BOOMS AND DEPRESSIONS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis «--u\^ f^c^^ <Z>M '/ 2 /€~r*-e Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Booms and Depressions Some First Principles By IRVING FISHER, LL.D. Professor of Economics, Yale University NEW YORK * ADELPHI COMPANY • PUBLISHERS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis COPYRIGHT, 1932 BY ADELPHI COMPANY PRINTED IN THE UNITED STATES OF AMERICA BY THE VAIL-BALLOU PRESS, INC., B I N G-H All TON , N. Y. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis To WESLEY CLAIR MITCHELL THE WORLD'S ACKNOWLEDGED LEADER IN THE STUDY OF THE SUBJECT OF THIS BOOK Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis "Money, as a physical medium of exchange, made a diversified civilization possible, . And yet it is money, in its mechanical more than in its spiritual effects, which may well, having brought us to the present level, actually destroy society." SIR JOSIAH STAMP (From Foreword to the English edition of The Money Illusion by Irving Fisher) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis PREFACE This book grew out of an invitation to speak on the De­ pression of 1929-32 before the American Association for the Advancement of Science and is an elaboration of my address at the meeting of the Association, held at New Orleans, Jan. 1, 1932. The vast field of "business cycles" is one on which I had scarcely ever entered before, and I had never at­ tempted to analyze it as a whole. The scope of the present work is restricted, for the most part, to the role of nine main factors, not because they cover the whole subject, but because they include what seem to me to be the outstanding influences in the present, as well as in most, if not all, other major depressions. By this restriction it has been possible to make the book much shorter and, I hope, much more intelligible to the lay reader than if it set out to be an exhaustive treatise on an inexhaustible subject. At any rate, the nine factors are so inherently and ob­ viously related to each other that we are not compelled to resort entirely to empirical correlation. Empirical studies are important and essential in this field 5 but, by excluding those which apparently have no rational basis, it is possible to mark out a clear cut set of "first principles*" The results of the analysis here presented seem largely new. But, being so unfamiliar with the immense literature, I decided to submit the first draft of this book in mimeo­ graphed form to a number of authorities, several of whom vii Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis viii PREFACE had given much of their lives to the study of the so-called business cycle. With few exceptions these have found in the theory much that they regard as both new and true. Yet, as I could not, without years of searching, be sure how far any or all of what to me seems new may have been anticipated by previous writers, I leave to others to de­ termine how far this book is the original contribution which it is intended to be. As will be seen, the main conclusion of this book is that depressions are, for the most part, preventable and that their prevention requires a definite policy in which the Federal Reserve System must play an important role. This problem is of even greater importance than the problems of our old national banking system which led, after two generations of delay, first to the Aldrich Report and then to the establishment of the Federal Reserve System. In my opinion, no time should, in this case, be lost in grappling with the practical measures necessary, including international cooperation, to free the world from such needless suffering as it has endured since 1929. If this very practical task is not soon undertaken in earnest, nor brought to a successful conclusion before an­ other such disaster overwhelmes the world, we may expect that a great body of informed public opinion will then hold specific individuals responsible. In short, ignorance cannot much longer serve as an excuse for neglecting this greatest of all practical economic problems. But, having myself only recently acquired such knowl­ edge as I possess on the subject, I have felt constrained, in this book, studiously to avoid casting blame on those who, here and abroad, might, had they done the right things, have prevented the depression. I am indebted to several of my own students for help­ ful criticisms, Lester V. Chandler, J. Edward Ely, Florence Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis PREFACE IX Helm, Harold D. Koontz, J. N. Lindenberg, Taulman A. Miller, Jr., and Hildreth Winton. I also wish to thank the many economists and others who have kindly read and commented, in a general way, on the first draft, including, James W. Angell, Leonard P. Ayres, J. M. Clark, Victor S. Clark, John R. Commons, John H. Cover, Alfred Cowles, III, W. L. Crum, H. C. Cutting, Davis R. Dewey, Charles E. Duryea, Lionel D. Edie, Henry W. Farnam, Warren F. Hickernell, Jacob H. Hollander, W. I. King, R. R. Kuczynski, William C. Lee, Edmund E. Lincoln, H. L. McCracken, Ernest M. Patterson, Nicholas Raffalovich, Malcolm C. Rorty, E. R. A. Seligman, Carl Snyder, G. F. Warren, Frederick V. Waugh, E. B. Wilson, Ivan Wright, Quincy Wright, and Edgar H. Yolland. I wish especially to thank the following who, evidently at personal sacrifice, gave considerable time and thought to studying, in a detailed and intensive way, part or all of the manuscript,—Harry G. Brown, J. D. Canning, C O. Hardy, Harold L. Reed, N. J. Silberling, and Charles Tippetts. Finally, I wish to thank my associate, Royal Meeker, who has assembled most of the factual material as well as scrutinized the entire manuscript and helped in rewriting it, and my brother, Herbert W. Fisher, who at every stage has helped in the exposition, from a layman's point of view, in the endeavor to make an obscure subject clear. With his help I have tried to write the book in such lan­ guage that "he who runs may read." IRVING FISHER New Haven, Conn. July, 1932 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS PART I THEORETICAL CHAPTER *AG2 I INTRODUCTION 3 What is a Depression? 3 The Recent Picture 3 The Mystery of a Depression 5 II FIRST THREE OF NINE MAIN FACTORS ... 8 Over-Indebtedness 8 (The First Main Factor) Criteria of Over-Indebtedness 10 The Debt Cycle 11 Nine Main Factors 12 Distress Selling 13 Volume of Currency 14 (The Second Main Factor) The Price Level 17 (The Third Main Factor) "Real" Debts 17 The Money Illusion 18 Gold and Credit 21 The Index Number 22 The Vicious Spiral Downward .... 25 Two Paradoxes 25 The Main Secret 26 Summary 26 The Dollar Disease is Needless .... 27 III REMAINING SIX MAIN FACTORS 29 Net Worth 29 (The Fourth Main Factor) xi Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis xii CONTENTS CHAPTER *AGE Profits 29 (The Fifth Main Factor) Production, Trade, Employment .... 30 (The Sixth Main Factor) Optimism and Pessimism 32 (The Seventh Main Factor) The Velocity of Circulation 34 (The Eighth Main Factor) Hoarding, a Slowing of Velocity . 35 The Two Paradoxes Again—Applied to Hoarding 36 Possible Consequences of Contraction and Hoarding 37 Rate of Interest 38 (The Ninth Main Factor) "Real" Rates vs. Money Rates .... 38 Deflation, the Root of Almost All the Evils . 39 Chronology of the Nine Factors . 39 The Trough of Depression . .41 The Boom Phase Again 42 A Vicious Spiral Upward 43 IV STARTERS 44 Unproductive Debts 44 Productive Debts 45 Some Historical Illustrations 46 The Shady Side 47 Monetary Inflation Alone 48 Combined Starters ....... 49 V "THE" BUSINESS CYCLE? 51 The Development of the Cycle Idea . .51 "Forced" Cycles 52 "Free" Cycles ......... 53 Any Unbalance may cause Cyclical Tendencies 54 But These tend to die Down 55 "The" Business Cycle a Myth? .... 55 Cycles as Facts or Tendencies 58 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS xiii CHAPTER PAGE VI OTHER THEORIES 60 Many Theories Mutually Consistent ... 60 Price-Dislocation Theory 61 Inequality-of-Foresight Theory .... 62 Changes-in-Income Theory 62 Fluctuations-in-Discount Theory . .62 Variations-of-Cash-Balance Theory ... 63 Over-Confidence Theory 63 Over-Investment Theory 63 Over-Saving Theory 64 Over-Spending Theory 64 Discrepancy- between - Savings - and - Investment Theory 64 Over-Capacity Theory 65 Under-Consumption Theory 65 Over-Production Theory 65 Conclusion 66 PART II FACTUAL VII THE OVER-INDEBTEDNESS THAT LED TO THE WORLD DEPRESSION 71 The War and the New Era 71 Investing in Equities on Borrowed Money . 72 Miscellaneous Influences 73 The Steady Commodity Price Level . -74 Investing Abroad 75 Miscellaneous Borrowing Movements . 77 Reparations 77 Inter-Governmental Debts Payable to America 78 International Private Debts 79 Public Debts in the United States .... 79 Private Debts in America 80 Brokers' Loans 81 Totals in 1929 81 Gold and the Debts 82 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St.