H623I F53 Cornell University Library HB 231.F53 A study of prices; the reasons leading to 3 1924 013 903 665 A Study of Prices The Reasons Leading to Advance and What is Necessary to Bring About Their Orderly Decline; the Manner in Which Prices AffeSi Credit Conditions By EDMUND D. FISHER VICE-PRESIDENT BANK OF DETROIT \ DETROIT \\- V53 ^tate (S^alUge of Agttcultute If^t Cl^oruell Hnioecaitg A STUDY OF PRICES THE REASONS LEADING TO ADVANCE AND WHAT IS NECESSARY TO BRING ABOUT THEIR ORDERLY DECLINE; THE MANNER IN WHICH PRICES AFFECT CREDIT CONDITIONS Address delivered at the Fifth Annual Michigan State Conference of Credit Men, on a subject suggested by the Conference, Detroit Board of Com- merce, November 23rd, 1920 X A- ^^,J.ECT cr, By Edmund D. Fisher Vice-President '^^ ?: wrf^ i 'r rrn'f-r^ BANK OF DETROIT Copyright, 1920, by Edmund D. Flsiir.R ViB^51 F5^ (^ ^s':!^ I 5 N old school rhetoric gives the following coup- let as an example of figurative expression : "The dashing waves with fury driven Mount up and wash the face of Heaven.'' During a storm at sea the power of the wind makes successive series of waves, the causes of which the observer is usually in no condition to analyze. It is only in the peaceful period that follows the storm that the thoughtful mind might study the subject of wave for- mation and develop a theory based upon the direct force of the wind in its relation to the reaction from the water, the bottom of the ocean, and the distant shore. Similarly it is perhaps now possible, with the storm of war subsided and with the experience of a period of inflation and some measure of deflation, to analyze the causes which make the successive waves of price move- ment which characterize our economic life. It may also be possible to develop some principles of action to stabilize our governmental and business relations in the period of deflation before us. In studying price relations in order to make the analysis as simple as possible, it may be well to empha- size in advance that, as in the formation of the waves of the ocean, there is a single initial force, the varying power of the wind; so in the price changes of our business life there is also a single initial force, the varying spend- ing power of governments and the people. It will be [4] A Study of Prices necessary, therefore, to consider the direct changes in the amount of money and credit used as spending power in relation to a given volume of commodities, and the relative amount so used when the volume of commod- ities change. Reference is frequently made to two forces affecting prices — one the buying power (demand), dependent upon the supply of actual money, bank deposits, or the latent power of credit supporting the purchaser; the other the selling power (supply), dependent upon the volume of commodities or the amount of service to be sold. Both of these tendencies are, of course, affected by a temporary indisposition to either buy or sell at a given level of prices, as we well know from present conditions. But as price grows out of a definite relation to the standard of value (gold), it should be considered as the result of a spending power which increases or diminishes directly (increase or decrease of money or credit), or relatively (increase or decrease of commodities), to the volume of trade. Thus, although the standard remains fixed, the value of the dollar in actual use increases or diminishes in relation to its own volume used as a spending power. The principle to be established, therefore, is that the average level of prices is determined by the amount of money available as spending power. This is effected by the amount of gold in reserve, the vokime of credit or currency which the gold supports, and the actual amount of money in the hands of the people. The greater the volume of money or credit, the higher will be the price level, production being relatively the same. On the other hand, assuming production relatively the same, the reverse is also true — the weaker the A Study of Prices [5] spending power, as when money is hoarded or when loans are called or paid, the lower will be the price level. The operation of the principle to which reference has been made is easily lost sight of in the history of business experience, because, although spending power is the dominant factor, it is frequently confused with what are seemingly new conditions, such as war and the variations in production and selling power. The entire subject may, perhaps, be better under- stood by a study of the following analysis: INFLATION COMMODITIES MONEY PRICES Stated volume of com- modities at prices then fixed If money or credit in- creases Prices go up Reduced volume of Amount of money or Prices go vip commodities credit then relatively increases Increased demand re- ducing commodities Amount of money or Prices go up credit then relatively mcreases During such a movement as the foregoing, as prices go up, the amount of credit and currency also directly, as well as relatively, increases, made necessary by the growing dollar amount of goods to be moved, until restrained by diminishing gold reserves or bank policy, impelled by increasing rediscount rates. [6] A Study of Prices DEFLATION COMMODITIES MONEY PRICES Stated volume of com- If money or credit de- Prices go off modities at prices then creases fixed Increased volume of Amount of money or Prices go off commodities credit then relatively decreases Reduced demand, rela- Amount of money or Prices go off tively increasing com- credit then relatively modities decreases During such a movement, as prices go off, the amount of credit and currency, directly, as well as relatively, decreases, made possible by the lessening dollar amount of goods to be moved, until stimulated by increased gold reserves and a more liberal bank policy, impelled by lowering rediscount rates. A period of inflation and deflation may be pictured as a definite wave of price movement; but like the ocean, there are short waves and long waves. The price waves range from the movements that grow out of the day to day fluctuations of the market to the long "ground swell" that seems to us extends over a long period of years. These movements are all operating constantly, are complexly interrelated, and grow out of the varia- tions of spending power with the reactions from varia- tions in production and demand. A disintegration of these movements, however, would seem to develop a fairly comprehensive classification, eliminating all tem- porary and superficial day to day price changes. A Study of Prices [7] PRICE CHANGES Seasonal Movement: Reactions from seasonal variations in pro- duction and demand. Annual Movement: Reactions from variations in annual produc- tion. Credit Movement: Direct result of varying amounts of bank credit and currency. Gold Movement: Direct result of variations of world gold pro- duction. Seasonal variations in prices are, of course, familiar to the business and buying world. Business men are also vitally interested in the statistics of annual production, as the increase or decrease of the principal crops in the reaction on spending power frequently makes important, though temporary price changes. The credit movement is a short period swing in prices. Without direct relation to the increase or decrease of gold, a spending power develops and recedes through the expansion and contraction of credit and currency. Beginning at a period when bank reserves are high and money is "easy," a growing business activity in all lines fosters a growth of loans made on both a sound and unsound economic basis. While individual loans made in such a period of expansion may be perfectly good from the standpoint of ultimate payment, the composite influence of many loans that are not self-liquidating, such as mortgages, loans on stocks and bonds, and government securities, merely adds to the spending power of the period and directly operates to increase prices. The higher level of prices thus established neces- sarily increases the dollar volume needed to conduct [8] A Study of Prices future trade, and so an endless chain of increased loans and higher prices is established. The emergency brake is finally jammed on, and the financial gears thrown into reverse, and there occurs the liquidation of loans and the reduction of currency, with the consequent diminish- ment of spending power. The gold movement, a long swing period in prices, is usually very sluggish, and is characterized by the basic variations in spending power caused by the economic effect of variations in gold production. As gold is the basis of bank reserves and currency issues, its gradual change in volume has an ultimate under-current effect upon all price movements. The credit swing in prices, however, is the one that is most unsettling to the business world. The movement has been frequently called a "financial cycle." Prior to the organization of the Federal Reserve System the financial cycle seemed to be permanently established as a reoccurring factor in American business life, although each succeeding period had certain characteristics pe- culiar to itself, which frequently tended to deceive even the veteran business man. Common to all these periods, however, was a period of inflation, followed by a period of deflation. Such a period was invariably characterized by a crisis year, one or more dull years, culminating in a number of active business years. These active business years were fol- lowed by another period of readjustment, included in another financial cycle. As the active years were years of increasing prices and years of growing inflation, it is evident that during these years there were committed the economic errors which were ultimately disturbing to trade and necessitated readjustments of prices and policy. A Study of Prices [9] Average Prices 1914-1919 (Annalist Index Number Showing Varying Prices) 1914. 146.069 1915. 148.055 1916 175.720 1917 261.796 1918 287.080 1919 295.607 Nov. 13, 1920 238.557 The period commencing with the World War in 1914, is ilkistrative of such a period of inflation, whose effects were world wide. The new and abnormal spending power of the various governments, growing out of non- liquid loans, fiat or quasi-fiat currency issues, and increased taxation, "bulled" prices. Business men bid against each other in supplying raw material and manu- factured goods to meet war demands. Labor received increasingly higher wages and came into the market for luxuries in abnormal volume. Bank loans increased, following the necessity for increased capital, to build new factories, and to finance the growing dollar volume of trade. Population of cities increased, weakening the primary basis of production. The normal relations of production, manufacture and distribution were dis- rupted. Much of the wealth produced was non-pro- ductive and fed the fires of war. Yet all these tendencies which made for an inevitable readjustment, were more or less obscured for a while, and the feeling developed in the United States that the nation was growing wealthy. People were certainly busy, but finally began to feel through the strain of increased prices that it might be a period of lessening wealth. [10] A Study of Prices Theoretically it is possible to conceive of prices remaining relatively stable during a war period, if the buying power of the people were restricted through saving, offsetting the increased buying power of the government. Practically, however, the people do not save the necessary amount for this purpose. The government, therefore, continues to borrow heavily, bank loans expand and the added spending power thus created stimulates the increase of prices. As a conse- quence, of course, the value of the dollar itself tumbles. The rather comprehensive subject suggested for this address includes in addition to the reasons leading to advance in prices — "What is necessary to bring about their orderly decline." As the phrase is, "There ain't no such animal." That is, yet to be found in the American financial zoo. It could not live with the "bulls" and "bears." An orderly decline in prices must follow a preceding period where business is well under control, where reserves are laid aside to break the shock of future changes, where inventories are not too large, where new equipment and new factories are planned for an average rather than an abnormal business, and where there is a potent economic control working through the entire financial cycle by a strong central banking organi- zation. In the past many European countries have had such relations fairly well established, and where the credit cycle has had no extremes in price movement. English experience ranging over a long period of years, shows that the credit cycle of prices very nearly coincides with the average annual discount rate of the Bank of England. As prices go up the discount rate advances. As prices go off the rate declines. The economic control of the bank over prices is thus made evident. This condition is particularly interesting in A Study OF Prices [11] view of the power of the Federal Reserve System to con- trol discount rates in the United States through the principle of rediscount for member banks of approved commercial paper. This power was not exercised during the war period because it was deemed wise to help government financing through the maintenance of a low interest rate. Furthermore, the gold reserves of the Federal Reserve Banks were comparatively strong, owing to the great influx of the precious metal from abroad, sent in payment of foreign purchases, chiefly in 1915, and the substitution of credit balances for money reserves in the member banks of the country. The con- ditions thus established, of course, were elements of inflation, particularly as the Federal Reserve Act provided for lessened reserves in the national banks. Under normal international conditions the advance of the discount rate of a central bank tends to draw capital from foreign countries and offsets the necessity of gold exports. It tends generally to minimize bank loans and promote liquidation. The effect of this policy, as we have seen, is to promote the reduction of commodity prices. On the other hand, a reduction of the discount rate would tend to increase loans, tend to stimulate enterprise generally, and ultimately advance prices. The proper function of a central bank, or of a central board with corresponding power, is, of course, to stabil- ize prices so far as possible and to minimize the ups and downs of credit movements. Such movements, however, are more or less inevitable, growing out of the inherent errors in business life. Recently, the rediscount rates of the various Federal Reserve Banks have been advanced. This action was followed by a tendency to curtail credit by the member banks, with the consequent reaction on the price fabric [12] A Study of Prices of the country. In general, therefore, it can not be claimed that in this particular credit cycle, the Federal Reserve System has acted as a stabilizing element; but it is now functioning along approved lines, although somewhat late, and should prove to be an important factor in approximating an orderly decline in prices. The chief element which has caused our present infla- tion, our great government debt, is likely to remain a non-liquid element in our banking and currency fabric for some time to come. This suggests that a large amount of inflation may remain in our price schedules and only be eliminated as the debt is gradually paid or absorbed through the savings of the people. It will be remembered that prices following the Civil War, with some erratic exceptions, declined very gradually for a long period of years. The changes are shown in the following index: 1864—249 1872—153 1865—229 (Peace established) 1873—147 1866—206 1874—143 1867—192 1875—135 1868—186 1876—120 1869—170 1877—116 1870—155 1878—100 1871—152 1879— 99 (Resumption of specie payments) The business world has no guide to point to future price movements, or determine a sane reduction from year to year. Prices will brook no control — they look out for themselves and are really the governors on the machinery of business, if not interfered with by govern- mental price-fixing schemes or trade agreements. It is A Study of Prices [13] possible that price-fixing may be justified during a war period, but from an economic standpoint the price tendencies are stronger than the forces of governmental or trade regulations. Fixing prices during a decline would be very difficult, although theoretically possible under seasonal readjustments. A merchandising concern that does an annual business of seventy-five millions of dollars, has taken an attitude which emphasizes a seasonal basis of prices. It. is announced that they have begun their spring buying in lines where the manufacturers have been able to stand- ardize prices. It is pointed out that business and confidence must be re-established, and that it devolves upon the producer to set prices which he can stand by. The statement in part says: "Labor must be kept employed; mills throughout the land must be heartened by real orders to set in motion wheels already stopped, and to speed up those that are running. "No sane manufacturer will at this time make goods without orders; because, however carefully he figures, he would have to force the goods for sale if they did not move quickly, and pocket new losses. "Prices are not done coming down, though some lines have struck the cellar, and must rebound a bit to reach a live-and-let-live basis. But a start must be made some- where to re-establish business and confidence. The pessimist will create worse havoc if the optimist does not prevail over him." An old English document states that in 1314 "Com- plaints to the King that the market of Oxford ran unreasonably high, so that poor scholars could hardly live, so the King sent down his Mandate to regulate this affair." An attempt was then made to establish the following price schedule, which is interesting in view of present costs: .00 16 00 .00 12 00 .00 10 00 .00 01 08 .00 01 02 .00 03 04 [14] A Study of Prices 1. s. d. A stalled, or corn-fed ox 01 04 00 A grass-fed ox A fat stalled cow An ordinary cow A fat mutton, unshorn A fat mutton, shorn A fat hog, of two years old A fat goose, in the city, 3d, but everywhere else . 00 00 02^ A fat capon, in the city, 2>^d, elsewhere . . . 00 00 02 A fat hen, in the city, l>^d, elsewhere. ...00 00 01 2 chickens, in the city, ll4d, elsewhere 00 00 01 4 pigeons (in the city but 3 pigeons) .... 00 00 01 24 eggs 00 00 01 This comment is made in the article in question: "Things could not be purchased at these rates, for people would not bring them to the market (and that is a thing that Parliaments can not remedy), and so the King was fain to revoke the former act, and leave the people to sell as they could (for a trade will do as it can, and never be forced, one way or the other)." Readjustment should contemplate a reasonable profit, and prices should bear a proper relation within the sea- son to the preceding season's or preceding year's price schedules. An economic commission might very happily analyze the entire subject, and, for what it is worth, publish what would seem to be a proportionate basis of prices from year to year within the economic period involved. In correlation with this, the government should develop a comprehensive plan of taxation fairly distributed and provide for a stated reduction of the national debt over a sufficiently long period of years. This would at least serve as a guide to the business world, and tend to prevent the business difficulties which are sometimes developed by the discussion or operation of unsound legislation. A Study of Prices [15] It is comforting to realize that a period of deflation, based upon average experience, is a period of growing wealth. Take a characteristic period of deflation in England experienced from 1874 to 1896 (a gold move- ment). During this period the average of wholesale commodity prices fell 40%. It was a period of increase in production the world over, and of growing wealth, in which England, of course, shared. It was a period of gradual increase in wages, although the greatest benefit to the wage earner came from the reduction in prices. An English economist states: "Looking at this period as a whole, there seems to be no evidence that employ- ment was any less regular than in preceding periods." A composite judgment based upon the thought of authoritative writers and speakers on the subject of "What is necessary to bring about the orderly decline in prices," may be stated as follows: 1. That bank credit for legitimate business be not unduly restricted. 2. That the public writings and speeches of influential men be directed toward the upbuilding of business morale by spreading the gospel of confidence in our own economic strength, which must be supported, however, by normal production. 3. That the maintenance of a fair volume of export trade will tend to stabilize prices, and through the helpfulness it will give to the upbuilding of stricken nations, will react favorably on the United States. 4. That as much stress as possible be laid on the argument that a small profit on a normal production is better than a large profit on a curtailed output. 5. That manufacturers and merchants in a strong financial position should place reasonable orders to encourage trade during depressed periods. 6. That a consistent advertising policy is necessary to stimulate the buying public. [16] A Study of Prices 7. That at the present time a revision of our tax laws is necessary to normalize business and investment relations. After all, and in conclusion, an orderly decline in prices is largely dependent upon the attitude ot the credit men and the credit grantors of the country. An analysis of credit statements during the period of deflation, will undoubtedly many times show a status of depreciated inventories and limited liquid assets. Forced liquidation, however, would tend to a disorderly decline and abnormally low prices. While a consistent reduction in prices is desirable, it is quite undesirable to have a greater reduction than is logical for a proper relation to the basic economic conditions. For stability, we must have full employment, continuity of spending power, and reasonable prices. The credit man, there- fore, must, when possible, permit the element of time and the principle of helpfulness to cure some of the business difficulties brought to his attention, A knowledge of the principles of prices is most im- portant in credit granting, as the movements of prices, as has been pointed out, directly affect credit conditions. The inventory is usually the most important factor in the commercial statement, and a radical change in value may mean much added wealth or ultimate insolvency. A most important factor to remember in a period of deflation is that while the value of the inven- tory may shrink and the surplus be reduced, the cause which brings this about — the decline in prices — is also increasing the value of each individual dollar. What is apparently a reduced surplus may and probably will indicate a greater wealth than the swollen surplus that previously floated on the froth of the tossing waves of inflation. Pamphlet Binder Gay lord Bros. Makers Syracuse, N. Y. l>Ai. m 21. 1901 1 Date Due Mar 15-5 m.] , Library Bureau Cat. No. 1137