This Business Relapse
VOLUME 161
NUMBER 2
FEBRUARY 1938
BY LEONARD P. AYRES
THIS business slump is not a new depression, for we have never completed in this country the recovery from the great depression that began in 1929. It is not a mere recession, for it is too serious to be designated by so mild a term. It is a relapse with complications.
It began last summer with a decline in stock prices which appeared at first to be nothing more than a normal corrective reaction in a bull market. But the decline continued with such increasing momentum that in two months the quoted values of stocks listed on the New York exchange had been reduced by some 25 billions of dollars. Meanwhile the contagion had spread throughout the business structure, and by the end of November production in the basic iron and steel industry had been reduced to low depression levels.
During all the final quarter of last year, business activity continued to shrink as if it were being rapidly evaporated by some potent invisible agency. The declines in manufacturing output were among the most drastic that have ever been recorded within so brief a time in all our business history. By the end of the year the volume of railroad freight had fallen almost to the low levels of the worst depression years. Unemployment developed on a large scale. In three short months most of the hard-won gains of the three recovery years of 1935, 1936, and 1937 had been canceled.
Business was good last summer when this relapse began to get under way. The volume of industrial production was almost as great as it had been in the last prosperity year of 1929. Employment had increased until it was nearly back at the levels of 1929. The profits earned by corporations in the second quarter of the year were the largest since the prosperity period before the depression. Agriculture was having its best year since that time. General business activity had so nearly regained its pre-depression proportions last summer that even the statisticians who measure such things with their index numbers were almost ready to pronounce the old depression ended and full recovery attained. They would have done so except for the fact that our population had increased by some eight millions since 1929, which still left our per capita production of goods somewhat below normal levels.
It was under the auspicious conditions prevailing last summer that the new collapse of business developed. The shock to confidence resulting from the stock panic and the business collapse was increased by the absence of conditions appearing to warrant any such precipitate and general retreat of trade and industry. Moreover, the first serious downturn came in the security markets about which there had been a minimum of anxiety. The new Securities Exchange Act which was passed in 1934 carried in its preamble the statement that a purpose of the new law was to prevent ‘ sudden and unreasonable fluctuations of security prices.’ The press and the public generally had approved the new act, and had reposed a good deal of faith in its effectiveness to protect investors. The sudden shattering of that faith has contributed to the loss of confidence.
Copyright 1938, by The Atlantic Monthly Company, Boston, Mass. All rights reserved.
It now seems probable that this rapid relapse of general business will become considerably more serious before its downward momentum can be checked. One reason for this is that unemployment is increasing far more rapidly than it did in the early stages of previous periods of hard times. The surpluses of corporations have been depleted during the depression years. Companies are unable to accumulate reserves because the new tax on undistributed profits forces them either to pay out their earnings in dividends or to hand over large proportions of them to the government.
Wages are so much higher than they wore a few years ago, and working hours are so much shorter, and the exactions of labor organizations are so much more drastic, that those industrial corporations which are operating without earning profits find that their losses mount with appalling rapidity. Under these conditions the managements of manufacturing concerns do not dare assume the risks of continuing to operate even temporarily while their costs exceed their incomes. Many companies are now closing down because they believe they must do so in order to survive.
II
The great sociologist, Giddings, once made the illuminating comment that ‘the causes of calamity are delusively obvious.’ Clearly it is a nearly universal trait of human nature to seek a scapegoat to bear the blame for misfortune. Nevertheless, in the case of this business relapse there has not developed so far any near unanimity of opinion as to who or what is responsible for the disaster. There are at least six explanations that have the support of responsible economic judgment.
The first of them holds that the seeds of this reaction were sowed last spring when the administration at Washington gave out a series of emphatic warnings that commodity prices were too high, and were advancing too fast. Business activity was increasing at the time, and men were confidently discussing the prospects for a coming boom, but the warnings effectively dampened their enthusiasms. Corporations which had been building up their inventories and increasing their forward orders began to curtail and then reverse these policies. As new orders fell off, manufacturers restricted production in order to work down the stocks of goods already accumulated. The theory is that the warnings issued in the spring brought their full effect in the autumn, when demand fell, prices of raw materials dropped, and depression descended on business.
A second explanation is that the administration doubled the reserve requirements of banks, forcing them to keep on hand twice as much cash in proportion to their total deposits as they had needed to previously. This caused the banks to sell bond holdings, which weakened security prices, and contracted credit. The increased requirements imposed on the banks were parts of the policies of administration officials designed to offset the boom which they imagined was in the making, and to erect safeguards against inflation. The authorities applied the credit brakes, but in their zeal they slammed them on and caused the long business skid that is still under way, and still threatening to end in a bad smash.
There is yet another explanation involving banking which attributes our troubles to a ruling by the Federal agency that insures bank deposits. That ruling requires banks to have capital at least equal to 10 per cent of their deposits. At the same time the administration has artificially reduced interest rates to such low levels that banks can neither earn enough to build up their capital assets by profits nor pay dividends large enough to attract new capital through the sale of stock. The result is that banks having deposits equal to ten times their capital cannot make additional loans because that would increase their deposits beyond the permitted ratio.
Probably the explanation having the widest support among economists is that our present difficulties are the direct results of attempts made by the administration to institute a balanced budget. During the recovery period, up to about the end of 1936, we had been trying to spend our way out of the depression by disbursing from four to six billion dollars a year more than we were taking in by way of taxes. This was done by borrowing, and it furnished a constant and enormous flow of consumer purchasing power which sustained our recovery. Then in 1937 the government sharply reduced its borrowings and increased its tax receipts until it was actually taking something away from the flow of the purchasing power of the people instead of greatly adding to it. Government suddenly handed back to business the task of keeping the people supplied with purchasing power without giving any adequate warnings of what it was doing, and without any tapering-off process.
One of the two remaining popularly accepted explanations attributes our present troubles to the widespread dismay prevailing among business men as the result of their brief and turbulent experience with the workings of the National Labor Relations Act. Many of them feel that it is simply not worth while for any man to continue trying to do business under present labor conditions if he has accumulated enough to support himself and his family, however modestly, amid the peaceful surroundings of retirement.
The last of the six explanations is somewhat like this one, for it holds that the cumulative effect of high income taxes, undistributed profit taxes, capital gain taxes, social security taxes, and unemployment insurance taxes has finally so nearly destroyed profit incentives that enterprise has become folly. Under such circumstances satisfaction and achievement can best be sought through working for someone else, and preferably for the government.
All six of these explanations have some characteristics in common. They all place the responsibility for our business slump in Washington. More astonishingly, they all attribute our troubles to ineptitude, and bungling, and inefficiency in high places, rather than to any purposeful attempt to supplant our traditional economic system with some other system. All six explanations implicitly assume that the administration had good intentions, but they conclude that those good intentions have come to constitute the paving of the hot spot on which we now find ourselves.
It seems wholly probable that future analysts studying these matters more calmly, and aided by the clarifying perspective of time, will agree that there is something of validity in each and all of these explanations. Nevertheless, they now fall short of telling us convincingly why it was that an apparently minor and normal reaction in the stock market last August kept on getting deeper and steeper until it developed into a panic, and initiated a business relapse of this magnitude. Perhaps the controlling factor which converted the reaction into the relapse was the cumulative effect of bad news.
When the decline in the stock market was getting under way, the news from the little world war in Spain was bad, and getting worse. Then came tidings of the operations of pirate submarines in the Mediterranean, and stock prices moved lower. Suddenly the news came that the British ambassador to China had been shot by a Japanese aviator, and again prices broke. Meanwhile we were getting successive rumors and finally definite reports that the President had decided to call a special session of the Congress for the hurried enactment of more laws for the further drastic regulation of agriculture, industry, and the utilities, and for a reorganizat ion of the administrative offices in Washington with greatly increased concentration of power.
When that news was verified, American investors suddenly and spontaneously adopted a policy of watchful waiting. These investors included not only individuals who purchase and sell securities for their personal accounts, but corporations which invest in properties by erecting new plants, extending old ones, and installing equipment. It was like a sit-down strike, except that it was unorganized and without leadership. What seems to have happened late last summer was that great numbers of both individual and corporate investors abruptly decided that they no longer had sufficient confidence in the future prospects for profits to be willing to bet on them with their own money.
There are two indicators of business confidence that are more reliable than any others. One of them is the action of stock prices, and the other the records of the sales of new securities to raise money for the promotion of business enterprises. They both tell the same story. When stock prices are rising, and flotations of new securities are increasing, business confidence is strong and gaining. When prices are falling, and fewer new securities are being offered, confidence is waning.
In these recent months, stock prices have suffered one of the most rapid declines in their history, and flotations of new securities have dwindled away to a mere trickle. These declines assumed serious proportions when it became known that a special session of the Congress was to be called for the hurried enactment of a sweeping programme of new legislation for the further regulation of business. Apparently investors decided then that stocks would probably be worth less in the future than they had normally been in the past. They thought they would be worth less because of restricted markets for dealing in them, the dangers of insolvencies due to the forced disbursements of earnings, the ever-increasing exactions of labor organizations, and the chronic fears of still more harassing laws and regulations.
The result was a hurried selling of stocks for whatever they would bring, and a general withdrawal by corporations of projects for financing extensions of their enterprises. The administrators of our national plan for a managed recovery had miscalculated the endurance of business. They had overlooked the fundamental fact that the most dangerous foe of business is chronic uncertainty. Business can overcome almost any obstacles that have known characteristics and fixed conditions, but it cannot prevail against continuous shifting of the laws, regulations, taxes, and labor conditions under which it must operate.
III
Our chances of recovering from this relapse without having to go through with a long, slow, depression convalescence depend in large measure on what happens this year to business in other countries. Most of the rest of the world is much further along than we are in the recovery from the great depression. In nearly all the other important countries the volume of industrial production is running well above that of 1929. It may well be that their business cycles have run so far, and mounted so high, that downturns could easily get under way.
It might readily happen that declines in business activity abroad might result from our depression conditions here, and foreign economists are already expressing anxious comments about that possibility. If that should take place, and if business activity abroad should slow down seriously, our chances for a prompt resumption of recovery here would be poor indeed. Depressions are no respecters of national boundaries, and poor conditions here may well engender hard times abroad, and those in turn may operate to postpone recovery in this country.
The statistical office of the League of Nations considers the average monthly volume of industrial production in 1929 to have been equal to 100 in each important nation publishing records of such measures. On that basis our production in November was 80. In the rest of the world as a whole the latest figure — which, as this is written, is that of September— stood at 114. In England it was 114, in Germany 118, in Denmark 133, and in Sweden 142. These other countries have far exceeded their old prosperity records, and have been experiencing new and greater prosperities.
The most significant international comparisons of all are those between the records of this country and those of Canada. Our Federal index of industrial production includes the outputs of manufacturing and mining. The official index of the Dominion includes other items, such as construction, but if we combine by statistical methods the data for manufacturing and mining we can construct for Canada figures that are directly comparable with our own, and they afford astonishing comparisons.
We find that the great depression was more severe in Canada than it was here. Our industrial production fell 46 per cent from the highest month in 1929 to the lowest month of the depression, but the corresponding decline from highest month to lowest month in Canada was 49 per cent. In this country our industrial production recovered from the lowest depression month, up to last October, 55 per cent of its depression losses. But, up to last October, Canadian industrial production had recovered 110 per cent of its depression losses, and was far above its highest records of the old prosperity period of 1929. Canada has done twice as well as we have in bringing back production.
Unemployment was more severe in Canada than it was with us, and the Dominion has done better with reëmployment than we have. From the low of the depression up to last October, Canada had regained in employment 93 per cent of the depression losses, while we had regained only 83 per cent.
It would be prudent for us to ponder well the questions suggested by the discrepancies between the results of our recovery efforts and those that Canada has achieved. There is a country so like our own in populations, institutions, and business procedures, that for thousands of miles along the border, except at its eastern end, the traveler crossing the line finds it hard to realize that he is in a different country. Canada’s per capita wealth is far lower than ours. The climate is more rigorous. She lacks many of our natural resources, especially coal and iron. She was harder hit by the depression. And yet Canada has done a far better recovery job than we have, and we ought to be asking ourselves why she has succeeded and why we have not.
This relapse of business is precisely described by the French phrase which calls such a collapse a ‘crisis of confidence.’ Two American statesmen, who have long since passed on, expressed in speeches exactly the basic principles which apply to this troubled time. Thomas B. Reed once said, ‘If a period of prosperity could be expressed in a single word, that word would be “confidence”; and if a period of adversity could be expressed in a single word, that word would be “distrust.”’ That sounds as though Reed had foreseen our present problems, but Daniel Webster, speaking in the Senate a little over a century ago, seems to have been discussing the difficulty of finding the solution we are seeking, for he said, ‘Confidence is a thing not to be produced by compulsion. Men cannot be forced into trust.’
The economic solution of our problem is simple. We could win our way back to a sturdy recovery far more easily than the Canadians have done if it were not for the political difficulties which confound us. The electric utilities are the key log in our depression jam. Before the depression they were raising a billion dollars of new capital each year, and spending it for new construction. In recent years they have been raising only about one twentieth as much new capital, and they have been doing little construction. They have great accumulated shortages of equipment which they are eager to make up. If there could be a treaty of peace between the utilities and the government, more than a billion dollars’ worth a year of new construction could promptly be got under way.
If the utilities should resume largescale construction, the railroads would have greatly increased traffic. Before the depression, the roads were spending more than two billions a year for materials and capital expenditures, but in the past five depression years their average expenditures of the same sorts have been reduced to three quarters of a billion per year. Since this present downturn began they have been further reduced to very small amounts. If the roads could gain the rate increases now being considered in Washington, and also gain important traffic from the utilities, they would promptly increase their own expenditures by perhaps a billion dollars a year. If the utilities and railroads were once more eager customers, the basic iron and steel industry would be prosperous. If those three industries were prosperous, the automobile industry would prosper also, and the expansion of the buildingconstruction industry would promptly get under way.
We have all the economic requisites for prosperity. We have the men, money, materials, and markets. We do not need to exploit some new invention, or to expand an infant industry, to find work for all. There are still waiting to be made up enormous shortages accumulat ed during the depression years in the durablegoods industries. We need large numbers of ships and bridges, generators and transmission lines, cars and locomotives, cranes and machine tools, new dwellings and industrial plants. Our troubles are political, not economic. Probably no nation stricken by a depression ever before faced a recovery problem so simple in its economic terms, and so complex in its political terms.
We need to start from where we are, and work with what we have. No new monetary manipulation will turn the trick this time. Budget balancing must again be postponed because new necessities for supporting the unemployed are upon us, but lavish expenditures for priming the pump of prosperity will not again avail to get a new recovery under way. Our solution must come through coöperation between government, business, and labor, and our problem is to develop a working combination of that coöperation.
The controlling condition of our problem is that we live in a profit-and-loss economy which cannot be changed into a managed economy except through a great social crisis, and after a dreadful new depression. The incentive which impels men to take present risks in the hope of making future gains is confidence in the prospects for profits. At present that confidence is lacking, and it cannot be coerced or intimidated into being. Only government can re-create it, if only government will.