Now it is obvious that no man can say with certainty how large a burden of debt an economic system can carry. No man can say with assurance that this vastly enlarged debt was enough to break the American system. For one thing, one man’s debt is another man’s wealth. Yet here was at least a potential source of strain: a rigid structure of claims—many of them imprudent—in an otherwise highly flexible economy.
Nor was this mass of outright debt the only source of strain. There was also the huge body of claims upon future earning-power represented by issues of stock. The wild financial expansion during the nineteen-twenties had multiplied these claims. Many of them, as we noted in Chapter XI, did not represent any substantial investment of money in the companies against whose earnings they were a charge, but represented stock bonuses to insiders or the issue of stocks for “services.” Again and again, in this book, we have noted the extent to which dividend claims—as well as debt claims—set up in the boom years were based upon hopes of steady fair weather in the future. Investment trusts and holding companies, for example, were largely dependent upon the cream which could be skimmed off the milk of corporate earnings. Write-ups and stock-watering operations necessitated fair-weather earnings to give them the appearance of validity. The stock-market boom had built up a general expectation of high earnings which corporate managers were bound to justify if they possibly could.
The burden of claims represented by issues of stocks was not, of course, rigid; it was not outright debt; yet it was very real. Not without a bitter struggle did corporations cut—or stop altogether—their dividends. Sometimes the dividends were continued even at the risk of disaster, as for instance in the Insull public-utility system. Even in the terrific year of 1932, when the corporations of the country were collectively more than five and a half billion dollars in the red, they were still paying dividends to the extent of more than four billion dollars; and of these four billions, over a billion and a half was paid by companies which were actually losing money.
Here, then, we have two circumstances appearing in conjunction. We have an economy that must grow in order to provide jobs for Americans. And we have this growth brought about by building up a vast load of fixed debt (and of dividend claims) which the economy must carry if it can.
Now according to the old-fashioned economics of rugged individualism, there was no reason why the country could not in due course adjust itself to the ups and downs of trade. From time to time deflation might be necessary—but this deflation would shortly bring about a cure. For one thing, as purchasing power fell off, the prices of goods would drop until latent buying-power was tempted into the markets and shops and the process would reverse itself. For another thing, during any serious depression enough companies would go into bankruptcy to reduce the burden of debt until it could easily be carried. Automatic adjustments of this sort had taken place during previous depressions; business men under the domination of the respected ideas of laissez-faire economics expected them to take place again and bring early and automatic recovery. Why did this not happen?
One reason was that there were now a great many big corporations—more than in any previous depression—with heavy administrative overhead expenses and heavy investments in plant and machinery. It was hard for these concerns to reduce their administrative expenses very much, or to reduce the fixed charges on their plant or machinery at all. The wages of machinery cannot be reduced. If these companies allowed prices to slide, they could not make enough money to meet their fixed charges, to say nothing of paying dividends. They were under an overwhelming compulsion to keep prices up if they possibly could, even if this meant making and selling less goods.
Some companies could hold prices up because they possessed monopolistic power, directly or through secret agreements with their rivals (ranging all the way from gentlemen’s understandings to racketeering combinations); but the same pressure of circumstances was felt by monopolies and non-monopolies alike. The easiest item of expenditure on which to save was the wage bill. They actually were better off—for a time—if they ran their factories or mills on an abbreviated schedule, or shut some of them down altogether, than if they let prices slide. The result—particularly in the capital-goods industries—was that the prices of goods did not fall so fast as did the wage bill.
Gardiner C. Means, in his pamphlet on Industrial Prices and Their Relative Inflexibility, throws light on what happened. Between 1929 and the spring of 1933, while the prices of agricultural commodities (responding in the orthodox way to the law of supply and demand) fell 63 per cent and the production of these commodities fell only 6 per cent, a very different sort of change was taking place in other departments of the national economy. For example:
According to the computations of Frederick Mills, between 1929 and 1932 the average price of capital goods as a whole fell only 20 per cent; yet production in the capital-goods industries fell 76 per cent.
The causes of this phenomenon are not wholly clear, but it seems reasonably accurate to say that in the effort to carry a load of irreducible charges, these corporations were throwing off workers—and thus were killing the goose that laid the golden egg of revival. A new burden of unemployment was being added to that which would naturally have come about anyhow as soon as the national economy ceased expanding.
But why did not the situation cure itself speedily through a succession of bankruptcies? The answer is that the financial superstructure of debt and of dividend claims had become so enormous—and so pervasive in its influence upon the whole economic structure—that the country could hardly have stood the shock of such bankruptcies. Here we come upon still another possible clue to the situation.
To a much greater extent than ever before in the history of the country, the investments of the country were now in liquid form—in other words, in such a form that they could quickly be turned into money. Securities were listed upon stock exchanges to a greater extent than ever before. Banks, as we have seen, had less of their funds in commercial loans and more in bonds and in loans on securities than ever before. According to the estimates of Berle and Pederson, the total of liquid claims in the United States had never amounted to more than 20 per cent of the national wealth until 1912; between 1912 and 1922 it had gone up to about 25 per cent; by 1930 it had shot up to 40 per cent. A liquid investment had its advantages for the individual: he felt safer if at any moment he could turn his holdings into money. But the existence of a large proportion of liquid investments enormously increased the chances of panic. When a large number of banks and of businesses were trying to unload simultaneously in the same market-place, a panicky market quickly developed. Not merely the bonds and stocks of companies which were in difficulties dropped in price, but nearly all bonds and stocks. Furiously as corporations were attempting to meet their fixed obligations and their unfixed dividend obligations by throwing men into unemployment, the prices of these obligations cascaded as a result of fear and of forced sales. When there was a big failure—like that of the Bank of United States at the end of 1930, or those of Insull and Kreuger in early 1932—the shock to these markets was immediately visible and for this reason all the more staggering. If the process had gone on.…
But it did not go on. President Hoover prevented it from going on by calling for the formation of the Reconstruction Finance Corporation to bring first aid to harassed banks and corporations and to stop the epidemic of bankruptcies. Thus another traditional cure for a business depression was withheld. Rightly or wrongly, the property interests of the country felt that the financial system could not stand such strong medicine. The debt structure—now supported by government intervention—remained almost intact. Many long-term debts—especially mortgages—were in default, but new ones had taken their places. The cold figures show what was happening: according to the computations of Dr. Simon Kuznets for the National Bureau of Economic Research, the amount of money paid out in interest in the year 1932 was only 3.3 per cent less than in 1929—though meanwhile salaries had dro
pped 40 per cent, dividends had dropped 56.6 per cent, and wages had dropped 60 per cent.
Thus the American economy went into a vicious downward spiral. The cutting of wage bills meant a decrease in purchasing power; the decrease in purchasing power meant a decrease in sales; the decrease in sales made the burden of capital obligations heavier and heavier and led to further cutting of production and of wages, and so on. Nor did the owners of debt claims and of stock prosper; for as the crisis was intensified, claims which they owned were becoming less and less valuable. The capital markets were demoralized, the demoralization of the capital markets demoralized the banks, and so on through another spiral of cause and effect.
Add to this chain of circumstances the unbalanced foreign-trade situation, the depression and financial panic in Europe, the weakened economic position of the American farmers, the inherent weakness of our collection of forty-nine banking systems, the direct though belated effects of the financial abuses and excesses and frauds of the nineteen-twenties, and the stubborn belief of American business men that a turn of the business cycle would inevitably bring back prosperity if wages were permitted to drop and capitalists waited hopefully for the dawn, and you have, perhaps, a reasonably adequate explanation of the great toboggan-slide of 1930 and 1931 and 1932. The era of high finance had so swollen the mass of claims upon the future that only roaring prosperity could sustain it; and the effort to sustain it even at the cost of purchasing power undermined the foundations of that prosperity.
4
It was a bitter time in which to be President of the United States. No presidential reputation can withstand an economic depression; even those people who are most insistent that the government should keep its hands off business will blame the government when business goes wrong. It was a particularly bitter time for a President who had proclaimed in his speech of acceptance that “given a chance to go forward with the policies of the last eight years, we shall soon, with the help of God, be in sight of the day when poverty will be banished from this nation.” Hoover had gone forward with the Coolidge policies; Andrew Mellon, the idol of the conservative business world, was still Secretary of the Treasury; and yet disaster was descending upon the nation with cumulative force.
By the autumn of 1930, the Hoover recovery moves of late 1929 and early 1930 were clearly failing. The cut in the income tax was accentuating a mounting governmental deficit. The public works program had not gone far—the deficit stood in its way. The President’s insistence that wages must not be reduced was being widely disregarded, and even where the wage rate still stood firm, the amount of money paid out in wages was becoming smaller and smaller as factories went on part time or shut down entirely. The Federal Farm Board’s effort to sustain the price of wheat was a dismal failure, involving the government in huge losses. And as for the campaign of synthetic optimism, by the autumn of 1930 it was already becoming a sour jest, and by the end of 1931 a compilation of the cheerful prophecies made by Hoover and his aides and by the leaders of business and finance, published under the scornful title of Oh Yeah? was greeted everywhere with derisive laughter.
What should the President do next?
From the middle of 1930 to the middle of 1931, he did virtually nothing. “This was the period,” George Soule justly reminds us, “which gave rise most of all to the legend that the depression President was a spineless mass of jelly in the face of the nation’s difficulty, that he was incapable of action. Yet he was pursuing a definite policy, a policy endorsed in theory both by the financially powerful and by the conservative economists. It was a slightly different one from that which he had attempted to practise at the beginning, to be sure, and yet the two were related. The first theory had assumed that there was nothing much the matter, and that if everyone could be induced to believe this, there would be no danger. The second theory had to admit that there was something the matter: in some mysterious manner, the system had got out of kilter. But the way to remedy the disease was to let it run its course without interference. The economic order was a self-compensating one, and if left alone would get into balance.” Accepting, then, the traditional laissez-faire theory that nature must take its course, Hoover stood aside.
The expected self-compensation, however, did not take effect. All through the autumn of 1930 and the winter and the spring of 1931 the decline continued, with but a momentary flare-up of hope in midwinter as the indices of production turned briefly upward.
Then in the early summer of 1931 the débâcle went into a new phase. The debt structure in Europe cracked. The Credit Anstalt, the largest and most powerful bank in Austria, was in difficulties; the Austrian Government was trying frantically to borrow enough money to shore it up; and throughout the Continent there was spreading a wild fear that the whole fiscal system of Central Europe would go to pieces. Here, felt Hoover, was an opportunity for constructive action by an American President. He proposed a year’s moratorium on governmental war debts and reparation payments. The essence of his plan was that the groaning weight of the mass of international private debt would be eased by postponing for a year all payments on the inter-governmental debt, so far as this grew out of the war and the peace settlement.
His proposal was accepted—with modifications insisted upon by the French. But although the announcement of it had provoked another outburst of hope—and of speculation for the rise on the Stock Exchange—the Hoover scheme was not enough to stop the spread of financial panic. The Austrian crisis was followed by a German crisis, and the German crisis by a British crisis; in September, 1931, England was driven off the gold standard; and by this time the panic had leaped the ocean and was raging in America too. On the New York Stock Exchange, the prices of foreign bonds of all sorts fell hard and fast. Other bonds followed their example as thousands of American banks and corporations and individual investors were forced to liquidate to save themselves. A crack in the structure of debt was proving to be a very serious matter indeed.
In American towns where not one person in a hundred had ever heard of the Credit Anstalt, disquieting whispers were soon running about: that the local bank was in difficulties, that its money was tied up in bad mortgages and depreciated bonds, that the local tire factory owed it a quarter of a million dollars and could not pay; that the only safe thing to do was to draw your money out and keep it in your mattress, in bills if not in gold. Panicky millionaires were transferring their funds to France, to Holland, to Switzerland, or were packing their safe-deposit boxes with gold. The Federal Reserve figures during the autumn of 1931 showed that something like a billion dollars was being hoarded in currency. Ever since the onset of the depression the rate of American bank failures—a rate scandalously high even in the nineteen-twenties—had been dismaying; but now all previous records were broken. In September, the month in which England left the gold standard, 305 American banks were suspended; in October, no less than 522.
The officers of thousands of other banks, miserable with worry lest the lines of men and women at the paying tellers’ windows should suddenly grow to panic length, were deciding to call a few more loans, to sell a few more bonds, to make sure they had plenty of cash—and as their selling orders converged upon the market, the demoralization was intensified. Not only did the pressure of liquidation play havoc with bond prices; it also drastically reduced the amount of money in the country. The process through which banks create money by making loans and setting up checking-accounts—the process of bankers’ inflation—was now working in reverse, automatically and rapidly. In the space of eight months, the amount of money in the country was reduced by as much as twenty per cent. Some ten billions of dollars evaporated.
As fear spread—the fear of a total banking collapse, the fear that America would follow England off the gold standard, and that vague fear of the incalculable future which expressed itself in the frequently heard phrase, “If everything goes …”—business shrank still more. Wage-cutting was general and unashamed. Unemployment was now going from bad to worse
; it was now estimated that eight or ten million men were out of work.
It was during this panic of the autumn of 1931 that Hoover decided that the American debt structure must not be permitted to fall to pieces. He called a group of financiers to Washington to form a pool of credit for the rescue of distressed capital; and presently he asked Congress to take over the task by setting up the Reconstruction Finance Corporation.
The situation which thus arose contained, perhaps, a certain element of ironic humor. Now financial magnates who still cried out for “less government in business” and inveighed against “the dole” could go, hat in hand, to Washington and get the government to put itself into business by giving a dole of credit to their banks or their railroads. The apostle of rugged individualism had taken the longest step in American history toward state socialism—though it was state socialism of a very special sort.
Yet the situation had also a graver significance. Hoover and his advisers were acknowledging that the possible consequences of letting nature take its course were too terrific to contemplate. It was not simply that they feared that the rich would be impoverished—though this fear undoubtedly colored their thoughts. It was that they feared that the debt structure was so built into the economic fabric of the country that its disintegration would result in general chaos. Banks, insurance companies, and corporations large and small would alike be paralyzed, and in the catastrophe the poor would be ruined along with the rich. And so—to borrow George Soule’s phrasing once more—the government increased the rigidity of the most rigid element of the American economic system, while doing nothing to stop the decline of its most flexible element.
Lords of Creation Page 39