§ 15. Capitalization theory of crises. Here, as repeatedly above, we verge upon a different type of explanation of the crisis—one of a psychological nature. The quantity of money, we have seen, affects prices more or less, according as credit is more or less used in connection with it. Money plus confidence has a larger power of sustaining prices than money without, or with less, confidence. And throughout the business cycle the amount of confidence, expressed in such ways as the readiness to grant credits and in the easy extension of the time of collection, is constantly changing. Over-confidence at one time is suddenly followed by widespread lack of confidence. This has led some to say that lack of confidence is the cause of crises. This is true, but does not explain what is the real cause of this lack of confidence, which, when the crisis comes, is not mere unreasoning fear that needs only to ignore the danger to banish it. Might it not just as truly, if not more truly, be said that the cause is over-confidence in the period preceding the crisis?

The essential characteristic of a crisis is the forcible and sudden movement of readjustment in the mistaken capitalization of productive agents. Capitalization runs through all industry. The value of everything that lasts for more than a moment is built in part upon incomes that are not actual, but expectative, whose amount, therefore, is a matter of guesswork, or " speculation."13 Many unknown factors enter into the estimate of future incomes. The universal tendency to rhythm in motion (material or psychic) manifests itself in an overestimate or underestimate of incomes and of every other factor in value. This is emphasized by a psychological factor called sometimes the "hypnotism of the crowd" and sometimes the "mob mind." Most men follow a leader in investment, as in other things. The spirit of speculation grows until often it becomes almost a frenzy, and people rush toward this or that investment, throwing capitalization in some industries far out of equilibrium with that in others.

The cause of crises immediately back of the maladjusted capitalization thus is seen to be a psychological factor; it is the rhythmic miscalculation of incomes and of capital value, occurring to some degree throughout industry, but particularly in certain lines. This subjective cause in men is given an opportunity for action only when certain favoring objective conditions are present. This rhythmic movement as it appears in the capitalization of enterprises is favored and magnified by the wide use of credit and by the constantly changing technical and physical conditions of industry. These call for constant revaluations of the sources of incomes, thus destroying customary and habitual valuations. Some of the new dynamic forces, such as inventions and growth of population, are distributed pretty regularly along the line, so that their influences are nearly equalized. But occasionally some large impulse may serve to start a swing, and if this impulse is somewhat regularly repeated, it may serve to keep up the rhythmic motion. But, the lack of coincidence in the impact of various influences which occur accidently, such as political changes, wars, and the rapid opening of new routes of transportation, serve to hasten or to retard, perhaps for a time quite to alter, what would otherwise be the rhythm of the cycle.

13See, e.g., Vol. I, pp. 271, 335, 365-367.

§ 16. Remedies for crises. The financial crisis must be looked upon as an economic disease which brings many evils in its train. The need is not merely to mitigate the severity of the brief period of crisis, but also to smooth out the curve of the business cycle, so as to reduce periodic unemployment, the lottery element in profits, and the number of unmerited failures in business. Several measures may aid toward this end. In the recent past the crisis has been more severe in America than in Europe because of certain well-recognized defects which now have been largely remedied in the Federal Reserve Act.14 The provision whereby any one may get credit on good commercial assets should make it difficult if not impossible for a crisis to degenerate into a panic. It provides springs to reduce the jolt of the change from a higher to a lower level of prices.

14 See above, ch. 9, §§ 5, 6, 8.

Probably other improvements may be made in our banking laws. Competent students of the subject have urged that the payment of interest on deposits not subject to notice before withdrawal should be made unlawful, because demand deposits constitute the greatest danger at critical times. In principle this objection is sound, though experience may show that this evil has been practically remedied by other features of the Federal Reserve Act. Moreover, bankers could, by pursuing a more conservative policy, discourage speculative methods of enterprise. The strong public disapproval of stock-market speculation on margins may some day be able to express itself effectively in ways that will not injure healthy business. Greater stability in our tariff policy would remove a constantly disturbing factor in prices, as would likewise the stabilizing of the standard of deferred payments. In the attempt to remedy the great evil of unemployment, public works of every kind might be planned and distributed in time so as to better equalize the demand for labor and materials. Finally, much better commercial statistics are needed, and for collecting them and reporting the outlook government organization is required comparable in range and methods to the Weather Bureau.

It cannot be expected, however, that financial crises, in the sense of general readjustments of prices downward from time to time, ever can be completely abolished. There will always be changes in general industrial conditions calling for re-evaluation of the existing sources of income; and in this process there will always be a tendency to rhythmic swing like that of a river, which carries the stream of prices now on this side of the valley, now on that. But this fluctuation of general prices surely can be so greatly moderated in magnitude and in evil results as to make the word "crisis" almost a misnomer. It is toward the attainment of this irreducible minimum of uncertainty and disaster in business that efforts should be directed.

References

Dewey, D. R., Financial history of the United States, 4th ed. N. Y.

Longmans. 1912. Hamilton, W. H., Readings in current economic problems. Univ. of Chic. Press. 1914. 91-93, 93-95, 95-98. Hobson, J. A., Evolution of modern capitalism. Ch. 7. Lond.

Walter Scott Pub. Co. 1912. Jones, E. D., Economic crises. N. Y. Macmillan. 1900. Juglar, C, and Thom, G. W., A brief history of panics and their periodical recurrence in the United States. N. Y. Putnam. 1916. Marshall, L. P. and others, Materials, for the study of elementary economics, Pp. 391-396. Chicago Univ. Press. 1913. Mitchell, W. C, Business cycles. Berkeley. Univ. of Cal. Press.

1913. Moore, H. L., Economic cycles: their law and cause. N. Y. Mac millan. 1914. Nelson, 8. A., The A B C of Wall Street. N. Y. S. A. Nelson. 1900. Phillips, C. A. (Ed.) Readings in money and banking. N. Y. Macmillan. 1916. Chs. XXVIII, XXIX. Sprague, O. M. W., The crisis of 1914 in the United States. A. E.

Rev., 5: 499-533. 1915. United States Bureau of Labor, Annual report for 1886.