New York State College of Agriculture At Cornell University Ithaca, N. Y. Library TO THE ECONOMISTS OF AMERICA ] ^^"L -^h- -')»• The New Depression Theory AS AGAINST THE VIEWS OF HOBSON, CROCKER AND A PROMINENT BANKER Among the replies which, came to me in response to my recent circular on "THE NEW DE- PRESSION THEORY" I received the following from the President of one of the most prosperous banking institutions of the Northwest, a man well known by his able discussions of the Ourrencjs Question, who sums up hi^ own views on the subject of depressions by saying : 500 Optimism is life. Pessimism is death. Optimism with sound discretion brings a demand, for labor, with the result of greater human progress. Occasional depressions are as certain as that nature is fickle in her gifts to man and that it is human to err. When confidence is destroyed, the wheels stop turning, demand slackens, labor is discharged and depression fol- lows. The work of optimism again slowly comes into play and the process is repeated again 505 and again. All human ingenuity can do is to lessen the effects of depressions. They cannot be absolutely avoided. Such a condition would be heaven, not earth. 540 545 The foregoing reflects the sentiment of the great majority of men of common sense, such as 510 have given a thought to the subject of de- pressions but it presents this sentiment in an un- usually clear, terse, and convincing maimer. So convincing indeed, that the reader is quite apt to lose sight of a certain self-contradiction con- 615 tained in those lines — they preach optimism, but they spell pessimism. They would have us maintain confidence, and an optimistic feeling, as an antidote against depressions. On the other hand they say that occasional depressions 520 cannot be avoided. Is not this latter view a clearly pessimistic one? I look at the matter from a more cheer- ful standpoint — I say, they cmi be avoided. But in order to guard against them, we must, 525 first of all, learn their cause. Where must we look for that cause? Is it the loss of confidence as assumed in the above letter? Hardly. True, the loss of confidence will do much harm in developing a panic; and 530 as the panic engenders the subsequent de- pression, most people incline to attribute both, depressions as well as panics, to the same cause — loss of confidence; and they conclude that pros- perity will return as soon as confidence returns. 535 A great mistake! In 1908 there was no lack of confidence, but there was lack of prosperity. In that year the cash funds came forth from the hiding places which they had resorted to dur- ing the dark days of 1907; they returned into the credit institutions, ready to invest in busi- ness' thus showing that confidence had been restored — but the opportunities for profitable 560 investment had disappeared in the meantime. Confidence had returned, but not prosperity. While no doubt the severity of the panic of 1907 was largely due to a loss of confidence, we should not overlook another very important 565 factor: the precarious position of the money market due to the over-strained credit con- ditions previous to the panic. These are con- sidered by most authors as the real and primary cause of the collapse of 1907. ' 560 Thus we have two factors responsible for the crash; strained credit conditions, and lack of confidence^/ And now mark : both factors had disappeared in 1908, after the subsidence of the panic. But why did not the depression disap- 565 pear at the same time? why did that par^riysis— ' — - of business continue, which had set in as soon as the panic set in? If panic and depression Avere both due to the same cause, why did the one survive the other? . 570 My answer is: A new element had stepped in in the meantime. After the two factors above mentioned had initiated the depression, this new element gave it continuity. Those two factors ceased to operate as soon as the panic 575 was over; the new element, however, continued to operate. This new element consisted of a change in the saving process; notably in the investment pro- 580 cess. Before the panic the people's savings found investment in their legitimate field, enterprise and new constructions, which gave em- ployment to millions of busy hands. After the panic had set in, most of the savings funds 585 followed an entirely different course of invest- ment, and in consequence many hands formerly busy on new constructions were thrown out of employment. /The saving process, when entering this peculiar phase (which I have styled its 590 "Impairing Form") creates a continuous dis- crepancy between the demand for working forces and the supply thereof — a process which is illustrated below, lines 698 to 725. Working forces formerly busy on new con- structions being thrown out of employment, the loss of much of their purchasing power reacts upon other working forces, throwing these out of employment too — and this, again and again, reacts upon still other working forces (working men and business men) thus causing a general diminution of employment, of income, of the purchasing power and of the demand. The de- mand for commodities thus being reduced, the factories already in existence prove more than sufficient to supply what this reduced demand calls for, so the incentive for enterprise, for building new factories and for extending the meaus of production falls away. Can such a state of affairs be cured by confidence? The encouragement of confidence would be well enough if ]3rosperity were dependent upon confi- dence alone; but not where a positive factor is at work, ^rliich creates a disparity between demand and supply. 600 605 610 THE VIEWS OF HOBSON AND CROCKER 615 620 625 630 635 640 645 650 655 660 665 In the foregoing I have stated that if the savings of the people are not invested in enterprise or new constructions (meaning, of course, only such savings as can be spared for that purpose) the saving process assumes the "Impairing Form," and then tends to throw working forces out of employ- ment and to cause depression of trade. Naturally the question arises: How are savings invested under such circumstances? This question, though of great practical importance, has been strangely neglected by our economists. A number of explanations have been given, all of them more or less vague. In my recent book * I have enum- erated ten of such explanations, taken from current Utera- ture and have shown every one of them to be untenable. I have not considered, however, a certain explanation pro- pounded by the Englishman John A. Hobson and the American Uriel H. Crocker, both of whom have concluded that under such circumstances the saving process leads to overproduc- tion. This view is likewise untenable. Overproduction of commodities is becoming more and more a matter of the past, at least in all industrial lines. Production everywhere adjusts itself to the demand. For instance, when the demand for iron and steel fell off to such a remarkable extent as it did in 1903 and 1908, the production was •promptly reduced in exactly the same ratio — and just so in all other lines of industry. Now, if there is no overproduction going on (except temporarily, in exceptional cases), how can the saving process be construed to lead to overproduction? If the savings are not used for the overproduction of com- modities, are they used for the overproduction of productive capital? Say, in building up factories, houses, &c? Evidently not, for at times of depression the erection of new construc- tions does not increase — just the reverse, it falls off. Though there is, at such times, an excess of productive capital, this excess was not built up during the depression, it was built up before, when the demand for commodities and for productive capital was quite brisk. So the overproduction theory of Hobson and Crocker can not be substantiated ; neither when referring it to the produc- tion of corhmodities, nor when referring it to the produc- tion of productive capital. Both of these men recognized the important fundamental point that the saving process bene- fits society only within certain limits and that, if carried on beyond, it acts injuriously and tends to depress business. But they have not been able to define the limits of healthy saving, nor could they give a correct explanation as to what became of the excess of savings, or how the harmful influence on so- ciety and trade was brought about. The explanations which they did give being wrong, and at that running counter to accepted views, we need not wonder that their theories were rejected by our economists, the latter preferring to continue in the old-established (though erroneous) belief that in modern society all savings are turned to a useful end and that, there- fore, the saving process can do no harm and cannot influence trade adversely. 670 Contrary to the views of Hobson and Crocker who hold that over-saving leads to overproduction ; and' contrary to the views of the great majority of economists, who hold that all savings lead to a good and useful end, even at times of de- pression, I have shown in my book that over-savings are in- 675 vested in a manner which has entirely escaped the attention , of the profession. If savings do not find investment in their / legitimate field, enterprise and new constructions, they find it in what I have styled the "Impairing Form" — in 3. manner highly injurious to' the commonweal. In a recent circular I ggQ have brought out these conditions by means of an illustration, as follows : Let us imagine a lone island, inhabitated by five men. who carry on business with each other on the money basis, in a similar way as we do. Each one of them supplies goods or services to the amount of $30 jper week, of which twenty dollars' worth goes to the other four men, 685-r«Sainst payment, the balance being absorbed by his own family, bo / long as each one of the men earns $20 per week, and buys goods or / services from tihe others to the like amount, so long the men are well employed, and there is an equilibrium between offer and demand— a hundred dollars' worth per week of the one and a hundred dollars worth of the other. , i » r <.i, - „„„ Let us designate this state of affairs as Phase 1, and let us further 690 assume, as Phase 2, that the saving process steps in. One of the five men, A, largely restricts his requirements. He keeps on selling his own goods or services to the other men, but buys nothing from them for purposes of consumption. He employs his surplus income, how- ever, towards having the others build a windmill on his estate, in 695 consequence,, the demand" for working forces will amount to $100, as 'before; the equilibrium between demand and supply will be maintained, and the men are fully employed. /Now let us suppose, as Phase 3, that the mill has been finished, but that A continues to save, without going into other enterprises, and without giving the other men an opportunity to earn any money from f7(\r\ him. Then the aggregate demand will drop to $80 per week, as against * ^'■' an aggregate oifer of $100. A corresponding degree of unemployment will ensue, coupled with a general diminution of the income — precisely that state of affairs which we call depression.^ After a while B says to A: "Lend me $20, I need , the money to buy some clothes." A gives him the money, but only against security on B's house, and makes him pay interest on the loan. Then C comes to A, asking him 'JQK for $10, and A says, "Give me one of your sl^eep for that amount, I ' ^•^ wish to enlarge my own herd." In this way things go on. A con- tinues by means oi his savings to acquire more and more of the pro- perty or others, either by purchase or by lien; and the others are compelled to expend for necessariea the money thus obtained from A. When they do, the savings funds of A cease to be "money in the shape of cash capital" and again become "money in general circula- 7"| f) tion." * ^^ ^The reader will notice that, under the conditions assumed in "Phase 3," the four non-savers will expend more than they earn — a feature which offers A an opportunity for investing his savings funds. With- out this feature there would be no investment, and A's savings would have to be hoarded — despite the notion prevailing among economists that there can be no saving without investment. Suppose we leave 715 out the said feature and assume that the four non-savers do not ex- pend more than they earn, but meet the reduction of their income by a reduction of their expenditures, by privation; then, what would be the consequence? If the saver A always earns one-fifth of the five men's aggregate income and lays his earnings aside, the aggregate income would be $80 ■ in the first week, $64 in the second, $51 in the third, and would gradually approach nil — so poverty would spread, 720 and the privation would have to be increased from week to week, making things a great deal worse than assumed in "Phase 3." In real life, people generally resort to both, privation on the one hand and borrowing on the other, whenever their income is stopped or reduced owing to adverse business conditions; and this borrowing (or eventually the selling of property) on the part of the afflicted affords the savers an opportunity to invest their surplus funds — precisely as assumed in 725 the saving-experiment above. On comparing Phases 2 and 3, we arrive at striking con- trasts. In either case the savings of A find investment; but how radically different is the bearing on society ! The erec- tion of the windmill, as considered under Phase 2, means an 730 increase of the island's wealth, and makes nobody poorer. Under Phase 3, however, we see no increase of wealth, only a .shifting of wealth — the saver becoming richer, others poorer. Under Phase 2, the demand for working forces suffers no diminuition, and the proportion between offer and demand 735 stands as 100 against 100; under Phase 3, however, as 100 against 80. And we should note the peculiar duplex action of the saving process in the latter case. On the one hand it creates savings funds which, once accrued, will seek invest- ment; on the other it creates market conditions which enable 740 these funds to find investment. It does this by causing unem- ployment and thereby reducing the income of many people below what they need for their living expenses, or for their business expenses, thus compelling them to borrow or to sell such property of theirs as they can realize on. This borrowing 745 process (mainly on the part of business men or corporations) affords the savers an opportunity to invest their funds. * .4. Neglected Point in Connection with Crises.— Nev? York, Bankers' Publishing Co. In the light of the foregoing conclusions, let us review some statements made by prominent authors, in connection with the saving process. Hobson says : "Every act of saving in a complex industrial society signifies making, or causing to be made, forms of capi- tal which are essentially incapable of present consumption — i. e. future or productive goods." This statement agrees with his overproduction theory, but does not agree with the facts. In the- saving experiment above, lines 698 to 725, 1 have disclosed a form of the saving process which does not lead to the formation of capital in the shape of future or productive goods. His analysis of the sav- ing process, therefore does not cover the point, just as little as his conclusions as to overproduction which he builds up on that analysis. Adam Smith said : "What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time, too ; but it is consumed by a different set of people." J. S. Mill said : "Everything which is produced is con- sumed ; both what is saved and what is said to be spent, and the former quite as quickly as the latter." Both of these statements are correct — but not the conclu- sions which have been made from them. _ The chief conclu- sion was that there is nothing in the saving process tending to diminish the general demand. If I spend ten dollars, I 750 755 760 770 775 bring a demand for. commodities into the market, to that ex- tent; if I save and invest the money, the investment, no mat- ter in what shape it takes place, will likewise result in a de- rnand for ten dollars' worth of commodities. So the conclu- sion seems justified that saving (unless the savings funds be 780 hoarded) will not abrogate the demand for commodities and' cannot influence business adversely — a conclusion which prac- tically has become one of the axioms of "academic" econo- mies. Still, the conclusion is wrong. It is completely refu- ted by the saving experiment presented above, lines 698 to 725. 785 In those lines I have shown that A's savings are expended for commodities (by the needy borrowers) — so, according to academic reasoning, the saving process should not result in a diminution of the demand — still it does. Saving under such circumstances will most positively cause a disparity between 790 demand and supply. And it is this kind of saving which so largely predominates at times of depression. ******** In this connection I will refer to another "academic" error which our economists commit when advising the business 795 vvorld: "Go ahead and produce, but do so judiciously; if you do, the demand will follow. As there can be no general over production, every dollar's worth of production will call forth a dollar's worth of demand — provided you always man- age to properly study the demand and avoid misdirected pro- diiction." This advice would be right enough if there were no such 800 factor at play as Impair Savhigs (illustrated above,' see lines 698 to 725) which eo ipso creates a disparity between demand and supply. This factor, which has so far escaped the atten- tion of economists, upsets quite a number of academic con- clusions. 805 ******** While in the foregoing (lines 627 to 667') I hftve disproved certain views of Hobson and Crocker — views which have much more hurt than benefitted their cause — I do not wish to be- little the useful work these men have done in disclosing the 810 evil tendencies of the saving process whenever the latter is carried on beyond healthy limits. Nor do I wish to discredit any of the numerous other points of economic research, unique as they are, which secure to Hobson a prominent place in economic literature. As to his views on the saving process, g-jg however, which in their general drift follow the same direction as mine, I thought proper to bring out the points of distinction and to show that the objections chargeable to certain' details of his theory are not applicable to mine. If anybody would do the same for me and point out errors actually existing in my own deductions, I would thank him for it July, 1909. N. JOHANNSEN, Rosebank, New York. The original of this book is in the Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013881416 ^i^!?^'f-;:::;;^^^<^^^f" >p V -.• '^ 2 -\.^ -^4^. fe..l: !=■ *i»^-Ni, ^"^ V' •'I'lS' . ' I til 1' 1^ ^-~,^'^i »:-«»>' ^i^ i^^' \ i? % 'C ^ -C^. ^<'^ '- ^ i^rir J r^^^^\ j"*v'r^