by James Grant
COURAGE: Don’t overestimate the courage you will have if things go against you.
ALERTNESS: To discover any new facts that change the situation; or which may affect public opinion.
PRUDENCE: Be pliable or you won’t be prudent. Become more humble as the market goes your way. It is not prudent to buy when you think the bottom has been reached. It is better to wait and see, and buy too late. It is not prudent to wait for the top of the market to sell—it is better to sell “too soon.” (Never buy so that your margin will be less than 85, or hold if it drops below 80. In a particularly “clear sky” situation with[out] “buts” or “ifs,” one can lower these margins to 80–75%.)
PLIABILITY: Consider and reconsider the facts, and your opinions. Stubbornness as to opinions—“cockiness”—must be entirely eliminated. A determination to make a certain amount within a certain time absolutely destroys pliability. When you decide, act promptly—don’t wait to see what the market will do.
THE FACTS
A. AS INDICATING THE FUTURE
Money market, Bond market, Savings Fund Deposits, Insurance being sold.
Federal Reserve Ratio and operations, Commercial loans. Yields of stocks including and excluding “rights” compared to bond yields and time money.
Volume of new security offerings. Ratio stock exchange loans to price of stocks. Volume of stock transactions.
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Trend of commodity prices (watch supply of gold and credit facilities).
Crop situation
Political situation; domestic and international.
Bank clearings;
Railway Traffic:—A falling off in tonnage is delayed for considerable time after depression begins; while an increase precedes recovery.
Orders:—Construction permits and contracts awarded.
Steel production orders.
Automobile production orders.
Volume Retail Trade:—Department and chain stores.
Employment
Foreign Trade
B. HISTORY:—Inventories and instalment purchases.
Production: Volume manufacturing, including electric power.
Volume mining.
Earnings.
C. INDIVIDUAL COMPANIES:
Is it a growing and standard business (not experimental)
Is competition becoming too keen.
Is it a dominant corporation.
Is it experimenting.
ONE MUST BE THOROUGH AS TO FACTS.
PSYCHOLOGY
Nearly all men are controlled by their emotions: they become alternately over optimistic and over pessimistic. After you have your facts and opinions, wait for the current. Have an opinion on what the market should do, but don’t decide what the market will do. The more the public becomes stock minded the greater it’s [sic] power. Don’t try to go against the mob on the one hand, and don’t go with it in it’s [sic] excesses. Don’t sell short if it is bullish, but don’t stay long if there is a chance that it may turn and rend you, and conversely. In a panic the best stocks may not be salable at any reasonable price. Be alert for anything which the public will greet with enthusiasm or fear. When the market is high beware of thinking of things that will make it go higher; think of adverse possibilities, and remember history; and conversely. Watch for the main currents, but be fearful of too much company.
“Stop losses and let profits run.”
In general run quickly. If you fail to do so hang on, reducing commitments. Always reduce commitments if doubtful. While you should act promptly when you make up your mind, irrespective of market action, nevertheless, you must at times consider the action of the market, in making your plans.
In comparing any situation with a previous one be sure you have the facts of both, so make allowances in psychology. Over action is always followed by overreaction.
The Unforeseen:—Always make allowances for chance. Keep a financial and mental and physical reserve.
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In general run quickly. At first not seeing what one was supposed to be running from, Baruch was slow to make his retreat, but by 1931, at least, he had done some significant selling. Certainly he lacked for no facts concerning the state of the nation. In August 1931 Hugh Johnson returned from a national inspection to report having seen “distinct signs of under-nourishment.” He said that real estate was moribund, the farm-implements business was worse than it had been even in 1921, and that prospects for construction, autos, and railroads all were nil. Concerning an auto-carpet business in which Baruch and he had invested, Johnson wrote:
It seems a shame to contemplate letting the carpet company go when (speaking relatively with other businesses) its prospects are so good, but I am so firmly convinced of the prolongation of this depression, that I have been unable to make up my mind.
In the third week of November Baruch directed Miss Boyle to take financial inventory.[49]
Millions were out of work, England was off gold, banks were failing, and investment-grade bonds were falling along with common stocks. The National Lead Company, which was better off than many, declared an extra 25-cent-per-share “emergency relief” dividend which it asked its stockholders to pass on to the needy. On November 11, 1931, at a reunion of the War Industries Board alumni at which optimism was de rigueur, Baruch could venture not much further than to say, after his old stock-market mentor Middleton Schoolbred Burrill, that “. . . we have disrupted the continuity of pessimism.” On November 18 he joined his colleagues at the B&O board in a unanimous resolution to halve their directors’ fees.
At this gloomy juncture Miss Boyle counted his stocks and bonds and cash and the loans he had made to his friends, and she copied the details on sheets of legal-sized yellow paper. The totals came out this way:
To have had $8.7 million in cash in 1931 was a rare and wonderful feat. Somewhere along the line Baruch had obviously shifted large sums out of stocks. Just as plainly, however, he had borne a loss. At the top in 1929, his financial assets had been worth perhaps $22 to $25 million.[50]
The list of stocks makes interesting reading. There are the conventional names of going concerns: blocks of Brooklyn Manhattan Transit Company, Babcox & Wilcox Company, Carrier Engineering Corporation, Consolidated Cigar Corporation, Consolidated Gas, Cream of Wheat, McCrory Stores, United Biscuit, and Wesson Oil, for example. But there are also numerous distressed or insolvent companies, including Electric Ferries, Mercurbank (of Austria, with branches in Rumania, Hungary, and Poland), Quemont Mining Corporation Limited of Canada, Revere Copper & Brass, Bahia Corporation, United Artists Theatre Circuit, Inc., and Mesabi Iron Company (of which Daniel C. Jackling was president and Herman Baruch and Tom Chadbourne were directors). All told, Miss Boyle found 114,563 shares of stock for which the market value was zero. There was a conspicuous absence of blue chips: no Standard Oil of New Jersey, General Electric, General Motors, American Can, Sears Roebuck, or US Steel. He owned only 200 shares of American Smelting and 165 of B&O.
She noticed that his bond portfolio had lost value. From the Crash through the summer of 1931, interest rates had fallen and bond prices correspondingly had risen. Following England’s departure from gold on September 21, however, the Federal Reserve raised rates to encourage foreigners not to exchange dollars for gold. At the same time Americans began to withdraw cash from banks; and banks, in order to raise money for worried patrons, sold bonds. Railroad bonds, of which Baruch owned about $500,000 worth (at par value), were especially hard hit, and by the summer of 1931 there was talk of having them struck from the list of eligible securities in which banks, insurance companies, and trust funds in New York State could legally invest.
At par value Baruch’s bond portfolio was worth $4,177,000, but at going prices it was quoted at less than three quarters of that. His largest holding was $811,000 (par value) of subway bonds, the Interborough Rapid Transit Company 5s of 1966. Their price had fallen from 78 in early 1929 to 52 when Miss Boyle ch
ecked up. In August 1932, just before the line fell into receivership (and ultimately into municipal ownership), the price was 44. Baruch also owned $148,000 of the bonds of the Manhattan Elevated Company, a money-losing subsidiary of the IRT, and almost $500,000 worth of the obligations of the New York Railway Company, a trolley-and-bus-line successor to the unmourned Metropolitan Street Railway Company. The New York Railway paper was quoted between five cents on the dollar and zero.
Baruch had a director’s interest in the creditworthiness of the Baltimore & Ohio Railroad. When he joined the board in 1927, the B&O was profitable but behind the times and in need of physical improvement. Not anticipating the Depression and electing to expand rather than to consolidate, the board—a Wilsonian group that included Newton D. Baker, the former Secretary of War, and Paul M. Warburg, an original director of the Federal Reserve Board, as well as Willard and Baruch, former War Industries Board men—voted in 1929 to spend $20 million on the acquisition of a pair of small railroads to complete a new route between New York and Chicago. Their timing was unhappy. Under the press of the slump and of their own miscalculations, the directors in March 1932 omitted payment of the dividend on the preferred stock for the first time since 1900. To alleviate a cash shortage, they approved a loan application to the Reconstruction Finance Corporation, lately established to check the bankruptcy wave. (Baruch had been asked by the Hoover Administration to join the new agency but had declined.) By August 1932, the B&O had become the RFC’s largest railroad borrower, outdistancing sixty-five other depressed roads for that unwanted distinction. Probably only federal aid saved the B&O from bankruptcy. It was at this crisis in the B&O’s affairs that Baruch chose to accept an invitation to serve as vice chairman of the National Transportation Committee, a panel that the government convened to propose a solution to the railroad crisis. In time, but without noticeable effect on policy, it recommended that certain competing roads be consolidated and that a national rail system evolve under federal aegis. Baruch, who was laid up with the gout, sent Johnson to deliberate in his place.[51]
As for herself, Miss Boyle had also made heavy weather of it. In 1929 she reported stock-trading profits of no less than $229,825.06 and received interest and dividend income of $32,883.66. (Her salary amounted to approximately one quarter of her federal income-tax bill, which was $57,028.88.) She was worth perhaps $500,000 to $750,000 at the top, but on November 20, 1931, she had only $120,000 in cash and less than $29,000 worth of securities. However, she was not so discouraged that she stopped wearing diamond jewelry to the office or gave up speculation. On inventory day she had $15,000 tied up in the cotton futures market.
At Baruch’s request early in November General Johnson picked out some stocks that looked cheap in the market, but there is no record of Baruch immediately buying them (there were three: American Safety Razor, Canada Dry Ginger Ale, and Commercial Credit) or of acting on the idea that the market had bottomed. In mid-December, in fact, as the Dow made new lows, he sold $187,482 worth of stocks and bonds and bought only $13,378 worth. What is recorded is his quickening interest in gold.
Characteristically, Baruch’s views on the subject of gold and money—not the mining but the monetary end—were intuitive rather than analytical. He took no known part in discussion of whether the rate of gold convertibility to which Great Britain returned in 1925 might not be (as it later developed) too high; or of whether the newfangled postwar monetary system, called the “gold exchange standard,” might not be inflationary in permitting two countries to count the same bar of gold in their separate monetary reserves. On the contrary, he told Bruce Barton in 1929 that the world’s “centralized” central-banking structure was a bulwark of prosperity.
By 1931 everybody knew that it wasn’t. Prices had fallen and the purchasing power of money had correspondingly risen. For those in funds the deflation brought a windfall, but for debtors it was ruinous. A mortgage that was manageable in 1929 was in many cases cumbersome or onerous in 1931. Bankruptcies mounted and schemes were devised to make money cheaper and more plentiful. Practically, this meant reducing or eliminating the gold backing of currency. Before Great Britain went off the gold standard in September 1931, Argentina, Austria, Uruguay, Brazil, and Germany had already done so; and India, Norway, Sweden, Canada, and Japan all shortly followed England. Relative to the world’s new paper money, the value of gold was rising.
In the light of the news Baruch decided that a man might prudently lay in some gold for himself. He began with the purchase of gold-mining shares. In the November 1931 inventory, his largest stock holding was Alaska Juneau, then quoted at 15; in 1927 it had traded at 1. (Goldfield Consolidated, however, wasn’t stirring; Miss Boyle counted 40,050 shares for which there was a bid of 12½ cents each on the Curb.) The decision to buy gold bullion was a more considered one, because in ordinary circumstances there was every reason not to own it. It paid no dividend or interest, cost money to store, and would go nowhere in price if the government kept its solemn monetary promises, which the Hoover Administration and, subsequently, Governor Franklin D. Roosevelt each vowed to do.
When, in the late 1930s, Baruch was officially asked by the then Secretary of the Treasury why he had bought gold, an investment that was outlawed in 1933 and was viewed, even retroactively, with suspicion by the Roosevelt Administration, he answered laconically, “. . . because I was commencing to have doubts about the currency.” And indeed in late 1931 and early 1932 there was no shortage of things to doubt. “Money was sick,” Malcolm Muggeridge wrote of that time, “and its many friends hurried to its bedside to revive it.” In February 1932, an act was passed to authorize the Federal Reserve System to issue greenbacks on the collateral of Treasury securities. Heretofore only gold and commercial paper had constituted eligible collateral, but gold was being drained off to Europe and so little business was being done that some banks had no serviceable paper. The upshot was that the Federal Reserve could issue paper money—its promissory notes—backed by the Treasury’s notes, a case of one debt propping up another. Without further ado the Fed began to create credit by the simple, and soon to become every day, expedient of “monetizing” Treasury obligations. In March US Steel Corporation suspended dividend payments, and the capitalists Ivar Kreuger and George Eastman killed themselves. In June the federal government closed its books on a $2.7 billion deficit, greatest since the aftermath of the war.
Of all these signs, Baruch was especially alert to the fiscal situation. Since (in his view) a balanced budget was a prerequisite to the return of business and investor confidence, it followed that there could be no end to joblessness and privation unless federal spending were reduced and taxes raised. He elaborated for the New York Evening Post on January 11, 1932, about a month after he had sold some securities at distress prices and a month or so before he began to buy gold bullion:
All efforts to bring back prosperity and the employment that will come with it are based on the credit of our Government. All must fail unless the United States moves at once and convincingly in the direction of a balanced budget. While this means less Government spending and heavier taxation, rewards will come in restoration of confidence and resumption of business activity.
Money is at the base of business. It is the Government’s promise to pay. It represents the credit of the United States. Its value is measured by the world’s faith in that credit. Our money is good beyond peradventure, but as long as our Government permits unbalanced budgets, our public and the world will continue to start at shadows. From the beginning of time, deficits have been the red flags of waning credit. In a world of alarms, our deficits have already impaired credit.
Thousands of people have thrown overboard investments representing their lives’ savings in frantic grasping for what they regard as gold. Vast numbers stand with their resources entirely in cash, although sound investment securities are selling at prices lower perhaps than we shall see again.
He closed with a plea for financial orthodoxy:
&nbs
p; The sound, effective, and quick way to balance budgets is to stop spending. We began our present Federal orgy with war inflation in 1914. For thirteen years [before that] we had spent for Federal Government an average of about six hundred million dollars. Eliminating charges on the public debt, we had increased that to 1.8 billions by 1923 and 2.8 billions—4⅔ times—by 1931. Nearly all economic indices, such as those of commodity prices and production, are back on the pre-war basis. We need no economist to tell us that reduced expenditure is something more than a desideratum, that it is the only road to balanced budgets and that an ax rather than a pruning fork is the necessary implement.
We must have higher prices for our basic commodities but the way to get them is to increase demand by greater activity through fortifying our credit mechanism—not to fool ourselves by reducing the value of money by destroying the basis of public credit.
On April 2, 1932, and from time to time through early 1933, Baruch’s vault in New York received shipments of gold. By February 1933, the Alaska Juneau company had sent sixty-six gold bricks (of which Baruch had had three melted down to test the company’s assay) while an unknown quantity was received from London. The size of his Alaska Juneau purchases is also unknown, because the bricks were unrefined and irregular. However, based on similar bricks shipped by the company in 1933, the figure is probably close to 72,000 ounces, which at the then-going price of $20.67 an ounce was worth almost $1,500,000. When Philip Bradley, president of the mine, was later asked, in the course of a legal set-to with the government, why Baruch had bought, he replied simply, “In anticipation of a higher price for gold.” In the event, the higher price materialized, but Baruch didn’t get it. In April 1933, President Roosevelt ordered Americans to surrender their gold at the customary dollar-exchange rate of $20.67 an ounce. Within three months the world price was pushing $29.