Mz •Mil!' •iiii: MM m '.'* ilipi I Cornell University Library HB3717 1920.C59 Business cycles and the depression of 19 3 1924 013 912 013 PCJLLETIN OF THE DEPAB « ^ITS OF HISTORY AND POLITIGAL AND ECONOMi .GlENCE IN QUEEN'S UNIVERSITY, KINGSTON, ONTARIO, CANADA. NO. 40, AUGUST, 1921 Business Cycles and the Depression of 1920-1. BY W. C. GLARK rhe JaclnoB PresB, Kisgaton BULLETIN OF THE DEPARTMENTS OF HISTORY AND POLITICAL AND ECONOMIC SCIENCE IN QUEEN'S UNIVERSITY, KINGSTON, ONTARIO, CANADA. No. 1, Tbe Colonial Policy of Chatham, by W. L. Grant. No. 2, Canada and the Most Favored Nation Treaties, by O. D. Skelton. No. 3. The Status of Women in New England and New France by James Douglas. No. 4, Sir Charles Bagot: An Incident In Canadian Parlia- mentary History, by J. L. Morlson. No. 5, Canadian Bank Inspection, by W. W. Swanson. No. 6, Should Canadian Cities Adopt Commission Govern- ment, by William Bennett Munro. No. 7, An Early Canadian Impeachment, by D. A. McArthor. No. 8, A Puritan at the Court of Louis XIV, by W. L. Grant. No. 9, British Supremacy and Canadian Autonomy: An Ex- amination of Early Victorian Opinion Concerning Canadian Self-government, by J. L. Morison. No. 10, The Problem of Agricultural Credit in Canada, by H. MichelL No. 11, St. Albaii in History and Legend: A Critical Examina- tion; The King and His Councillors: Prolegomena to a History of the House of Lords, by L. F. Rushbrook Williams. No. 12, Life of the Settler in Western Canada Before the War of 1812, by Adam Shortt. No. 13, The Grange in Canada, by H. MichcU. No. 14, The Financial Power of the Empire^ by W.W. Swanson. No. 15, Modem British Foreign Policy, by J. L. Morlson. No. 16, Federal Finance, by O. D. Skelton. (Continued on inside back page> BUSINESS CYCLES AND THE DEPRESSION OF 1920-1. "We have just gone through a time of busy industry, and are come upon sorrow and ill fortune; but the same things have befallen us often within the knowledge of those now living. . . A period of bustle, or of gambling, cut short in a trice and turned into a period of suffering and loss, is a phenomenon so often recorded, that what is most to be noticed is that it should excite any wonder." — Dr. Hyde Clarke, "Physical Economy — a Preliminary Inquiry into the Physical Laws governing the Periods of Famines and Prices," 1847. Another business cycle has about run its course. If one may hazard a guess based on previous experience and on a few current indices, we are somewhere near the middle of the busi- ness depression which is liquidating the artificial boom of the war and the post-Armistice period. As this is being written, in July, the "between seasons" month, normal midsummer dullness has aggravated the cyclical depression and the general tone of the business world has been not inaptly characterized as one of enthusiastic pessimism. Bad news is doubtless still in store for some trades ; probably for business as a whole it may be next March before the worst is reached ; and perhaps after that, recovery may be very gradual and halting. Yet funda- mentally there is reason for confidence and courage. Indeed now almost for the first time, those who face facts squarely find solid ground for optimism. The gradual but substantial measure of liquidation already achieved, the increasing realiza- tion of the necessity of a restored economic equilibrium on the part of groups like the building trades which had long resisted the inevitable, the settlement of some major strikes and the avoidance of others, the improved transportation situation, the easing of money rates, the back-to-work move- ment in most European countries, and the improved political situation lead one to believe that we are already near the bottom and that the rest of the descent need not be so danger- ously rapid as to result in a crash. Perhaps there is a wider realization than ever before of the nature and cause of the present stagnation. But memories are short and historical perspective is still sadly lacking. Duringthe 2 later years of the war, everybody knew the world would have to pay the usual price for the hectic prosperity which had no solid basis. But the reaction was expected to come immedi- ately and when after a few months' hesitation, business began to pick up, the lessons of history were again promptly forgotten and the fall of 1919 saw an outbreak of speculation in business and stock market circles that for recklessness has had few parallels. It may therefore be worth while to sketch the his- tory and present position of opinion on the subject of industrial fluctuations before undertaking a brief description of the course and significant features of the current depression. Crises, as we now know them, are largely phenomena of the last century and a quarter, and of countries which have come under the sway of the factory and credit systems. "The first modern panic" is said to have been the severe one of 1793. True, there were serious commercial disturbances in 1720 (when the South Sea Bubble collapsed) , 1763,1772-3, and 1783 ; and W. Stanley Jevons professed to find what were currently called "stock-jobbing" panics at regular intervals in the other decades of the eighteenth century, but on scanty evidence. The characteristic modern crisis does not appear until the nine- teenth century. Its explanation early gave trouble to the economists and the literature of the subject is very extensive and highly controversial. Generally speaking, one may say that until recently the tendency was to regard crises as sudden catastrophes interrupting the "normal" course of business and to explain them by special causes or accidental happenings such as wars, crop failures, bad banking systems, inventions, changes in trade routes, tariff legislation, unsettling adminis- tration by your Roosevelt or my Lloyd George, or the failure of some conspicuous business establishment. Study was con- centrated on the external and incidental features of each indi- vidual crisis and on the spectacular three or four weeks in which the "crash" occurred. To-day the theory of crises has been broadened into a theory of "business cycles," the crisis itself being regarded as simply the most dramatic and the briefest of the three phases of the cycle through which modern industry recurrently passes. Thanks to some inherent charac- teristic -of our economic organization, business activity to-day presents the aspect of a wave-like motion, prosperity leading to a crisis, the crisis being followed by a depression, and de- pression ultimately giving way to prosperity. The student's task is therefore to analyse the complex processes of business life in order to discover why they inevitably work out a change from good times to bad and from bad times to good. Special factors must of course be taken into consideration but their influence will be found to be by way of complicating the pro- cess or furnishing the occasion rather than the cause. Attention was first turned from the search for separate causes of each isolated crisis by the regularity with which crises have continued to run their course decade after decade in every highly industrialized nation. That regularity is indeed suspicious. In England, for example, and with some variations in France and Germany ,we find crises in 1793, 1803, 1810, 1815, 1825, 1836-9, 1847, 1866, 1882, 1890, 1900, 1907, and 1914. In the United States, the corresponding dates are 1818, 1825, 1887, 1847, 1857, 1873, 1884, 1893, 1903, 1907, and 1914. A double pulsation seems apparent, the disturb- ances of 1818, 1837, 1873, 1893, and 1907 being especially severe. To economists of forty or fifty years ago the periodi- city was striking and the usual claim of a ten or a ten and a half-year duration seemed to have an historical basis. This periodicity stimulated a number of investigators, including Dr. Hyde Clarke (as early as 1838), Sir William Herschel, John Mills, Poynting, J. T. Dawson, James Wilson, W. S. Jevons, and others, to search for a single persistent cause of all cycles. The work of Jevons^ is well known. By a brilliant stretch of scientific imagination, he attributed the decennial recurrence of industrial crises to the variation of the sun-spots or rather, to be strictly fair to him, to meteorological varia- tions depending upon cosmical conditions of which the sun- spot activity is only one index. Jevons, however, was misled by a mistaken calculation of meteorologists of the time, that the sun-spot cycle was 10.45 years in length — a duration which coincided almost perfectly with the 10.46 years which he had worked out as the average length of the thirteen eco- nomic cycles between 1721 and 1857. Unfortunately for his ijevons. Investigations in Currency and Finance, Chaps. 1, 6, 7 and 8. theory, later investigations have definitely established the sun- spot cycle as 11.125 years. The exact relation of sun-spot activity to climate again is still the subject of controversy. Finally, more intensive study of earlier industrial fluctuations shows that Jevons somewhat exaggerated the measure of periodicity that did exist in earlier times, and our more recent experience has shown marked departures from the ten-year duration. Indeed the length of the most recent normal cycles seems to average seven or eight years. A recent writer sug- gests with some appearance of justice that a trade cycle inclines to be about either twice or three times a period of approximately three and a half years. Regularity is therefore far from perfect, though a comparatively high degree of periodicity is usually admitted.^ Realization of the above facts gradually dampened the enthusiasm of those who sought a uniform cause of cycles in physical or meteorological conditions and it has become the custom of the present generation to smile at Jevons and his sun-spots. Recently, however, there has been a revival of interest in this type of theory. In 1908, the younger Jevons published an article,^ attempting in an ingenious way to revive his father's theory by making use of the results of later astro- nomical and meteorological investigations. More important is the work of Professor H. L. Moore of Columbia University.* A master of mathematics and statistical technique. Professor Moore uses the most refined methods of harmonic analysis to establish eight-year cycles with maxima approximately at 1882, 1890, 1898, 1906, 1914 in the annual rainfall of the Ohio Valley, in the May and June rainfall of the Dakotas, in the yield of wheat, oats and barley in the Dakotas, the United States, the United Kingdom and France, and in the production in the ^Professor Chapman suggests a resemblance to the oscillations of a pendulum when a kitten is playing with it. ^H. S. Jevons, Trade FluctiMtions and Solar Activity, Contemporary Review, August, 1909. *See his book, Economic Cycles, their Law and Cause (1914), and articles in the Quarterly Journal of Economics, February 1921, the Poli- tical Science Quarterly, June 1919, and the Journal of the Royal Statis- tical Society, May 1919, and May 1920. United States of coal and iron and of raw materials of manu- facture. He also finds that the eight-year cycle in the yield per acre of the crops tends to generate an eight-year cycle in the prices of the products and concludes that the law of the cycles of rainfall is the law of the cycles of crops and the law of economic cycles. Even to those for whom mathematics is not an unfathomable mystery, Moore's periodigrams may not be entirely convincing. The range and accuracy of our me- teorological data are probably not sufficiently great nor their interpretation sufficiently uniform'^ to provide a convincing basis for what he has attempted to do. Fortunately much work is being done at the present moment in the United States, England, Sweden, Russia, Japan, India, and Canada in the col- lection of meteorological data and in the investigation of the precise relation between climate and agriculture. Doubtless much more will also be done in the application of harmonic analysis to our economic data and Moore's work may just mark the beginning of a fruitful type of investigation. Mean- while with the scant data at his disposal he has made a strong case for believing that weather cycles are at least an important contributory cause of "economic cycles.^ But even lacking a full comprehension of the influence on industrial fluctuations of physical factors of this sort, we can show that there is something in the nature of our complex business mechanism which of itself inevitably produces the rhythmic movement which we have discovered. This we pro- pose to show by paraphrasing W. C. Mitchell's" analysis of a typical business cycle. The process to be described is so com- plex that in so condensed an exposition it is difficult to depart far from Mitchell's methods of analysis or even from his iln regard to periodic oscillations of climate, for instance, the only cycle fairly well accepted by meteorologists is the Bruckner 35-year cycle in temperature and rainfall. ^Contrast the able analysis by A. Piatt Andrew in Quarterly Journal of Economics, August 1906, of the influence of the crops on business in America. ^See his masterly work on Business Cycles (1913). Among other works of importance (from most of which Mitchell has drawn in the building up of his eclectic theory) are the following: Beveridge, Unem- 6 phraseology. The broad underlying factors, it will readily be noted, are the extreme specialization characteristic of modern industry, the large-scale production carried on months ahead of demand and in anticipation of demand, the intricate inter- locking of firms and places through the credit system, and the mob-mindedness of men. Since it is necessary to dip into the cycle at some point, we may start with the revival of activity just after a depres- sion. The period of stagnation has left us with a low level of prices, narrow margins of profit, liberal bank reserves, a con- servative policy in capitalizing business enterprises and in granting credits, moderate stocks of goods on dealers' shelves, cautious buying on the part of consumers, and drastic reduc- tions in the costs of doing business (because the management is striving to eliminate wastes, the workers are more efficient through fear of losing their jobs, and funds can be borrowed at low rates) . For reasons to be explained later, these condi- tions are accompanied by an expansion in the physical volume of trade, slow at first but of cumulative force and frequently hastened by some propitious event such as a very favorable harvest (as in 1915), heavy purchases of supplies by govern- ments, or a marked increase in export trade. This initial revival may at first be confined to a small group of industries. But, even if so, the active concerns must soon buy raw ma- terials and current supplies from other firms, the latter from still others, and so on indefinitely. Meanwhile the larger volume of wages paid and profits earned brings an increase in family incomes and a consequent expansion of consumer's de- mand which also spreads out in ever widening circles. Retail- ers, wholesalers, manufacturers, importers and producers of raw materials find their trade growing, increase their pur- chases, pay out more money to employees and lenders, and thus ployment; May, Das Grundgesetz der Wirtschaftskrisen; Aftalion, Essai d'une Theorie des crises gmerales et periodiques; Bouniatian, Studien Zur Theorie und Geschichte der Wirtschaftskrisen; Spiethoflf in Schmol- ler's Jahrbuch fiir Gesetzgebung, 1902, 1903 and 1909; Hull, Industrial Depressions ; Lescure, Des Crises generales et periodiques de surproduc- tion; Veblen, Theory of Business Enterprise; and Jones, Economic Crises. The writings of J. A. Hobson, Irving Fisher, T. N. Carver and W. Som- bart also contain valuable suggestions. stimulate afresh the demand for both producers' and consum- ers' goods. It is not long before this expansion of orders reaches back to the firms which gave the initial impetus to revival, and then the whole complicated series of reactions begins again at a higher pitch of intensity. The psychological factor has also been at work. Increasing business makes busi- ness men optimistic and this feeling not only justifies itself but heightens the forces which engendered it by making the public readier to buy with freedom. But what has been happening to prices during this re- vival ? Obviously, to bring out the increased production, prices must rise, and once started they rise rapidly, for, as we found out so clearly during the war, every advance in quotations puts pressure on the buyer to recoup himself by a similar rise in the prices of what he has to sell. But the price changes are far from uniform, and this irregularity is important for our story. For reasons that lie buried in technical differences in market organization and in relative demand for and supply of different classes of goods, retail prices always lag behind wholesale, staple consumers' goods behind staple producers' goods, fihished products behind raw materials, and raw animal or farm or forest products behind minerals. More important perhaps, wages rise often more promptly but always in less degree than wholesale prices; discount rates (for short time loans) may rise more slowly or more rapidly than commodity prices; interest rates on long time loans always rise more slowly, especially at first, while the prices of stocks both pre- cede and exceed the rise in the price of goods. The significant feature of these price changes is the failure of production costs to keep up with the prices of finished products. This coupled with the increasing volume of sales means larger profits for business men. Increased profits and the prevailing spirit of business optimism lead to a marked expansion of investments and the resulting heavy orders for equipment still further swell the volume of trade and drive prices upward. Finally, all these varied forces — augmented trade, rising prices, growing optimism, expanding profits, increased investment — act and react on each otheB with cumulative effect. The squirrel cage turns faster and ever faster. 8 On the surface at least there seems no reason why this process of enhancing prosperity should not continue indefi- nitely, and the business world acts on this assumption. Gradu- ally, however, there accumulate stresses or strains within the delicately balanced system of business which ultimately under- mine the conditions upon which prosperity rests. These stresses are of two chief types. In the first place, there is a gradual increase in the cost of doing business. Old contracts for buildings, supplies, officials, funds, etc., expire and have to be renewed at higher levels. Poorly located plants and anti- quated equipment have to be conscripted for steady use, as so many times during the war boom. Labour costs increase be- cause of higher standard rates (which can now be easily forced), heavy overtime payments, and decreasing efficiency thanks to the necessity of employing the least desirable work- men and the inability, when jobs are plentiful, of driving crews at top speed. Finally, raw materials continue to rise faster than manufacturers' selling prices and the press of busi- ness leads inevitably to numerous small wastes. The second and perhaps more obvious strain is the accu- mulating tension in the investment and money markets. Funds for long time purposes fail to keep pace with the rapidly swell- ing demand, capital becomes scarce and dear. Short time funds show the same characteristics, for bank loans are limited by cash reserves. These high rates in the bond and money mar- kets are unfavorable to the continuance of prosperity, because they reduce the prospective margins of profit and check the expansion of trade out of which prosperity developed. Either because borrowers conclude that the interest would eat up the profit or because lenders flatly refuse to extend further capital or credit, many projected undertakings have to be postponed or given up altogether. The check from this stress is espe- cially severe on steel mills, foundries, machine shops, smelters, quarries, lumber mills, cement plants, construction companies and other firms which depend primarily upon the demand for industrial equipment. While they may be busy with old con- tracts, they face a serious decline in business in the near future because high money rates and high construction costs have deferred so many plans for extending old and erecting new plants. 9 The larger grows the, inverted pyramid of prosperity, the more severe become these internal strains or stresses. The only salvation lies in a perpetual rise of prices which will postpone the evil day when costs catch up with profits. But, fortunately for the consumer, the rise in prices cannot go on forever. In some lines prices are fixed more or less rigidly by law, by public commissions, by long time contracts, by custom (note the five cent fare on street railways), or by business policy. There are other lines in which prices depend on weather risks and vary up or down with crop reports. In some industries the capacity for production has increased faster than demand for the product at the higher price. This type of maladjustment is a dominating influence in some cycles. Contracting firms, as we have found, are in special difficulties, and their difficulties react upon those from whom they buy materials and supplies. Thus as prosperity approaches its climax, a minority of business enterprises face the prospect of declining profit. This minority grows larger, the more intense prosperity becomes. A radical readjustment is only a matter of time. But why, precisely, does trouble actually develop in the threatened group of industries? In default of special condi- tions which are sometimes important, the primary reason is doubt which the decline in profits arouses as to the security of outstanding credits. Business credit is based on the capi- talized value of present and future profits. Now at the peak of prosperity the volume of such credit outstanding is based on the exaggerated expectations which prevail when the volume of trade is enormous, prices high, and business men optimistic. With rising interest rates and declining profits, creditors see their security melting away and begin at once to refuse renew- als of old loans, probably also insist on repayment of outstand- ing accounts. Just as soon then as rates of profits cease to be as large as expected, the huge towering structure of business credit is undermined and a process of liquidation ensues. The acute stage of liquidation is what we mean by a crisis. It is characterized by a falling off in orders and a consequent con- traction in trade, a rise in discount and interest rates, a fall in the price of commodities and of securities, reduced employ- 10 ment and extensive unemployment, an increasing number of business failures, and a general halting character to all busi- ness operations. It may be short and intense or long drawn out and less severe, but normally lasts only from one to three months — whereas the preceding period of prosperity is usually a matter of two to four or five years. The crisis which is primarily an industrial phenomenon may degenerate into a financial panic. This usually happened in the United States before 1913, thanks chiefly to the an- tiquated National Banking System. If, when a crisis is im- pending, a conspicuous concern happens to be in an especially weak position, its bankruptcy may bring down a large number of other firms and spread unreasoning alarm among the busi- ness public. At such times the country's banks are suddenly forced to meet a double strain. Business men want sudden in- creases in their loans and the man in the street wants cash for his deposits. If the banks can meet both these demands with- out flinching, as they have been able to do in England, France and Canada, the alarm is quickly dispelled. But the old United States banking system, with its independent local banks, its lack of unity, and its scattered reserves, made such a bold policy impossible. Many solvent firms had to be re- fused loans at any price, cash payments had to be suspended in whole or in part, and, as a result, the usual incidents of a financial panic crowded one upon the other — a premium upon currency, hoarding of cash, use of unlawful substitutes for money, a sudden jump in interest rates, numerous bankrupt- cies, slow collections, dislocated exchange rates, serious unem- ployment, price declines, sacrifice sales, violent contraction in the volume of business, maximum expansion in bank-note cir- culation, frantic efforts to import gold, and frantic appeals to the Government for extraordinary aid. All these features were especially marked in 1907 when the failure of the Knick- erbocker Trust Co. precipitated the panic in New York City. But the panic, if it does occur, will not last long. After four or five weeks of financial storm, with or without a slight temporary revival of activity, a period of depression ensues, gradually spreading over the whole field of business and becom- ing more severe as it spreads. The reasons are not far to seek. 11 Unemployment and under-employment mean lowered family incomes and decreased consumers' demand. As a result pro- ducers' demand for raw materials and current supplies falls off. Investors' demand for construction work of all kinds shrinks still more rapidly. These several shrinkages in demand cause further discharges of employees and reduce consumers' de- mand once more. Thus the whole round begins again at higher speed. Competition for the declining volume of business brings lower prices. Each drop in prices facilitates or forces other price reductions, and this force also becomes cumulative. But these price declines, like the previous increases in the price level, are by no means regular. Goods sold by wholesalers fall in price faster than those sold at retail, producers' goods faster than consumers' goods, raw materials faster than manufac- tured goods, commodity prices more rapidly than wages and long-time interest rates, discount rates and stock prices to a greater degree than commodity prices. For business men the significant result of all these forces is the decline in present and prospective profits. This spreads an atmosphere of gloom among business men which deepens as it spreads, and still fur- ther aggravates the forces which engendered it. In analysing the early stages of the cycle, we found forces at work in the period of prosperity which inevitably produced a crisis. Are there forces at work in the period of dullness which will automatically bring an end to depression? In the first place the costs of production are greatly lessened by de- pression. Prices of raw materials and of bank loans have fallen greatly. Labour is more efficient because men are anxious to hold their jobs, and overtime is seldom necessary. Managers are forced to economize and eliminate the small wastes. The water is squeezed out of inflated capitalizations. Rents are re- duced and loans refunded at lower rates. Bad debts are charged off, property values written down, and in other ways supple- mentary costs are reduced. In the second place depression after a time leads to a material increase in the physical volume of trade. Old stocks are gradually exhausted. Clothing, fur- niture, and other moderately durable articles eventually wear out and must be replaced by current consumption. A larger population mugt be fed and clothed, new tastes appear, busi- 12 ness men become less timid, and the demand for industrial equipment revives because bonds can be floated on especially good terms and the cost of construction is low. For all these reasons, and usually within one or two years after the initial collapse, the depression gives way to a revival of prosperity and the business cycle is complete. So runs the story of a typical business cycle. What light, if any, does it throw on the present industrial situation ? Our last depression in Canada began with the breaking of the Western construction and real estate boom in the winter of 1913, was aggravated by the outbreak of the war, and con- tinued until the miraculous grain crop of 1915 and the placing of large war orders by the Imperial and Dominion Govern- ments, initiated a revival of prosperity in the autumn of 1915. With some slight reactions boom conditions persisted in Can- ada, as in most other countries, until the close of the war. The general features of this boom and its underlying causes in abnormal war demands, huge borrowings, and inflated cur- rency, are well known. More striking and not so well under- stood is the secondary boom which followed the Armistice after a few intervening months of hesitancy and readjustment. Most people expected the fall in prices and the other incidents of crisis and depression to follow rapidly upon the heels of peace. But they had not realized that the shelves of the world were bare and that a large part of the world was hungry, scan- tily clad, poorly shod, and poorly housed. They had also some- thing yet to learn of the mysterious workings of currency in- flation and national borrowing. After an anxious winter, busi- ness commenced to pick up in April. As the wheels of indus- try began to turn faster and faster, the business world once again made the mistake that has been made in every period of boom. Men thought that they had at last surmounted eco- nomic laws and that this time an artificial boom would not have the usual results. The brakes were therefore thrown off and the machine was driven full steam ahead, regardless of pos- sible consequences. The most spectacular index of the reckless pace at which business was being driven was the rise in prices. In the last six months of 1919 prices rose more rapidly in -Canada, as in 13 most other countries, than in any similar period during the war, and the increase was added to a price level which was al- ready considered to be at the limits of tolerance. It would be difficult to say whether the initial impetus came from Europe or from inflation of currency due to government borrowing, or from the increased domestic" purchases by returned soldiers who in Canada at least had been liberally bonused out of Gov- ernment funds secured by borrowing. Certain it is that the European factor soon became the dominant influence. After the Armistice Europe took an easy but short-sighted method of getting goods and paying debts. Instead of following the straight and narrow path of work, thrift, and taxation, the peoples of Europe set the printing presses to work to bridge the ever-broadening gap between public revenue and public expenditure. In Germany, for instance, paper money increased by over 50 per cent, in 1919, and again by nearly 60 per cent, in 1920. On Dec. 31, 1920, Reichsbank and war loan bank notes alone reached the incredible total of 80,838 millions of marks, — which in five franc notes of the size of one of our dol- lar bills would be sufficient to cover the old German Empire thirty layers deep. The same process went on to a greater or less extent in other countries, and was usually accompanied by a similar inflation of bank deposits. Currency depreciation and soaring price levels were the inevitable sequels. For a time the manufacture of money seemed to be Europe's most impor- tant industry. The goods which she failed to produce, the war-ridden Continent was buying in enormous quantities from every part of the world, but her purchases were being made on credit. Between January 1, 1919, and September 15, 1920, the United States alone, according to one estimate,^ sold to Europe on "open account" not less than three and a half billion dollars' worth of goods. This is a net figure obtained after making proper allowance for Government advances to Europe of $2,820,000,000, a commodity trade balance in favour of the United States of $6,600,000,000, and the other relevant debt and credit entries in the balance sheet during the same period. The building up of this huge unfunded debt was apparently IB. M. Anderson, in Chase Economic Bulletin, Oct. 5, 1920. 14 made possible by London assuming financial responsibility for the Continent and by American Banks providing the funds through the creation of new bank credit. Some of this bank credit was granted directly to European importers or to Euro- pean' importers on the guarantee of British Banks, but prob- ably most of it was an indirect advance in the form of ordinary "line of credit" loans to American producers and exporters who had tied up their working capital in indefinite advances to European traders. Much the same thing was going on in Eng- land, in Canada, and in other countries. Detailed Canadian information is not easily accessible, but Canada's favorable balance of trade with all countries other than the United States, of over $1,100,000,000 in the fiscal years 1919 and 1920 may be taken as a rough index of our relations with Europe. Meanwhile this apparently insatiable European demand was building up throughout the world a fictitious prosperity and laying the foundations for ultimate collapse. For one thing it drained the non-European markets of goods, and thus accentuated the influence of huge Government expenditures and the other forces which were already making for higher prices. More importantly, it encouraged the spirit of specula- tion which still further raised prices by creating artificial shortages and by raising exaggerated hopes of future price increases. The speculation in commodities, securities, and for- eign exchange which began in the summer of 1919 has been described by a recent financial writer as nothing short- of ap- palling. At the time the tendency was to attribute the rise in prices almost wholly to scanty output on the one hand and to lavish consumption on the other. There is no doubt that partly as a result of unusually high money incomes for some classes and partly as a reaction after the war tension, the spirit of extravagance did run wild. There was little or no haggling over prices when purchases were being made — though perchance much academic cursing afterwards — and high price rather than high quality was alleged to be the de- ciding consideration with the customer. As time went on, of course, high prices began to pinch and consumers had of necessity to reduce their expenditure. Real scarcity, either 15 the result of short production or of Europe's abnormal de- mands, also played its important part, as we have seen. But there can be no doubt that, temporarily, speculation accentu- ated the real shortage in many lines. Tlhe high-priced pro- ducts tempted to speculative holding and to overstocking on the part of middlemen in the expectation of still higher prices. The facts in regard to sugar are vfell known. The United States index number for the wholesale prices of lumber and building materials rose from 162 to 341 between April, 1919, and April, 1920, though there was really very little building. Raw cotton in the same period rose at New Orleans from 26% cents per lb. to 41 Va cents, though the cotton crop was very large and the output of cloth was declining under the high prices of marketed textiles. Meanwhile, despite larger sales, stocks in the retail trade had been piling up on merchants' shelves, and in the first half of 1920 were 40 to 50 per cent, greater than in the corresponding period of the preceding year.^ These few straws may be taken as indicative of the way in which, both as a result and as a cause of the rapidly mounting price level, there was piling up in the world's mar- kets an unprecedented volume of products, unabsorbed by con- sumers at the high prices and for the most part "sequestered away by high-bidding operators in quest of still higher prices." We have not the space necessary to follow in detail the development of the other phases of this post-war boom. Suf- fice it to say that as the year 1919 wore on to its close, the strains or stresses which we have found to be typical of the later stages of a normal boom began to make their appear- ance. Costs of production rose with startling rapidity. The increase in labour costs was great and rapid. The spring and summer of 1919 saw a very large increase in the number of persons on strike for increased wages, shorter hours, and union recognition. Shop discipline was difficult to maintain and efficiency was much below normal. In spite of the return of four million men from the army and navy to industry in the United States, there was a decline in the physical volume of production in 1919 as compared with 1918, estimated at 4 per ^Standard Daily Trade Service, July 18, 1921. 16 cent, by Prof. Stewart, at 5.5 per cent, by Prof. Day, and at 7.4 per cent, by Mr. B. M. Anderson. Canadian figures would show roughly the same conditions. Business managers them- selves showed a similar decline in efficiency. They found it too easy to add increased costs to selling prices to be bothered much by small wastes. They were sometimes too easily persuaded to incur extravagant overhead expenses by persua- sive promoters with 'ideas to sell" — witness the huge expendi- tures on long-run advertising by firms who were swayed by the argument that in view of the excess profits taxes a million dollars' worth of extra advertising could be obtained for an expenditure of that sum less the 30 or 40 per cent, which would otherwise have to go to the Government in taxes. Raw materials again, especially building materials, rose more rap- idly than finished products. Between April, 1919, and April, 1920, bituminous coal at the pit's mouth in the Pittsburgh dis- trict, rose from $2.25 to $4.25, and by July the price had rea,ched the impossible level of $10.00 per ton. As we shall find, the cost of money both for short and long term purposes also increased steadily. As these various constituents of cost of production rose during the Fall of 1919 and the first half of 1920, the position of industrial enterprises became less and less sound. Espe- cially was this true of industries like gold mining, railroading, and public utilities, whose prices were more or less fixed. Their difficulties multiplied rapidly during the early part of 1920. But even for the ordinary industry, costs began to creep up as rapidly as, or more rapidly than the prices of finished pro- ducts, now at an intolerable level, could be raised, and the pro- spective margin of profit threatened to become too low to sup- port the superstructure of credit which had been built up. In some booms, as we have seen, maladjusted production, and es- pecially, over-expansion of the equipment industries, may play a dominant part. Thus over-building of railways was the pri- mary cause of the English crisis of 1847 and the American crisis of 1873. In the most recent boom this factor played a less important part. True there was a fundamental disturb- ance in the world's industrial equilibrium, when Europe almost ceased to be a producer of manufactured goods and began to 17 purchase such goods in enormous volume from North America. During the war, also, a tremendous amount of capital went literally "up in smoke" and much was spent on munition plants and aircraft factories, demand for whose products ceased with the war's close. But the burden of these wastes of capital was borne chiefly by governments. Business men made provision for the risks by charging higher prices and building up large reserves. More serious in its effects was the elaborate shipbuilding campaign undertaken by the Ameri- can, Canadian and certain other Governments after the Armis- tice. The over-building which resulted may be indicated by a single illustration. The United States' merchant marine built at a cost of over three and a half billion dollars has now an estimated market value of about one billion dollars. Much of the difference is sheer irrecoverable waste. Finally the epi- demic of extravagance to which we have already referred re- sulted in over-expansion in a number of luxury industries such as those producing automobiles and automobile accessories. On the whole, however, the war period was one of restriction in construction and equipment; and there was, and still is, a shortage of -houses, business blocks, cars, locomotives, and other capital goods. The present depression is, therefore, the result not so much of an industrial reaction as of a price col- lapse following a period of unprecedented credit inflation. Meanwhile as costs and prices rose and the markets wit- nessed wave after wave of speculative activity, there was a growing tension in the investment and money markets. The strain on the banking systems of the leading countries soon became terrific. In a single year, loans of the chief banks to business men increased by about 25 per cent, in the United States, 41 per cent, in England, and 32 per cent, in Canada. This huge expansion was the result of the credits granted to Europe and of the rising prices and speculative activity which compelled all business men to borrow more largely in order to carry their inventories. While current loans were thus in- creasing, stock market speculation required a heavy volume of loans at call, the United States was loaning gold in large amounts to the non-European world, and the cash reserve ra- tios of the different banking systems tended steadily to fall. 18 It was in the call loan market that trouble first developed. During the Summer of 1919 rates had fluctuated widely, but it was not until November that the strain which speculative activity was exerting on the banking position forced the ruling rate to around 15 or 20 per cent, and even to a maximum of 30 per cent, on November 12. The strain continued through- out the winter months with the rate ranging from 6 to 25 per cent. In November also, official discount rates, which for a time had been held at an artificially low level, were raised hothr in London and New York, and successive increases followed. The market rate for commercial loans also grew steadily firmer. For instance, in the United States the rate on prime commercial paper, which during the summer of 1919 was steady around 5l^ per cent., strengthened to 5y2 in November, to 6 in February, and to 7 in March. Finally, the investment market showed evidences of a similar strain. Firms which had bonds issues maturing during 1919 found that they could renew their loans only on exceedingly difficult terms, and the numerous issues of short-time notes and of 8 per cent, prefer- ence shares with many of the privileges of bonds showed how strenuously business men tried to avoid long-time contracts to pay, the high interest rates. By the spring of 1920 the price and credit situation had reached the explosive point. The collapse came first in Japan with the sudden break in the silk markets, followed by the closing of the important exchanges, and a rather serious finan- cial panic. The movement spread to India, then to Cuba, then to Europe, and finally to the United States and Canada. In April and May in the two latter countries two things happened at about the same time. The public, exasperated at the cqp- tinual rise in prices and with buying power sharply curtailed, began the so-called consumers' strike; and the banks, con- vinced that prices could with safety rise no farther, com- menced to restrict credits and compel reduction in merchants' inventories. Then started a rapid price decline, at first chiefiy in woollens, rubber, leather, sugar, and food products, but soon becoming fairly general. The following table summarizes the trend in wholesale prices for the leading countries : 19 INDEX NUMBERS OF WHOLESALE PRICES. United United Canada States Kingdom Prance Germany Japan a^ 3" u i3-