Sec. III. Various Explanations Of Crises

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This section is from the book "The Principles Of Economics With Applications To Practical Problems", by Frank A. Fetter. Also available from Amazon: The Principles of Economics, With Applications to Practical Problem.

Sec. III. Various Explanations Of Crises

1. Over-production and under-consumption theories are those most widely held. In the first annual report of the United States Commissioner of Labor (1886) is given a long list of theories, more or less wild, that have been advanced in explanation of crises. It is simply a catalogue, not a logical grouping. Most of the views can be classed as underconsumption or over-production theories, which are but two aspects of the same idea. One view is that too many things are produced, another that too few are consumed. The over-production theorist, seeing that warehouses are filled with goods that cannot be disposed of for what they cost, that factories are shut down and men are out of employment for lack of demand, declares that productive power has grown too great. The under-consumption theorist, seeing the same facts, says that the trouble is lack of purchasing power. He admits that there are people who would like to buy these things, but he asserts that such people lack money because production grows faster than wages, wages being fixed, as he believes, by the minimum of subsistence - a theory akin to the iron law of wages. In both over-production and under-consumption theories the inequality of demand and supply is looked upon as a general one. There is supposed to be not merely an unequal and mistaken distribution of production, but a general excess of productive power.

Glut theories of crises.

The wide vogue held by these views would justify a fuller discussion and disproof of them here, did space permit. It must suffice to indicate merely that they have the same taint of illogicalness as the "fallacy of waste," the "fallacy of saving" and, still closer likeness, the "fallacy of luxury.' They overlook the fact that an income, either of money or of other goods, coming even to the wealthiest, will be used in some way. It may be used either for immediate consumption or for further indirect use in durable form. Through miscalculation there may be, at a given moment, too many consumption goods of a particular kind, but the durable applications can find no limit until the inconceivable day when the material world is no longer capable of improvement. At the time of a crisis, there is unquestionably a bad apportionment of productive agents, and a still worse adjustment of their valuations, but these in no wise negative the basic economic fact of the scarcity of wealth.

Defects of glut theories.

Money theories of crises.

2. Another group of theories explains the crises as being due to money, either too much or too little. The unregulated issue of bank-notes has been assigned as the cause of crises, especially under the circumstances accompanying such crises as those of 1837 and 1857 in America, when bank-note issues chanced to be the agency most marked in the undue and unsound expansion of credit. The issue of government paper money, leading to inflation and speculation, is assigned as a cause leading up to such a crisis as that of 1873, following our Civil War. The reverse view is taken by the advocates of a cheap and plentiful money. They say that these crises were caused, not by the expansion, but by the reduction of bank-notes; for example, not by the inflation of prices through the issue of greenbacks in 1862 to 1865, but by the contraction of the currency from 1866 to 1873.

Their inadequacy.

There is only a fragment of truth in these various views. It is always lack of money at the moment of the crisis that causes any particular failure, and in that sense it is always lack of money that causes a crisis. But the question is, whether in any reasonable sense it can be said that it was lack of a circulating medium before the crisis that brought it on. There is no support for this view, except in the rare case when the money standard is undergoing a rapid change, as in the United States from 1866 to 1873, and the statement then needs much modification and explanation. The money theories of crises are nearer to the truth than are the overproduction type, for the crisis is always connected with money and prices. But it cannot be said that the absolute amount of money in circulation in the period preceding crises gives occasion to them. In a few instances a rapid change in the amount has had an important effect, but this fact does not explain crises in general.

Lack of confidence is said to be a cause of crises. This is a truism, but the lack of confidence is not without reason and cause. Over-confidence in the period of expanding prices is succeeded by extreme depression when many false hopes are shattered.

3. Crises must be explained essentially as 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 rents that are not actual, but expectative, whose amount, therefore, is a matter of guesswork, or "speculation." Many unknown factors enter into the estimate of future rents. The universal tendency to rhythm in motion (material or psychic) manifests itself in an overestimate or underestimate of rent and of every other factor in value. This is emphasized by a psychological factor called the "hypnotism of the crowd/ Most men follow a leader in investment as in other things. The spirit of speculation grows till 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 use of credit enhances the rhythm of price. A large part of business is done practically on margins. If the value of a thing fully paid for falls in the hands of the owner, he alone loses; but if the value of a thing only partly paid for -falls so much that the owner is forced to default in his payment, the loss may be transmitted along the line of credit to every one in the series of transactions. A credit system, highly developed, is a house of cards at a time of financial stress. There is an element of credit in all modern business. Enterprisers enter into strenuous rivalry to secure the profits of a rise, ever hoping to get out whole before the crisis comes.

Capitalization theory of crises.

Psychological nature and objec- i tive condi-fi tions of crises.

The fundamental cause of crises thus is seen to be psychological; it is the rhythmic miscalculation of rents and of capital value, occurring to some degree throughout industry, but particularly in certain lines. But this subjective cause in men is given full opportunity for action only when certain favoring objective conditions are present. Most noteworthy of these besides the credit system is a dynamic condition of industry. The past century has opened up new fields for investment on an unexampled scale. Investment has advanced both intensively and extensively in a series of great waves. New machinery and processes have given undreamed of opportunities for enterprise in the older countries, and the physical frontier of investment has moved outward with the march of millions of immigrants to people the fertile wilderness. Such factors disturb the equilibrium of prices both in time and space, give a powerful impulse toward higher values in the older lands, and stimulate the hopes of all investors. When the balance between the capitalizations of various industries and between the rents of the various periods proves to be false, the inevitable readjustment causes suffering and loss to many, but particularly in the inflated industries. But, because of the mutual relations of men in business, few even of those who have kept freest from speculation can quite escape the evils.

Widespread effects on incomes.

4. Crises must be discussed in connection with other subjects than profits. In the text-books the subject of the crisis is variously classified. It may well be discussed with money, credit, and banking. It has its bearings on wages, justice in distribution, the theory of interest, and the consumption of wealth. But the reasons for taking it up in connection with the subject of profits are strongest. In no other connection is the presence of the element of speculation and of chance profit and loss in business so forcibly seen.

The income of every class of society is to some extent affected by these more or less periodic fluctuations. They are in part the price paid for progress under the constantly shifting conditions of our dynamic industry. In part they are the proof of industrial maladjustment The force of the shocks will no doubt be much reduced by better banking and business methods, and by a sound currency system. More important still, the development of moderation, conservatism, and a less speculative spirit among the leaders of business will do much toward softening the asperity of these scourges of industry.

Their probable mitigation.