Must We Have Another Boom?
I
IT may seem paradoxical to discuss the danger of a boom when seven or eight million people are out of work, yet the press is filled with warnings. The president of the New York Stock Exchange in a year-end statement advised against ‘a too sudden or too full use of the nation’s swollen bank deposits,’ several days later the chairman of the Chase National Bank and the president of the National City Bank sounded notes of caution, and Chairman Eccles of the Federal Reserve Board, speaking in New England, expressed concern over inflationary possibilities in the large and growing volume of bank deposits. Most significant of all, the monetary policy of the country, expansionist since 1933, has been changed to one of mild control. A preliminary step occurred last summer when Reserve requirements were raised 50 per cent; a second occurred late in December when the Treasury announced a scheme for partially ‘sterilizing’ gold imports by buying bullion with money borrowed from the banks; a third was the recent increase in the reserve requirements of the banks to the full permissible limit by the Federal Reserve Board. Concern over the possibility of a runaway boom is not confined to the United States. The London Economist has recently conducted a symposium of leading British economists on the subject of controlling the boom, and Mr. Keynes discussed the topic at length in the London Times. Sweden is planning her 1937-1938 budget for the purpose of producing a restrictive effect.
As a matter of fact, booms and a large volume of unemployment are not incompatible. A boom is simply the kind of business expansion which generates its own collapse, and there is no reason why this kind of expansion cannot occur while millions are out of work. Indeed, this happened on a small scale during the late spring and summer of 1933, when about twelve million men were unemployed. The expectation of sharply higher prices produced a rush among business enterprises to build up inventories. There was a sudden and substantial rise in production and employment, followed by a drop after inventories had been substantially increased. There are other kinds of booms and other ways in which booms bring about their own collapse, but this simple example shows that a boom and a considerable amount of unemployment may exist together.
II
Why is there concern over the present situation? Certainly no one could have felt much alarm over a runaway boom during the first two years of revival. Despite the heroic efforts of the government to stimulate recovery by depreciating the currency, by the NRA, by the AAA, and by a huge volume of public spending, industrial production during the second quarter of 1935 was only 10 per cent above the second quarter of 1933. The reasons for this slow progress need not concern us here. Suffice it to say that between the middle of 1935 and the middle of 1936 industrial production made twice as much progress as during the preceding two years.
The rapid rise in production which began in the summer of 1935 occasioned no concern as long as it was accompanied by little or no rise in prices. Indeed, throughout 1935 and the first half of 1936, prices were remarkably steady. About the middle of last year, however, they began to rise. True, the general index, which contains many sluggish prices, advanced only 2 per cent between July and December. Concealed by the general averages, however, was a spectacular rise in prices of raw materials. From the end of May to the end of the year, the Dow-Jones index of commodity futures advanced 42 per cent. Other things began to happen also. Money began to circulate faster, and commercial loans, which had been decreasing during most of the revival as enterprises paid their debts, began to increase. And all the time the money on deposit in the banks was being steadily increased by government borrowing and by gold imports. Demand deposits, indeed, are already above the level of 1929. Furthermore, they are being spent at little more than half the normal rate. Even without further increase in demand deposits, there might be a huge jump in the demand for goods simply from a disposition to spend money at a more normal rate.
III
Early in February one might have argued that the problem of preventing a boom is more likely to be a problem of 1938 or 1939 than of 1937. During January there occurred a sizable drop in the future prices of commodities. The war scare had somewhat subsided and there was prospect that the effects of the drought would be offset to some extent by acreage increases which the Department of Agriculture is encouraging for 1937. Doubts arose as to whether the increases in wages and raw-material prices that occurred in the late months of 1936 could be passed on sufficiently in the form of higher prices to preserve profit margins.
Since the middle of February, however, the outlook has changed. The growing world-wide armament race has encouraged speculation in many international commodities, and the victories of Mr. Lewis have started a fresh cycle of wage increases in this country. From the armament boom and the growing aggressiveness of labor, forward buying has received a new impetus, and this in turn raises prices and stimulates new wage demands and more forward buying. Hence there is real danger of our getting caught in a spiral of wage-price increases.
In the face of this spiral of rising wages and prices, the monetary authorities find themselves virtually helpless. Their control over the quantity of money in the country is very great, — greater, in fact, than the man in the street appreciates, — but unfortunately they have no way of curbing commodity speculation without at the same time curtailing investment in industrial plants and equipment. This is none too large now and it is badly needed in order to absorb the unemployed. Hence the country finds its price level pretty much controlled by the plans of foreign governments and of organized labor.
There is a good chance that the present unhealthy forward buying may be brought to a halt within the next few months by a perfectly normal process. For example, the output of many raw materials, particularly crops, may be increased sufficiently to halt the rise in prices. Furthermore, the building up of inventories against price advances may come to a halt within a few months simply because managers regard inventories as large enough. If the drive of labor for higher wages continues with little abatement after forward buying falls off, business may be confronted with a difficult situation, because it has been largely forward buying which has made it easy for enterprises to pass on wage increases to consumers. A business recession produced by a drop in forward buying and by an encroachment of costs upon prices is not an attractive prospect. Nevertheless, since forward buying is so obviously dangerous and since it is also beyond the control of monetary authorities, a mild recession would not be entirely unwelcome. The problem is to keep the recession mild by preventing the drop in forward buying from producing a drop in investment in plant and equipment. That is why it is so important to keep long-term interest rates low.
IV
Whether or not a recession before the end of the year postpones the problem of controlling the boom, the problem is almost certain to confront us sooner or later and plans for dealing with it should be made at once. The problem will arise from the fact that for five or six years the country has fallen far short of meeting its needs for most forms of durable goods — housing, public utility equipment, railroad equipment, and industrial equipment in general. The estimates of the deferred demand are necessarily crude, but the totals are impressive. For three years during the depression, residential construction was less than one tenth the current requirements of the country, and the accumulated housing shortage is estimated at approximately 1,800,000 houses. Purchases of locomotives and freight cars by the railroads sank to virtually nothing and are still moderate. The railroads are short approximately 5000 locomotives and 400,000 freight cars. The output of the public utilities is now 15 per cent above 1929 and steadily increasing, but their capital expenditures during the last three years have been low. Purchases of other forms of industrial equipment sank to less than 40 per cent of normal. Estimates of the accumulated demand for industrial equipment (other than railroad and public utility) range from $7,000,000,000 to $10,000,000,000.
Suppose that, about 1938 or 1939, the country attempted on a large scale to meet its accumulated needs for housing, railroad equipment, public utility equipment, and industrial equipment in general. What would happen and what could we do about it? Obviously there would be a substantial increase in production and employment. The unemployment problem, on the whole, would cease to worry us (it might be replaced by the problem of those who prefer not to work). Long before plants as a whole would reach capacity operation, some branches of industry would be unable to meet the demand for goods. These points of shortage, which we may call ‘bottlenecks,’ would be of decisive importance because they would make deliveries of some types of goods difficult to obtain and cause premium prices to be offered for prompt delivery. The shortages of some goods and the rise in their prices would induce increases in the prices of other goods, and the appearance of sellers’ markets would encourage the speculative accumulation of inventories and would make the sellers’ markets worse. No one knows precisely how much increase in industrial production would be necessary before bottlenecks in industry became numerous. My guess is that a 20 per cent rise in production, if occurring within eighteen months, would reveal many bottlenecks.
V
The kind of boom which I have described might be called ‘a deferreddemand boom,’ because it would derive its impetus largely from expenditures which should have occurred in the period 1931 to 1936. It might also be called a ‘bottleneck’ boom, because the rise in prices and the speculative buying would be largely induced by bottlenecks. Many people believe that booms can be controlled by monetary policies. Now it is true that the power of the Treasury and the Reserve Banks to control the amount of money in the country and the rate of interest is very great. The Reserve Banks, for example, possess huge holdings of government bonds which they could sell for the purpose of reducing the reserves of the member banks and forcing a drop in demand deposits. The Treasury has over a billion dollars of deposits in banks around the country. By withdrawing these deposits, it could compel a great reduction in bank credit. Even the government’s deficit might be used as a deflationary device if the government so desired. All that would be necessary would be for the Treasury to remove from the banks the money which it borrows from them. This would reduce their reserves and force them to reduce their loans. In fact, if monetary policy alone would control booms, there would be nothing to worry about except the willingness of the authorities to act.
Unfortunately, a boom produced by deferred demand and bottlenecks does not lend itself readily to control by monetary policy alone. Suppose that the Reserve Banks, assisted by the Treasury, tried to halt the increase in prices by stopping the growth of demand deposits and raising interest rates. The interest rates which would be high enough to control the rise in prices at the bottlenecks would be too high for the rest of industry. They would halt the increase in production at a time when many branches of industry still had idle capacity and when millions were still unemployed. Such a policy cannot be regarded as satisfactory. Obviously it would be wasteful in the extreme to halt the increase of production throughout industry simply because inadequate productive capacity at some points threatened to start a spiral of price increases. And even if this policy seemed the least of several evils, the country would scarcely tolerate putting on the brakes while thousands of men were desperately seeking work and hoping for jobs to appear.
On the other hand, if prices were permitted to rise at the points of shortage and to affect the rest of the price structure, temporary inflation would be introduced into prices which would be likely to be followed by a drop in prices and a recession in business as the bottlenecks were eliminated. Monetary policy has an important part to play in bottleneck booms by preventing the rise in prices from getting out of hand and producing a spiral of speculation which eventually collapses. It fails to reach the heart of the problem because (1) it does not prevent the development of bottlenecks, and (2) it does not assure that there will be adequate sources of new demands to support markets when the deferred demand for housing and equipment begins to taper off.
VI
If monetary policy is insufficient, what is needed? Let me begin by suggesting three rather obvious and simple devices which would be helpful, although in themselves not sufficient. Most important of all is reduction of the expenditures of the government as business spending increases. Certainly the government should not aggravate a bottleneck and deferred-demand boom by spending more than it collects. Mr. Keynes and Mr. Eccles, two of the ablest exponents of government deficits during depressions, are advising that it is high time that government budgets show surpluses. They are right, for obviously the policy of deficit financing during depressions implies that there will be surpluses during prosperity. Sweden, which financed public works and unemployment relief by a deliberately created deficit during the depression, is now, as I have indicated above, setting a notable example by expressly creating a budget surplus for the purpose of controlling the boom. Our own government is having such difficulty in reducing its expenditures that increased taxes may be necessary to avoid a continuation of a deficit next year. Congress naturally will balk at raising taxes just before elections, but it may have to raise them. If it does not, the government deficit may have an inflationary effect in 1938.
A second device that may be of some help is the reform of the accounting practices of business concerns. Business managers, quite naturally, determine the expenditures of their enterprises largely by the outlook for profits, and they judge the outlook for future profits in no small measure by present profits. But the usual methods of accounting overstate profits in good years and understate them in bad. Hence they introduce fluctuations into business by encouraging managers to spend too much part of the time and too little part of the time.
There are two principal ways in which business men are fooled by their present methods of accounting. One arises from the methods of handling depreciation. The only way in which an enterprise can recover the depreciation of its equipment is by selling goods.
Consequently, one might suppose that each unit of output would be charged a uniform amount for depreciation. As a matter of fact, a very different procedure is usually followed. A machine which is expected to last ten years is ordinarily charged off in ten equal installments. This means that in good years the depreciation charge per unit of output is too small and in bad years too large. As a result, profits are overstated in good years and understated in bad. If each unit of output were charged a uniform amount for depreciation, the profits of business enterprises in the long run would not be affected, but they would fluctuate less from year to year.
The other way in which present accounting methods mislead business men is found in the handling of inventory gains and losses. Most concerns permit these gains and losses to affect their statement of profits. When prices rise, for example, the profits of the enterprise are swollen by inventory gains. This, of course, is ridiculous, because the inventory gains of this year are merely the basis for an inventory loss some other year. No concern should let inventory gains or losses affect its statement of current profits — inventory gains should be credited to a special reserve and inventory losses charged against the reserve.
There is nothing to prevent business concerns from reforming their methods of keeping books, and a substantial sprinkling of enterprises have already made the changes that I have outlined. Many more will do so in the years to come. The government, however, is in a position to encourage these changes. At present the Treasury does not permit profits to be computed for tax purposes by the methods which I have suggested. Hence an enterprise which reforms its accounting methods must keep two sets of books, an accurate set for its own use and a wrong set for taxcomputing purposes. By permitting corporations to keep books as I have suggested for tax purposes, the government would accelerate the reform of business accounting. With profits more stable, the temper of the business community would fluctuate less from year to year, and the expenditures of business enterprises, the volume of production, and the volume of employment would all be steadier.
A third device for moderating the boom is the control of installment buying. This is a very touchy subject. Indeed, the people who have much to say about government deficits have little to say about consumer deficits. Nevertheless, one may inflate demand as much as the other. When installment buying is on the increase, consumer demand is greater than consumer incomes; when it is on the decrease, consumer demand is less than consumer incomes. If we were looking for a scheme to make consumer demand (and, therefore, business in general) unstable, we could not do better than to encourage installment buying.
The total volume of consumer indebtedness at the present time is probably not excessive. Furthermore, in spite of the recent increase in installment buying, consumer indebtedness may be decreasing because thousands of persons are reducing their mortgage debts. Installment buying for goods other than securities and real estate, however, is already above the limits of 1929. No one knows exactly how large it is or how many companies are engaged in the business. The number seems to be increasing and the volume of loans by the larger companies is at record-breaking heights. Plainly the present inflation of consumer demand is paving the way for contraction sooner or later when new borrowing is not sufficient to offset the repayment of old loans. This contraction in consumer demand will be doubly disastrous if it occurs just about the time the deferred demand for equipment by business enterprises begins to fall off. The use of credit to finance installment buying needs to be brought under control, and yet it is not clear how this can be done. Most of the concerns in the business are not subject to regulation; no one knows how many of them there are or how much business they are doing. A study of installment buying for the purpose of devising ways of bringing it under control is badly needed.
VII
None of the steps that I have suggested quite adequately meets the problem ahead of us. None assures that bottlenecks will not develop, and, more important, none assures that there will be new sources of demand to offset the eventual drop in deferred demand for housing and industrial equipment.
There is only one way to prevent the development of bottlenecks. That is to see them coming and to expand productive capacity before they develop. To a great extent the discovery of incipient points of shortage is a responsibility of the marketing and purchasing department of business concerns. The better they do their jobs, the fewer and less serious will be the bottlenecks. But should the task be left entirely to individual business enterprises? Trends in demand are notoriously difficult to predict, and the job of forecasting them is likely to require more elaborate statistical research than most private concerns can afford. A Division of Bottleneck Research in the government, which would give constant study to trends in demand and to the interaction of changes in one type of demand upon other types, would reveal many points of inadequate productive capacity which private enterprises might miss until too late to prevent a shortage of goods. The Department of Commerce might assume the responsibility of conducting a continuous and systematic search for incipient bottlenecks, or the task might be undertaken by the Research Division of the Federal Reserve Board. By making its studies public, the government agency would cause private enterprises to check its conclusions and stimulate them to adjust their capacity so as to prevent shortages of goods.
VIII
This brings us to the most difficult problem of all — the development of new sources of demand to offset the eventual drop in deferred demand. About this problem there is not a great deal that the government can do. It can defer some public construction during the height of the boom and later expand public works to offset the drop in private spending. But obviously this would not go to the heart of the difficulty. It would limit the cumulative effects of the drop in private spending, but it would not create the basis for an expansion. The government might also encourage (as it is doing) the accumulation of unemployment reserves from which consumer demand might be financed as industrial employment drops, and it might supplement the unemployment benefits with relief expenditures. What has just been said about expenditures for public works applies also to unemployment benefits and relief — they limit the contraction in business without providing a basis for expansion. The government might control the volume of installment buying so that a recession in business would not find consumers heavily burdened with short-term debts. Finally, the government might combat a recession in private investment by a credit policy which made for lower interest rates. But a drop in interest rates is a notoriously feeble device for halting a general drop in business. Something far more powerful would be needed in order to stimulate investment in the face of a contraction in deferred demand.
A redistribution of income would be helpful, provided it increased the demand for consumer goods without raising the cost of capital goods. The increase in consumer demand would create new opportunities for the profitable investment of capital. This would tend to halt the drop in the volume of investment — particularly if the price of capital goods were not increased. The necessary change in the distribution of income would probably be accomplished by raising wages in the consumer-goods industries toward the end of the boom, while leaving wages in the capital-goods and construction industries unchanged. It is difficult, however, to see how such planned changes in prices could be made in a free economy. They imply a central control of prices and a regimentation of industry which are incompatible with our present institutions.
What, then, can we do? The accident of a war starting at the right time might prevent the eventual drop in deferred demand from being followed by a business recession. But war, aside from being a calamity infinitely worse than a depression, would only postpone the evil day and would make the ultimate collapse far worse. An expansion of world trade based upon reductions of trade barriers might offset the drop in deferred demand. This consummation is devoutly to be wished, but it cannot be counted upon.
This brings us to technological progress as a protection against depression. Improvements in present products and methods, and the development of new products and methods, create new opportunities for investment. If the engineers, physicists, chemists, and others engaged in industrial research only make enough discoveries during the next five years, they will be able to create sufficient new opportunities for investment to offset the eventual drop in deferred demand.
As a simple illustration, consider the matter of housing. There are about 25,000,000 houses in the United States. The replacement demand for housing is small because the average life of a house is above fifty years. Improvements in design and materials, and reductions in cost sufficient to reduce the average life of a house to thirty or thirty-five years, would create an enormous replacement demand for housing. Suppose that by a series of improvements the cost of a house which is now $4000 was reduced to $2500, and suppose that the $2500 house was substantially superior in design and materials. Such a reduction in cost is not unthinkable. It is far less than the reduction made during the last thirty years in the cost of automobiles. I do not venture to predict precisely how much the replacement demand for housing would be increased by a 37 1/2 per cent cut in the cost of construction, accompanied by improvements in design and materials. The increase would unquestionably be large. Indeed, it does not seem extravagant to predict that the replacement demand might be stepped up to 500,000 or 600,000 houses a year. Granted substantial technological progress, the building industry might be kept busy for twenty or thirty years replacing most of the present houses in America with better-planned, betterconstructed, more convenient dwellings. It all depends upon how rapidly the engineers and others improve the product and reduce its cost.
Similar possibilities of creating investment demand exist in the field of railroad equipment, agricultural implements, public utility equipment, and industrial equipment in general. It is essentially a matter of technological progress. Consequently, it is beyond the control of the government, of economists, of money experts, and indeed of everyone except the engineers, physicists, chemists, and other industrial researchers and the business concerns for whom they work. From this statement a conclusion of first importance follows: The responsibility of avoiding a severe recession in business four or five years hence, after deferred demand begins to drop, rests above everything else upon the initiative and enterprise of thousands of business men scattered from one end of the country to the other and upon their willingness to spend money on industrial research. Business, in other words, is being presented with a test of its foresight and its resourcefulness. It must not rely upon government direction and planning to produce stability. The government, to be sure, has a highly important role to play. It must help by pursuing a wise budget policy, by controlling speculation and installment buying, by encouraging the reform of accounting practices, by building up unemployment reserves which will aid in preventing any recession in business from becoming cumulative, and by helping to discover incipient bottlenecks. None of these policies, however, will develop new sources of demand to offset the eventual drop in deferred demand which has accumulated during the last five or six years. This is the greatest problem of all, and it is one which only business men and their technical staffs can handle. Whether or not stability is achieved during the next decade will depend more than anything else upon how successfully the business men and their technicians create new opportunities for investment by improving equipment and products and by developing new products.