
abominable shortcomings of the housing-mortgage system as it had 
existed. The Home Loan Bank Board, supervising general policy, 
was able to extend significant help and ultimately had about two billion 
dollars outstanding as the result of its mortgage-rescue operations. It 
marked a first step in the direction of much more fundamental reforms 
that will shortly be discussed. 

In addition to setting up the RFC, the Hoover Administration per- 
mitted the Reserve Banks, through the Glass-Steagall Banking Act, to 
issue notes on the basis of long-term Federal Government bonds, sup- 
plementing the usual backing of gold plus commercial paper. The 
Federal Reserve Banks thereupon began large purchases of United 
States Government securities, and by the end of 1932 they had increased 
holdings by nearly one and three-quarter billion dollars and had made 
their notes available to member banks as a means of meeting currency 
needs. This was a move designed to attack the second great problem — 
that of deposit withdrawals. But again it was in the nature of an 
emergency stopgap that did not reach the cause of the difficulty. Despite 
the easing of credit conditions after the middle of 1932 there continued 
to be a widespread uneasiness and suspicion as to frozen assets. Even a 
sharp recovery in the prices of bonds ^ and common stocks in the early 
autumn failed to restore confidence in the banking system. The very 
fact of resort to Federal financial pulmotors tended to create the impres- 
sion that the rescue work was not over.^ When the Ottawa Conference 

^ A 100-million-dollar bond-supporting pool was formed in Wall Street in June 
and may have been responsible for part of the temporary rally in security values. 

* In November, 1932, Frank A. Vanderlip, formerly president of the National City 
Bank of New York, wrote for The Saturday Evening Post a pertinent and very candid 
article on the banking problem and the steps being taken to deal with it. Referring to 
failures, he wrote: “A great proportion of these insolvent banks had been constant 
borrowers from other banks over a period of years. Many of them had been heavy 
borrowers even at the height of the New Era of prosperity, when depressions were 
supposed to have been permanently banished. Many had invested too heavily in 
new and too elegant bank buildings. Many had boards of directors who had been 
inactive and negligent. There were a considerable number of dishonest officers. 
Local enterprises had been given capital financing which should have been assumed 
by permanent investors, instead of permitting demand deposits to be frozen in loans 
that had no true due date on which payment might reasonably have been expected. 
There were hundreds of cases in which the bonds of small local corporations having 



adjourned in August, there were those who foresaw abrupt curtailment 
of our already shrunken wheat and cotton exports to countries of the 
British Empire. In December bank suspensions, after having declined 
temporarily, again began to increase. In the first six weeks of 1933, a new 
wave of failures became apparent, and these involved a number of 
metropolitan banks of considerable importance. ‘^The volume of 
deposits of the suspended banks was particularly large in southern New 
Jersey, District of Columbia, Tennessee, Illinois, Iowa, Missouri, Nevada, 
and California. Finally, renewed banking difiiculties in February, 1933, 
led to the temporary closing of all banks by official action, first in the 
State of Michigan, then in other States, and finally by Presidential procla- 
mation throughout the country.’’^ 

The closing of all banks by the declaration of a banking holiday on 
Mar. 6, 1933, gave the new Administration an opportunity to devise 
emergency measures of far-reaching character. The panic had to be 

no general market were carried in the investment accounts in a manner which led 
depositors to assume that they were readily marketable securities. Competition led 
to paying unsafely high interest rates on deposits. Larger loans were made than 
were permitted by legal limitations. 

^Tn a word, it was unsound banking that caused the bank failures, and not a 
depression which engulfed welbmanaged banks. . . . 

“Why did not bank examiners stop practices of which they wore aware and con- 
cerning which they wrote constant criticisms? 

“The reason why bank examiners do not close banks before the depositors^ money 
is lost, even though they know the banks are not well run, is easily understood by 
anyone who has ever had the responsibility of deciding whether or not to close a bank 
which is nearing, but has not reached, a critical danger point. 

“Closing a bank is capital punishment for the bank. Every jury hesitates before 
pronouncing a death sentence. The evidence must be ‘beyond a reasonable doubt.' 
There is much the same sort of hesitancy when considering a life or death sentence 
for a bank.'' 

Turning back a century and a half, let us add, for contrast, the words of Adam 
Smith: “The banking companies of Scotland . . . were for a long time very careful 
to require frequent and regular repayments from all their customers, and did not care 
to deal with any person, whatever might be his fortune or credit, who did not make, 
what they called, frequent and regular operations with them. By this attention, 
besides saving almost entirely the extraordinary expense of replenishing their 
coffers, they gained two other very considerable advantages. . . . 

“First, by this attention they were enabled to make some tolerable judgment 
concerning the thriving or declining circumstances of their debtors, without being 
obliged to look out for any other evidence besides what their own books afforded 
them. . . . 

“Secondly, by this attention they secured themselves from the possibility of 
issuing more paper money than what the circulation of the country could easily 
absorb and employ." (“Wealth of Nations," Book 2, Chapter 2.) 

1 J. D. Paris, “Monetary Policies of the United States, 1932-1938," p. 5, New 
York, 1938. 



stopped once and for all. The most direct way to accomplish this quickly 
was to take drastic action with respect to gold. The President, as the 
result of emergency legislation, was empowered to prohibit all trans- 
actions in gold, and the Secretary of the Treasury was authorized to 
mobilize all gold coin and bullion in the United States in the Treasury 
vaults. Banks were forbidden to pay out gold, and gold exports were 
prohibited except on license. This meant that the United States had 
abandoned the gold standard and circulation for internal commerce, 
although not for foreign intercourse. On Apr. 5, the President nation- 
alized^^ all gold coin, bullion, and gold certificates by requiring delivery 
to the Federal Reserve Banks. Permission to secure gold was given to 
those requiring gold for industrial use or operations not interpreted as 

While these measures were being taken, there was a decided impetus to 
inflationary sentiment in Congress by recognition of the wide latitude now 
afforded by modification of the gold standard for internal credit expansion 
or even paper-money inflation or reflation.’^ The prices of raw materials 
had declined from the temporary rally in the fall of 1932 to a very deep 
new bottom in January, 1933, but thereafter the expectation of some 
inflationary measures continued to be a stimulating speculative factor. 

Broadly speaking, the modification of the former gold standard of the 
United States resembled what followed the complete suspension of gold 
by Great Britain. Prices of commodities and securities rose very rapidly, 
and a burst of speculative activity affected even commodity prices in 
British sterling. In other words, enough psychological stimulus was 
given by the inflationary implications of the gold policy to bring about a 
rise in the world price of basic commodities, particularly agricultural 

Early in May the President gave a radio address in which the deter- 
mination to raise prices of basic commodities was thus expressed: ^^The 
Administration has the definite objective of raising commodity prices 
to such an extent that those who have borrowed money will, on the 
average, be able to repay that money in the same kind of dollar which 
they borrowed. This pronouncement recognized the existence of a 
large and more or less distressed commodity debt and conditions in some 
agricultural areas that from time to time had verged upon revolution. 
Fulfilling these expectations, there came into existence the Agricultural 
Adjustment Act, the main purpose of which was to accomplish what 
agricultural experts were by this time fairly well convinced was the major 
problem — surpluses. Contraction of excessive acreage and production 
of a few key products seemed to be called for. This Act, however, con- 
tained a potentially inflationary amendment (the Thomas Amendment), 
authorizing the President at his discretion (1) to purchase through the 



Federal Reserve Board Government bonds in the open market to the 
extent of three billion dollars; (2) to issue United States notes up to a 
maximum of two billions; (3) to reduce the weight of the gold dollar to 
the extent of 50 per cent; (4) to fix the weight of the gold and silver dollar 
at such a ratio as the President might find necessary and provide for 
unlimited coinage of gold and silver at that ratio; and (5) to accept silver 
at 50 cents an ounce to the amount of 200 million dollars from foreign 
governments in payment of indebtedness.^ 

In order further to implement his monetary revolution, the President 
in June signed a joint resolution that formally invalidated clauses in 
contracts calling for payment in gold coin. Also, Federal Reserve notes 
and National Bank notes were for the first time made legal tender. The 
important point in these radical changes is that the United States avowed 
a new form of gold standard, subject to modification at any time as a 
means of maintaining a money of ‘‘constant purchasing power over 
debts, this being primarily understood to be the debts of those producing 
commodities^ whose debt-paying power can be roughly measured by an 
index of commodity prices. The intrusion of the familiar potent agri- 
cultural influence in Congress in the early 1930’s kept in the background 
the very much more important mass of debt, much of it frozen or insol- 
vent, representing urban mortgages, railroads, and other public utilities 
that did not derive any power of validation from commodity prices as 
such. The Administration was content for the moment to leave these 
matters in the hands of the RFC, which, by the end of 1933, had managed 
to extend a helping hand to the extent of some 4 billion dollars, of which 
1.4 billions served the purpose of resuscitating embarrassed banks, 400 
millions went to shore up railroad companies, while about 200 millions 
served directly the purpose of assisting mortgage companies (mainly in 

In June, 1933, there was, however, a significant effort to extend the 
capital salvaging process by setting up a special organization within the 
Federal Home Loan Bank System, known as the Home Owners’ Loan 
Corporation, to furnish emergency relief to distressed homeowners w^ho 
were faced with the loss of their homes through imminent foreclosure or 
tax sale. This was accomplished by refinancing the mortgages on more 
favorable terms. This was a temporary arrangement, the operations not 
extending beyond June, 1936. Through the combined efforts of the RF C 
and this HOLC, an enormous amount of impaired mortgage capital was 

1 As a safeguard against excessive inflation, the Federal Reserve Board was 
authorized, with the approval of the Secretary of the Treasury, to take appropriate 
steps to prevent undue credit expansion and to increase or decrease under certain 
restrictions and with the approval of the President reserve balances against demand 
or time deposits of member banks. 



at least temporarily held in suspense or refinanced. In order to carry 
the program still further, it was desirable that broad leeway be used to 
permit Federally sponsored agencies to convert old debt into new debt. 
This required, in short, that interest rates be kept as low as possible and 
that no limiting restrictions be placed upon the expansion of such short 
credit as might be necessary in achieving this general purpose. This 
meant that rigid adherence to a definitely fixed gold standard or any 
system of rigidly determined minimum banking reserves — implying fre- 
quent or spasmodic limitation upon the credit-extending power of the 
Reserve System — had to be scrapped. Old debt was to be, in other 
words, translated into new debt, carrying much lower fixed charges, but 
in order to accomplish this an atmosphere of expansive, yet regulated, 
monetary, credit, and capital facilities had to be developed. Toward 
this general purpose the measures taken with respect to gold and the 
monetary standards were of prime importance. We shall now trace the 
further expansion of these policies in succeeding years. 

The experiments in the direction of what has come to be called in 
Government circles 'Hhe New Finance explain the negative attitude 
taken by President Roosevelt in July, 1933, toward the proposed London 
Economic Conference. There were some indications that the British, 
French, and other representatives preparing to discuss ways of stabilizing 
world economy again were building their agenda around a program con- 
templating the reestablishment of some form of fixed gold standard. 
Mr. Roosevelt apparently felt that this matter might so confine or limit 
his New Finance within the economy that he suddenly took action that 
virtually blocked the proceedings. In this he was also strongly pressured 
by inflationist organizations and money theorists. A great opportunity 
to rectify international economic relations along fundamental lines was 
lost, perhaps for many years to come. The die was cast in the direction 
of rebuilding the economy of the United States to the already vaguely 
delineated plans of regionalized hegemony conforming to the pattern 
of change in the basic philosophy of all the great nations. This momen- 
tous shift, briefly, looked toward rebuilding and fortifying internal finan- 
cial structures after the great storm by governmental agencies using 
flexible instruments, armed with vastly magnified administrative powers 
and discretionary authority. The year 1933 marked a great turning 
point in American affairs, as it did in world affairs. 

During the balance of 1933, gold was bought with paper money or 
credits by the United States from domestic mines at prices fixed by the 
Secretary of the Treasury and more or less comforming to the existing 
foreign-exchange valuations of the dollar.^ The price at the end of the 

^ The RFC, financial handy tool, was pressed into service in the closing months of 
the year as the agency to handle gold purchases. 



year stood at about $34 per fine ounce. This rise in price naturally 
meant that the gold now held by the Treasury had risen in ^Mollar^^ 
value, automatically expanding the dollar^s worth of potential credit that 
might be created on this base. But as we shall see presently, this struc- 
ture was not built on the old model, making large credit resources 
available to private speculation or semi-investment processes. The 
foundations were enlarged to provide for a new superstructure of Federally 
dominated credit for capital and quasi-capital purposes,^ 


Thus far the Government had merely suspended the circulation of 
gold as money and the circulation of paper backed by gold but had not 
formally revalued its gold. This step was taken by the Gold Reserve 
Act of January, 1934. The Treasury was now to be the exclusive holder 
of all (nonindustrial) gold; even the Federal Reserve Banks were to be 
permitted to hold reserves only in gold certificates or credits on the 
books of the Treasury, not in actual gold in their own vaults. Inter- 
national transactions could be settled only by gold released through 
central banks. The President was given power to set the nominal stand- 
ard weight of the gold dollar between 12.9 and 15.48 grains of gold, nine- 
tenths fine, as compared with the old dollar of 25.8 grains. Mr. 
Roosevelt actually set the dollar at 15^i grains of gold, nine-tenths fine. 
This represented a devaluation of 41 per cent or, in other words, a 59-cent 
dollar. Expressed in terms of the new price of gold, this meant $35 an 
ounce, as against the old price of $20.67 a fine ounce, an increase of 
close to 70 per cent.^ Chart 36 illustrates the results, in comparison with 
the experience in Great Britain. 

One important fact in this connection is that the nominal profit of 
about 2.8 billions was not all added to the reserve potentially available 
for sustaining credit expansion. An amount close to 2 billion was set 
aside as a special Stabilization Fund, somewhat similar to the Equaliza- 
tion Account used by the British Government and designed to be used 
as a secret means of stabilizing international-exchange rates, snubbing 
speculative movements in these rates, and, in the event of unusual 

1 In the references to gold and monetary policy immediately following in the text, 
the writer has drawn material from the convenient summary presented by J. D. Paris 
in Chapter 2 of the work previously cited, 

* A short time before the new policy became effective, the price of gold in the 
United States was about 60 per cent above the old parity, and the price of gold in 
London was about 60 per cent above the presuspension level. The Canadian price 
was about even with that of the United States; South Africa was lower, but Australia 
and New Zealand considerably higher — about 90 per cent above the old parity. In 
other countries the price varied as high as about 100 per cent above 1929 levels in 
Argentina and 150 per cent in Japan. 



difficulties, stabilizing Government security values. The new gold 
price of $35 an ounce proved, on the whole, to represent an undervaluing 
of the dollar (that is, too high a price) in considering the average of 

Chart 36. — Commodity prices in gold and currency and the price of gold, 1926-1940. 
The price of gold in Great Britain is shown as an index number with base at August, 1931, 
to enable comparison of relative movements. The price of gold in the United States is 
shown as an index number with base at February, 1933. The price index numbers are 
those of F. A. Pearson, Cornell University. 

relationships between typical basic prices expressed in the currencies of 
many foreign countries and the same articles or forms of wealth stated 
in dollars bpt ti'iBslated into the various foreign currencies through 



New York exchange rates. This was one factor among others that soon 
caused a heavy inflow of gold from foreign countries, a flow that, as we 
have already noted on Chart 9, ultimately became an avalanche. It is 
inaccurate to say that our buying price alone caused this movement 
as more powerful factors were at work. There was the return flow of 
American capital which had been hastily sent abroad in cash in 1932 
and 1933; more important was the growing flight to the United States 
of foreign capital (largely in the form of actual gold) seeking a haven of 
refuge from the growing danger of serious international friction. 
Although giving the country only a slightly enlarged base for its credit 
banking or even for emergency Federal financing, the new dollar plus 
other factors drained into the United States in the next few years a pre- 
ponderance of the world’s stock of gold, enlarging reserves beyond all 
reason and requiring new steps for control. Thus one step in the direc- 
tion of flexible or opportunistic financial manipulation produced the need 
for many more.^ 

The political forces of the world after 1934 rapidly shifted toward a 
grim competitive struggle among more or less clearly defined groupings 
and alliances of powers, leading to the final d6nouement of a new World 

1 We may note in passing the somewhat parallel policy, and a strange one indeed, 
with respect to silver. A Silver Purchase Act was approved in the summer of 1934, 
providing that the Treasury purchase silver at home or abroad, issuing legal-tender 
silver certificates therefor, with an upper limit that would maintain a silver reserve 
not over one-third of the gold reserve. In fact, the President had previously, in 
December, 1933, authorized the mint to accept all domestically produced silver at a 
price nearly 20 cents above the prevailing market. This silver, however, has not 
actually been considered as an addition to the monetary reserve in the eredit system, 
and such mild and indirect inflationary effects as the policy may have had have 
resulted from the placing in circulation of more silver certificates. Of course, one 
ulterior object in this silver legislation was to raise the value of the money in which 
Chinese trade with the world was supposed to be paid and thus, by helping the 
allegedly ‘‘oppressed” domestic silver miners, the Chinese were also to be assisted 
to a higher standard of living. In actual fact, the raising of the world value of silver 
depressed Chinese prices quoted in silver, and soon forced China off the silver standard 
and into monetary chaos, followed by war inflation. 

One other effect of the policy of purchasing silver w'as to keep in existence a flow of 
foreign remittances to buy silver, thus preventing any marked rise in the value of the 
dollar in the foreign-exchange markets. In any event, a great hoard of silver was 
accumulated, the ultimate use of which (apart from some wartime uses) remains a 
mystery. Basically, the curious silver episode illustrates the powerful effect of a small 
sectional group upon legislative policy. The growth of such articulate blocs has 
directly contributed to the formation of powerful central governments. Today 
governmental authority is greater in all countries, partly for the reason that highly 
organized group pressures are immensely greater and national governments cannot 
function if they do not by compromise or force make terms with these mobilized 
factions pressuring for special favors, special legislation, and all manner of economic 
benefits. This, in turn, is a phase of the breakdown of trade and industry after 1929. 



War in September, 1939. By early 1936, after localized conflicts in Spain, 
Africa, and China, international financial and price developments clearly 
reflected a new and grandiose pattern of aggression and accelerated plan- 
ning of armaments in all directions. The United States, after adopting 
a revised form of the gold standard serving internal trade by paper and 
credit proxies and foreign transactions by carefully supervised actual 
use, relinquished formal adherence to even a fixed international gold 
standard when it appeared to be expedient in the autumn of 1936 to 
participate with Great Britain and France in a three-way ‘‘exchange- 
stabilization^^ plan. This aimed to support sterling, because the British 
were so heavily engaged in the purchase of materials and reserve stocks 
of foods in preparation for the coming crisis that the pound was under 
persistent pressure. 

At the same time, the United States desired not to permit the dollar to 
appreciate with reference to either sterling or the franc. The year 1936 
was one of rising social tension in France, which had insisted upon retain- 
ing a fixed gold standard as set up in 1928, despite the terrific decline 
since that time in world prices in terms of gold. The devaluation of the 
dollar had further intensified this strain on the French price level, and 
thus there were two factors threatening to raise the relative value of 
the dollar and depress prices after several years of rise.^ The Popular 
Front administration that came into power in France in 1936 was follow- 
ing a generally inflationary course in public finance, and this led finally 
to suspension of the gold standard by decree in the autumn. 

In October, France formally devalued the franc more or less in line 
with the reduced purchasing power of French paper money, and, the 
smaller gold powers having already devalued or abandonc'd gold, th(^ 
record was complete. Further devaluations then occurred in Italy and 
various other minor countries. Our agreement with Britain and France 
to participate in stabilizing the rates of exchange, now moored to nothing- 
very substantial, was part of the operation whereby France belatedly 
joined the procession of managed currencies divorced from a fixed gold 
basis, without internal circulation of gold coins. In connection with these 
arrangements, it was found necessary even to restrict gold shipments 
for settlement of international balances to such operations as would 
contribute to the purpose of this agreement. The dollar and the pound 
were maintained for several years in a fairly stable relation, but the 
French, even before the outbreak of the new war in September, 1939, 
found it impossible to maintain the value of the franc as contemplated 

* As early as the spring of 1934, Czechoslovakia had been forced to devalue its gold 
unit. Belgium followed in April, 1935, by a 28 per cent devaluation; Poland resorted 
at the same time to exchange control. The end of the gold bloc came when Holland 
limited export of gold and Switzerland virtually revalued her franc by 30 per cent. 


by the tripartite agreement. As the war crisis approached, the British 
also found it difficult to prevent some further depreciation in sterling 
due to the mounting import balances. 

In the meantime, Germany had gone a long way to develop an unprec- 
edented technique of foreign-exchange manipulation and export price 
control. The need for conserving gold and deliberately rationing foreign 
exchange already existing in 1931 was exploited to capture foreign mate- 
rials needed for war. With the coming of Hitler and the activities of 
Dr. Schacht as head of the Reichsbank in the spring of 1933, the govern- 
ment, in the words of Douglas Miller,^ ^^had made a virtue of necessity^’ 
and begun to use the ^totalitarian control of foreign commerce trans- 
actions as an offensive as well as a defensive weapon. From that time 
forward an intricate series of allocated exchange drawn on foreign 
financial centers, multiple prices on export goods, direct barter deals, 
etc., all represented a policy converging toward a single purpose — the plac- 
ing of foreign trade and finance and, incidentally, all production of goods 
entering into foreign trade, in the control of the central government. This 
meant that the traditional system of free exchange and international 
trade among^ individuals was ended. Efforts were made, temporarily 
with some success, to place the import and export affairs of Germany on 
a unilateral barter basis, with the government setting the price of export 
goods and regulating or allocating all imports according to domestic 
policy and, of course, with an eye to restricting imports to those things 
most likely to develop the armament program. Thus came about the 
formation of a Central European money bloc, the widening of the gulf 
between the group in which the United States was financially an active 
participant, and the militant, increasingly self-contained, war power 
centered in Berlin. 

As Europe stepped up its preparations for the new conflict and as the 
United States remained the great source of needed materials, gold con- 
tinued to flow to our shores so rapidly that it appeared for a time in 1936 
that the offer to purchase gold from all and sundry at $35 an ounce 
might have to be discontinued. No change was made in the price, but 
an important new departure was begun in order to prevent the avalanche 
of gold from raising reserves in the banking system above deposit require- 
ments by too fantastic an amount. It harks back to the suggestions of 
Carl Snyder years before as to direct reserve control. 

In December, 1936, the Treasury began to sterilize gold by acquiring 
with notes most of the receipts and impounding them in an inactive 
account, really a very simple and effective device. This was important 
in that it has since continued to form part of the evolving technique of 
reserve and credit control. With an abrupt rise of commodity prices 

^ “You CanH Do Business with Hitler, “ p. 64, Boston, 1941. 



stimulated by war-material buying in many parts of the world and a 
growing atmosphere of speculative enthusiasm, rising stock prices, and 
accumulation of industrial inventories, it was felt by the Federal Reserve 
that some further action was necessary, not to prevent further increase 
in member-banks excess reserves but actually to reduce the unwieldy 
volume of excess reserves. Therefore, in January, 1937, the Board of 
Governors, by legislative authority, announced that minimum reserves 
required against member-bank deposits would be raised 100 per cent,^ 
one-half taking effect in March and the balance in May. Such a broad, 
direct power to vary the previously fixed minimum ratios of reserves to 
deposits was a far-reaching step in credit-control authority and technique. 
Its unfortunate aspect was that it proved to be exceedingly strong medi- 
cine that injured the patient rather than helping to attain his equilibrium. 
The action contributed to the drastic reversal of general business condi- 
tions in the latter part of 1937, and it was therefore necessary to reverse 
the policy in some degree in the spring of 1938. At that time the Treas- 
ury also released the impounded gold that had accumulated up to that 
time in the inactive fund, but all this was done months after the country 
had begun to suffer from a severe intermediate depression. 

The net effect of the gold policy, together with the insistent flight 
of liquid capital back from Europe, plus the use of new gold mined in 
the British Empire and Russia to make war-preparation purchases in 
the United States, combined by the end of 1940 to bring the gold stock 
of the United States (valued at $35 an ounce) to 22 billions of dollars. 

The foregoing discussion has given special emphasis to the manner 
in which the world-wide financial chaos, coupled with the inherent weak- 
ness(%} in our own methods of handling credit and capital, led to drastic 
political action. Our devaluation of the dollar is a prime example of 
emergency policy. The action of our Government was conceived in an 
atmosphere that made it natural for us to go along with monetary and 
financial expedients rapidly circling around the globe. Following this 
emergency stage there came various plans and revised stnictures that 
were conceived in calmer deliberation and were, on the whole, salutary 
steps, as we shall see in Chapter 15. As the Government proceeded 
along a course of experiment, reform, and managed recovery, it became 
evident that finance was to occupy an important place in all public 
policy. Accompanying these novel measures, sometimes by way of 
rationalizing indiscretion, there naturally evolved theories — expressions 
of principle and formulas to justify practical action. Although the 
economic philosophy of the New Deal is still in a formative process and 
will no doubt be further modified by the emergencies of World War II, 

‘ By law the Reserve Board might not make adjustments below the former require- 
ments or beyond 100 per cent above them. 



it seems important, before we proceed further, to summarize and to 
evaluate, at least tentatively, several of the more articulate expressions 
of monetary thought that appear to have been woven into the fabric of 
the New Finance. 


Let us first consider the ideas that seem to have led to the devaluation 
of the dollar. This grew principally from the ideas of the late George F. 
Warren and of F. A. Pearson at Cornell University. Warren was an 
agricultural economist who had been greatly impressed by the farmers^ 
difficulties throughout the 1920’s and whose conclusions regarding the 
monetary means of creating farm solvency by raising prices were pre- 
sented in a book entitled Prices^’ in January, 1933. The principles 
developed in this book formed the framework for Mr. Roosevelt^s 
emergency monetary policy as Warren, along with James H. Rogers 
and Irving Fisher, conferred with the President on this subject. Unfor- 
tunately the principles are not so clearly formulated as one might wish. 
They include stray bits of very old ideas on altering the coins of the 
realm, convictions popular in the 1920^s on “ managing the currency, 
but withal, strangely enough, a skepticism as to the effectiveness of 
credit policy or the management of banking operations as a means of 
accomplishing price recovery. The basis of the ideology is goldy not 

With regard to gold and prices, the doctrine o!* Warren does not 
run along the lines of the traditional “quantity theory^’ of the money 
and the price level. ^ In one sense Warren agreed with the quantity 
theorists in believing that ‘‘for an explanation of the price changes, we 
must look outside the commodities themselves. The logical place to 
look is at the other side of the price equation — the supply of and demand 
for money. This was, in fact, a demand-quantity theory rather than a 

^ Warren looked upon all credit and paper currency as similar to warehouse receipts 
for wheat. Their value is established by the “value” of gold, just as the value of a 
wheat receipt is established by the value of wheat. This is indeed a crude and extra- 
ordinary theory, denying to gold any value by virtue of its properties as a circulating 
medium and reserve for the credit and paper-money superstructure. This forms a 
substitute for gold in a very different way from the sense in which a warehouse certifi- 
cate is a “substitute” for the commodity in storage. Flour is not made with ware- 
house receipts. 

* By this we refer to that body of doctrine that regards the price level as incapable 
of influencing money or trade and general price-level changes as the proportional 
result of changes in the combined amount of velocity of money and credit in use — 
changes in the physical aspects of supply and trade being considered relatively 
unimportant. Irving Fisher has referred to the advice given the President by Henry 
Wallace as representing the “overproduction” school, a very different doctrine. 

» “Prices,” p. 56. 



quantity theory of money. The crux of Warren^s thinking lies in the 
peculiar concept that money is primarily gold (at least, in the world as a 
whole prior to 1930), whereas the circulating bank credit generated by 
drawing checks upon demand deposits is merely a resultant, subservient 
to trade and 'prices. In another of his writings, Warren went so far as 
to say ‘‘rising prices and increased business result in extensive use 
of credit. The rising prices are a cause of the expansion of credit rather 
than that the expanding credit is a cause of rising prices.”^ And further, 
“banks are more influenced by business than business is influenced by 

Because of this peculiar view of the unimportance of bank credit 
among the forces operating to form the pattern of the price level, Warren 
paid little or no attention to the fact that a given amount of gold, serving 
either as circulating money or as reserve for the credit system, may 
support a total of circulating credit of widely varying magnitude as the 
gold reserve may or may not be effectively economized. Warren seemed 
to regard changes in the “ value of gold as due to variation in the demand 
for and supply of the metals and these value changes somehow caused. 
changes in the level of prices. The usual doctrine holds that the price- 
level change and change in value of gold (under a gold standard) are 
aspects of the same thing. The supply of gold available to “support’' 
the price system seemed a matter of acute concern to Warren. He did 
his principal thinking about these matters in a period of declining prices, 
particularly farm-product prices. As we have seen, the war price level 
was not favorable to gold production, and it was some time before the 
postwar slump in gold output was reversed, particularly by the rising 
trend in the Transvaal, Russia, and Canada. 

The idea of a “gold shortage" had been a source of concern to many 
influential financial writers. Gustav Cassel, in Stockholm, had for years 
been endeavoring to persuade the world that gold scarcity was a desperate 
threat to monetary stability.^ Warren seems to have considered the 
alleged scarcity value of gold after 1930 as due not merely to several 
years of subnormal output but to the existence of a hoarding demand 

^Warren and Pearson, World Prices and the Building Industry,*^ note, p. 94. 
New York and London, 1937. 

* Ibid., p. 144. 

® See, for example, Cassel, '^The Crisis in the World^s Monetary System,'' Rhodes 
Memorial Lectures, Oxford, 1932. ‘*If gold production had continued normal . . . 
the present scarcity of gold would have been far less intense and the Central Banks 
would certainly not have been so eager in their competition for the gold coming on the 
market. Thus a more liberal discount policy would have been possible, and the extra- 
ordinary pressure to which the general price levels throughout the world have been 
exposed during the last few years would have been at least very much relieved.” 
(P. 20.) 



for gold. He was aware that various countries in the late 1920^s had 
attempted to revert to the gold standard and in so doing had apparently 
created a strong demand for the metal for their reserves. When, 
however, the world crisis became serious, there was not only a continued 
race among the leading nations to secure w^hat gold they could but a 
general hoarding demand due to distrust of economic conditions and of 
the banks. This seems to have impressed Warren as a very significant 
element in making the ‘ ‘ value of gold so high and therefore prices so 
low. In order to remedy this unnatural demand for gold, it was first 
necessary to restore the solvency of basic industry and particularly of 
farming so that the farmers could pay debts contracted at a higher price 
level. Obviously, according to his philosophy, this meant cutting gold 
pieces into smaller units. By thus assisting hard-pressed debtors, 
harassed by falling prices and further exposed to price decline insofar as 
important countries insisted on standards of fixed gold pieces, the hoard- 
ing could at once be checked, the value” of gold lowered, and prices 
therefore raised. 

Warren considered that during major wars the value of gold always 
declines because the demand for it declines. Instead of saying, what 
we can prove to be correct, that wars lead to enormous use of paper and 
credit currency, at a time when physical supplies of goods are inadequate 
to meet emergency needs, he chose to view everything in the light of 
gold. Because gold declines in value, prices rise; hence if gold pieces 
are made smaller, prices will rise. Without much regard for consistency, 
he also argued that when prices were rising, the demand for gold in the 
arts usually rose considerably. He did not stop to consider also that 
during major wars governments usually seek in every possible way to 
conserve their gold resources in war chests, thus raising the demand for 
gold.^ The reader can easily perceive by this time the tenuous and 
d(ivious reasoning pervading the Warren philosophy of money. 

It was repeatedly made clear by Warren that he was not interested 
in the general price level” but rather in particular groups of commodity 
prices, especially of the basic raw materials. He ignored entirely and 
specifically repudiated the possibility that any changes taking place 
in physical supply in relation to market requirements might have any- 
thing to do with their price movements. Everything centered upon 
gold. The solution of the current difficulties was, after all, so simple. 
Could not every country create its own price level and validate its debt 

^ Warren said, ^‘The great rise in prices in the United States was due to the fact 
that most of the gold-using world ceased to use gold and ceased to bid for it. This 
reduced the demand and the value of gold, and commodity prices rose. When the 
whole world began to bid frantically for gold, its value rose and commodity prices 
collapsed.*' (“Prices," p. 90.) 



structure merely by revising the terms of its gold standard? Since 
everything depended upon the value of gold in the accepted money 
unit, a larger or smaller amount of gold defining that unit immediately 
changed the basic prices and hence the general commodity level. As 
simple as pushing a button. 

In this one respect Warren’s thinking was typical of that of many 
managed-currency enthusiasts. Their efforts cannot, of course, be 
brushed aside as unintelligent, in view of the known vagaries of gold 
supply, changes in commodity supply, expansion and contraction in 
credit, and many other sources of instability and disequilibrium that 
call for something better if it will work. But the suspicious feature 
about these panaceas is their stress upon simplicity and the ease with 
which complicating factors can be ignored, calmly brushed aside, as it 
were, so that emphasis can center upon discount rates, the juggling of 
security holdings of central banks, the manipulation of gold money, and 
what not. So far as the latter is concerned, it is the ancient device of 
debasing the coin to make it cheap. 


All this dubious and vaguely defined theorizing is quite unnecessary 
in explaining why creating a lighter or adding to a heaviei* dollar, if 
carried far enough, must produce certain effects on the price level and 
on some other things^ also. What it all reduces to is the willingness of a 
country faced by falling prices and distressed debtors to declare economic 
and financial war on the rest of the world. It devalues its money and by 
parting from the rest of the world’s monetary structure determines its 
own price level. Or it may, as in the British instance, keep a manipulated 
price level without any metallic standard. (All things bought and sold 
become the ^‘standard.”) As Warren correctly held, a country can have 
whatever price level it chooses, so long as it makes its money changes 
while other countries do not. This is equivalent to the proposition that a 
country can obtain as much of raw materials, land, and industrial plants 
as it deserves, provided that other countries remain inactive and do not 
defend their property against conquest. We enter here the realm of 
moral questions rather than purely economic questions. The basic 
question Is : Should all countries engage in an endless devaluation race by 
continually readjusting their money units to gain advantages over each 
other? Does this in the end solve anything? Or does it raise innumer- 
able new problems that defy solution? 

It was perhaps one of the merits of the old gold standard — crude, 
unstable it undoubtedly was — that it introduced at least a kind of moral 
code applying to international economic affairs and exchange relations. 
It tended to restrain an important country from going permanently off 



at a tangent to seek advantages in export trade by selling its product 
for momentarily cheap exchange. Under the gold standard there was 
not (so long as the rules were generally respected) a strong temptation 
for a government to scale down its internal debts by currency debase- 
ment, at the same time stealthily pursuing a trade war by cheapening 
its export products against its rivals. Instead of having the terms of 
foreign trade rest upon relative advantages in quality and efficiency of 
production, this insidious new philosophy implies, in what Mr. Warren 
personally advised Mr. Roosevelt to do, an endless juggling of money and 
prices, irrespective of relative efficiencies, for purposes not confined to 
economic stabilization. The result is likely to be in the long run exactly 
the kind of economic warfare leading to the utter destruction of external 
trade that the world Is now beginning to face. 

This aspect of the matter does not, of course, dispose entirely of the 
question as to the wisdom or unwisdom of devaluing the dollar in 1934. 
Probably some devaluation then was politically inevitable. The United 
States had extensive extractive industries that were in acute distress. 
By cutting down the content of the gold unit, the prices of the basic 
international commodities exported did rise in price, more or less propor- 
tionately to the rise in the paper price of gold, as we have seen. The cost 
in dollars of imported commodities rose and contributed another factor 
to the general rise in commodity levels. The general level of prices 
was elevated to an intermediate degree only. But the moral aspect is 
seen in the fact that no serious effort was made by major governments 
of the world to stabilize their cheaper gold (or paper) moneys by some 
firm understanding or agreement so that international relations and 
peaceful trade might once again be restored. There was in the Warren 
philosophy no such thing as willingness to discuss, Warren unfortu- 
nately seemed quite unconscious of the fact that he was urging the 
nation to engage in economic warfare much more certainly than he was 
urging it to reestablish a defective mechanism. In fact, so long as the 
ITnited States retains its present anomalous kind of partial gold standard 
(mth Presidential authority to vary it still further at his discretion), 
other countries can, and probably will, remain upon variable metallic or 
nonmetallic standards, and when the time comes someday to develop 
American export markets, the present amorphous international cur- 
rency situation may well produce a great devaluation race plus the logical 
concomitant — unilateral barter dealings forcing still further devaluations. 

We may, therefore, pay heavily in the end for our artificial price sup- 
port, which very probably could have been achieved through the various 
agricultural control measures developed under the AAA, and the revival 
of general income and buying power through expeditious housecleaning 
in capital finance and broad rehabilitation of the construction industry. 



In point of fact, all this furore regarding gold and devaluation and price 
reflation seems actually to have delayed by several years the sound 
recovery of the heavy industries, whose prosperity does not primarily 
rest upon a rising price level in the commodity markets. It is significant 
that the U.S. Department of Commerce estimated, at about the time the 
gold manipulation matter was being discussed, that of a total of nearly 
120 billions of long-term debt in the United States, the farm mortgage debt 
was only about 9 billions; most of the balance was not the kind of indebtedness 
that juggling of commodity prices could directly alleviate. The rescue of 
marginal farmers was an urgent problem, and we cannot deny that deval- 
uing the dollar did contribute something to inflate farm income and that 
this assistance extended to other industries by diffusion; nevertheless, as 
a solution of the general debt phases of this great depression, devaluation 
of the dollar cannot be rated very highly.* 

^ The Warren-Pearson doctrine emphasizing the possibility of price adjustment 
through gold devaluation was given enormous circulation through the formation of 
what was known as the Committee for the Nation to Rebuild Prices and Purchasing 
Power. Although neither Warren nor Pearson was a member of this Committee, 
which was headed by a group of businessmen under the leadership of J. H. Rand, Jr., 
there was a close liaison between these parties. In May, 1933, the Committee began 
a public campaign of wide scope demanding that the dollar be revalued to reestablish 
the 1926 price level and that the price of gold in the future he changed in such manner 
as to maintain dollar of stable purchasing power that will protect us from future 
disruption of our price level.’^ It seems typical of the proponents of monetary, as 
well as credit, manipulation that they are all excellent propagandists. 

This Committee seems to have had considerable influence upon the Roosevelt 
Administration in urging that the United States refrain from entering into definite 
commitment regarding international stabilization, it being feared that this would 
prevent an adequate revaluation of the dollar and the price level, in view of the fact 
that so many other countries had already revised their currency basis drastically. 
In these efforts the Committee found support in a similar hostile attitude toward gold 
^‘deflationism’’ and stabilization attempts expressed by J. M. Keynes, who desired a 
British- American plan of ^‘managed paper money. Aristide Briand, in France, 
meanwhile was urging Britain to join the Continental gold bloc in the interest of 
developing his favorite proposed project, a United States of Europe. 



Let us turn briefly to several other important changes in banking 
policy and structure. These are important in view of the fact that 22 
billion dollars of bank reserves, or potential reserves, even in a banking 
system having some degree of direct control over reserve requirements, 
is certainly an impressive base for credit inflation. It is remarkable how 
persistently since 1933 has been the opinion of financial authorities and 
writers on investment problems that inflation was inevitable and would 
be of tremendous proportions. What these analysts omitted to consider 
was the powerful combination of banking regulations and reforms that 
came into existence as the gold