by Unknown
He averages at least two baths a day and owns sixteen dressing gowns and nine cigarette cases. His favourite hors d’oeuvre is a trenche of melon eaten simultaneously with a slice of jambon de Parme. He is an ardent movie fan but doesn’t give a whoop for baseball.
TWILIGHT OF THE ECONOMIC GODS
JAY FRANKLIN
FROM APRIL 1931
One does not have to be an optimist to realize that the great advantage of having a panic is that it compels us to think about our institutions and to overhaul our ideas. In the process, we get rid of a lot of notions which had been regarded as dogma handed down from Jehovah to our economists.
For a fat decade we have been hearing—chiefly from the bankers and business men—that bankers and business men are preeminently qualified to manage world affairs and that politicians and sociologists are either inefficient knaves or dangerous cranks. Prompted by the big bankers, we have dutifully held our noses whenever politics or statesmanship were mentioned and we have leaped to our feet and cheered ourselves hoarse whenever the Federal Reserve has tried a forward pass with the rediscount rate or the National City Bank has assayed a goal from the field. We have been taught to hew to the ticker and let the stocks fall where they may and we have actually been persuaded that banks and money can cure any international ailment from military flatulence down to hardening of the political arteries.
• • •
This golden age of bankers is passing, however. Few of the faithful can confidently affirm the immaculate conception of the Federal Reserve System, after the failure of scores of banks in every part of the country, and with its very existence challenged by demagogues and its organization branded as inadequate by Carter Glass, the man who started it. Those who believed in the literal inspiration of the Stock Exchange have already made the supreme sacrifice and are no longer able to testify financially. With more than five million unemployed, the patented air-tight prosperity formulae of high wages and mass production make Ford and Edison look as up-to-the-minute as the Anti-Saloon League.
When we put a great practical economist in the White House and watched him assist in a neolithic tariff and spend $400,000,000 of our money in a futile attempt to keep up the price of wheat and cotton, a whole economic legend died before it could be used for a second term.
We are now witnessing the twilight of the economic gods. The platitudes and glib formulae of the American economic system are pretty nearly as solvent as the Bank of United States. The old theory that the best way to make every one healthy, wealthy and wise is to let the rich get rich and the poor get children is as dead as McKinley. Our whole system is on trial, in our own eyes, for the first time in sixty years. Never again will we take it for granted that a banker must necessarily be right or a reformer necessarily wrong in his approach to public problems.
For bankers are only human. They are all too likely to invest in Coppers at the peak or to try another round of Oils. They are quite as liable to the vice of self-importance as musicians or lawyers, and they are as likely to make mistakes as doctors. Just as doctors think that every ailment requires a prescription and fee, so do bankers insist that every problem can be treated with a bond-issue and a commission.
• • •
If our economic leaders had been endowed with more knowledge than is at the disposal of the average intelligent man, they might have had a little more luck in heading off this recent world disaster. As it was, they were unable to do so as they had bound themselves to the insane, if human dogma that nothing had any existence which was not purely financial. There were no racial animosities, no political problems, no diplomatic arrangements or historical traditions, no conflicts of culture or clash of systems: nothing but loans, currencies, trade balances and risks.
As a consequence of this economic effrontery, the bankers were entrusted with world power for a decade and made a complete mess of it and of the world. There are, for example, three major problems which must be settled before the world can regain its economic health. Bankers cannot settle them, because they are political problems, but bankers and economists could have called attention to their existence and demanded their solution by the political forces of society as a prerequisite to prosperity. These problems are not unemployment, deflation and debt—for these are only the symptoms of the failure of economic statesmanship. The failure lies deeper—in politics—in Germany, Russia and China.
The bankers have had two chances to deal with the question of German Reparations—by the Dawes Plan of 1924 and the Young Plan of 1929. The first was the achievement of a Chicago banker, the second of a New York industrial economist. The failure was worse than abysmal, for the bankers preferred to base the financial credit of the entire world on the shaky foundation of Reparations rather than admit their own inadequacy. There is no doubt that the Germans should pay Reparations. They have admitted it repeatedly. There is, on the other hand, still less doubt that their liability to pay ought to be settled by arbitral procedure. Our bankers simply reckoned German capacity to pay, never German liability to pay, and so put international credit at the mercy of a German default or a German moratorium. The Allied claims for payment have never been impartially assessed. They include such absurd categories as civil pension and undoubtedly incorporate inflated valuations and false claims. They have never been properly offset by German claims against the Allies—as with the German-American Mixed Claims Commission—or by a fair accounting for the huge sums delivered by Germany between the Armistice and May 1921. Until Germany’s liability has been legally established and Germany’s payments legally accounted for, the smooth clauses of the Young Plan, the glittering Bank of International Settlements at Zurich (which the international bankers so humanely proposed as a solution of all these reparations and war-debt problems) will last just so long as Germany is too weak to throw them out. This is the first opportunity which our economic wonder-workers overlooked in their self-appointed mission to save mankind by foreign loans and adulation.
The second failure is even more damning, if somewhat more understandable. Despite the fact that, without Russia, the world is economically lame, our professional economists have attempted to get on without Russia for twelve fateful years. Of course, Russia deserved it. No American can doubt that. Yes, Russia was in the grip of a foul financial heresy and was being run by a group of socialistic adventurers who were breaking all the rules and getting away with it, but our economists failed deplorably, both as a matter of policy and as a matter of judgment, to recognize the existence of Soviet Russia.
• • •
In the first place, they made no determined effort to devise any formula for adjusting the methods of the Russian heresy to the unnecessary processes of the capitalistic world. For the sake of a few millions sunk in deplorable anemic Czarist bonds and for the love of a few bales of depreciated rubles, the bankers strenuously oppressed any effort to adjust our society to the Russian experiment. They instituted and maintained a financial and economic blockade against the Soviets. Even to-day they act as though they were conferring an inestimable boon in permitting the Russians to buy our goods. The financiers withheld help from Russia during the most critical period in her ghastly and difficult evolution and thus assured to our society the future enmity of the most incalculable people on the face of the modern globe. Worse still, our economic lords had the folly to attempt to organize our system of production and exchange after the war, without any reference to Russia. Russia was an economic vacuum, they decreed. Bolshevism could produce nothing, and therefore could neither import nor export. The corrupt tree could not bring forth good fruit. Russia had the wrong idea, so how could wheat grow on the steppes, trees be felled in the forest, or coal be brought out of the mines? As a result of this Old Testament line of reasoning, Russian exports, which were resumed in a large way last summer, dropped on our economic system like a brick from a sky-scraper.
Finally, the disorganized condition of China has placed
a huge burden upon world trade and has been a drag upon world prosperity for years.
No, one does not need to go muckraking in the mess of our foreign trade or to remove the fig-leaves from our foreign loans to dictators, to bankrupt governments, to any and every agency that enabled an investment banker to get a commission and unload a batch of bonds on the public. One does not need to point out that our business men, far from keeping government out of business, have positively dragged it into business. One does not need to emphasize the Administration’s refusal to consider Senator Wagner’s intelligent bills for approaching the problem of unemployment. These are all details. When the bankers and their friends, the economists, can prove themselves so wrong as to misjudge the political potentialities of the Germans, the most vital race in Europe, of the Russians, the most portentous people in Asia, and of the Chinese, the most numerous and industrious race in the world; when the financiers leave out of reckoning a full third of the human race, we cannot be expected to have too much respect for them.
The plain fact is that neither our economists nor our bankers have the foggiest notion of where we are going or how we are going to get there. They scold and mock Soviet Russia for her ambitious Five Year Plan, and have no corresponding idea of what is to be our own course in the next three years. They denounce socialism and then applaud the use of half a billion of the tax-payers’ money to pay the farmers for producing too much at a loss.
Of course, our economic leaders are not altogether to blame. Just as the world war demonstrated the bankruptcy of politics, so it seemed logical for the world to turn to non-political leaders. Surely, the world felt, they could do no greater harm than the statesmen had done. High finance could be no more dangerous than high diplomacy, and might even prove beneficial. The world was mistaken.
The financiers did make a mess of it. The economists successfully demonstrated their incapacity and the politicians are coming back to power.
For the underlying factor in the present crisis is, that despite their pretensions to omnipotence, bankers and economists must still take their orders from politics. It would never do for the public to guess that the Young Plan was a weak compromise to conceal the existence of irreconcilable political feuds, or that Adolf Hitler is the result, not of international finance, but of the Anglo-French policy of one-way traffic for reparations. It would not be seemly for the banks to admit that they guessed wrong on Russia, that their anti-Russian bluff has been called, and that they are now powerless against the current of anti-Russian political feeling which they themselves did everything to create. It would be highly indecorous for high finance to admit that nothing can be done to restore China to economic order because political forces prevent any clear-cut solution of Chinese anarchy by the Western powers.
Our economic leaders have never had the power which they have claimed for themselves. Economics, in their hands, has been a science which is purely descriptive, like geography. Their “solutions” have simply been sublimated political manœuvers. Their failures have been political failures. For their pretense that they alone could do the job, they are being punished by the obvious fact that the job is still undone. Rather than admit their own fallibility, they have preferred to lay a time-bomb under international credit and to endanger our entire economic system. It is a high price to pay for a political fiasco. Rather than pay it, a few politicians—demagogues, in the first place, like McFadden, to be followed by vocalizers like Borah—are beginning to suspect that the bankers should be made to pay. In every country and in every age, from Rome down to America, a time has come when it becomes necessary for politics to take command and to oust the financiers from a position of privileged and irresponsible power. For politics is greater than economics, if only for the reason that politics includes economics. We are beginning to wonder whether it will not soon be time to remind our economic leaders of the fact that the whole is greater than the parts, and that economic leadership has been weighed and found wanting in the balance of international politics.
BANKS AND THE COLLAPSE OF MONEY VALUES
J. M. KEYNES
FROM JANUARY 1932
A year ago it was the failure of agriculture, mining, manufacture and transport to make normal profits, and the unemployment and waste of productive resources ensuing on this, which were the leading features of the economic situation. Today, in many parts of the world, it is the serious embarrassment of the banks which is the cause of our gravest concern. The shattering German crisis of July, 1931, which took the world more by surprise than it should, was in its essence a banking crisis, though precipitated, no doubt, by political events and political fears. That the top-heavy position, which ultimately tumbled to the ground, should have been built up at all, was, in my judgment, a sin against the principles of sound banking. One watched its erection with amazement and terror. But the fact which was primarily responsible for bringing it down was a factor for which the individual bankers were not responsible, and which very few people foresaw,—namely, the enormous change in the value of gold money and consequently in the burden of indebtedness that debtors, in all countries on the gold standard, had contracted to pay in terms of gold.
The German crisis was heralded by the Credit Anstalt trouble in Austria. It was brought to a head by the difficulties of the Darmstadter Bank in Berlin. It led to distrust of the London position on account of the heavy advances, out of relation to the liquid resources held against them, which London had made to Berlin. It culminated in Great Britain’s suspension of the Gold Standard. Its final sequela as I write these lines, is a feverish removal of foreign balances from New York. But all this nervousness, and hysteria and panic, which is making a farce of our currency arrangements and bringing the world’s financial machine to a standstill, is only superficially traceable, though it has all happened suddenly, to quite recent events. It has its roots in the slow and steady sapping of the real resources of the banks as a result of the progressive collapse of money values over the past two years. It is to this deep, underlying cause that I wish to direct attention in this article.
Let us begin at the beginning of the argument. There is a multitude of real assets in the world which constitute our capital wealth—buildings, stocks of commodities, goods in course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money. A considerable part of this “financing” takes place through the banking system, which interposes its guarantee between its depositors who lend it money, and its borrowing customers to whom it loans money wherewith to finance the purchase of real assets. The interposition of this veil of money between the real asset and the wealth owner is a specially marked characteristic of the modern world. Partly as a result of the increasing confidence felt in recent years in the leading banking systems, the practice has grown to formidable dimensions. The bank-deposits of all kinds in the United States, for example, stand in round figures at $50,000,000,000; those of Great Britain at £2,000,000,000. In addition to this there is the great mass of bonded and mortgage indebtedness held by individuals.
All this is familiar enough in general terms. We are also familiar with the idea that a change in the value of money can gravely upset the relative positions of those who possess claims to money and those who owe money. For, of course, a fall in prices, which is the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real asset is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy it. This, we all know, is one of the reasons why changes in prices are upsetting.
But it is not to this familiar feature of falling prices that I draw attention. It is to a further development which we can ordinarily afford t
o neglect but which leaps to importance when the change in the value of money is very large,—when it exceeds a more or less determinate amount.
• • •
Modest fluctuations in the value of money, such as those which we have frequently experienced in the past, do not vitally concern the banks which have interposed their guarantee between the depositor and the debtor. For the banks allow beforehand for some measure of fluctuation in the value both of particular assets and of real assets in general, by requiring from the borrower what is conveniently called a “margin”. That is to say, they will only lend him money up to a certain proportion of the value of the asset which is the “security” offered by the borrower to the lender. Experience has led to the fixing of conventional percentages for the “margin” as being reasonably safe in all ordinary circumstances. The amount will, of course, vary in different cases within wide limits. But for marketable assets a “margin” of 20 per cent to 30 per cent is conventionally considered adequate, and a “margin” of as much as 50 per cent as highly conservative. Thus, provided the amount of the downward change in the money-value of assets is well within these conventional figures, the direct interest of the banks is not excessive;—they owe money to their depositors on one side of their balance sheet and are owed it on the other, and it is no vital concern of theirs just what the money is worth. But consider what happens when the downward change in the money-value of assets within a brief period of time exceeds the amount of the conventional “margin” over a large part of the assets against which money has been borrowed! The horrible possibilities to the banks are immediately obvious. Fortunately, this is a very rare, indeed a unique, event. For it had never occurred in the modern history of the world prior to the year 1931. There have been large upward movements in the money-value of assets in those countries where inflation has proceeded to great lengths. But this, however disastrous in other ways, did nothing to jeopardise the position of the banks; on the contrary it increased the amount of their “margins”. There was a large downward movement in the slump of 1921, but that was from an exceptionally high level of values which had ruled for only a few months or weeks, so that only a small proportion of the banks’ loans had been based on such values and these values had not lasted long enough to be trusted. Never before has there been such a worldwide collapse over almost the whole field of the money-values of real assets as we have experienced in the last two years. And, finally, during the last few months—so recently that the bankers themselves have, as yet, scarcely appreciated it—it has come to exceed in very many cases the amount of the conventional “margins”. In the language of the market the “margins” have run off. So long indeed as a bank is in a position to wait quietly for better times and to ignore meanwhile the fact that the security against many of its loans is no longer as good as it was when the loans were first made, nothing appears on the surface and there is no cause for panic. Nevertheless, even at this stage the underlying position is likely to have a very adverse effect on new business. For the banks, being aware that many of their advances are in fact “frozen” and involve a larger latent risk than they would voluntarily carry, become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. For it means that the banks are less willing than they would normally be to finance any project which may involve a lock-up of their resources.