Crows outside the Bank of United States after its failure, New York, 1931.
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A RECENT statement by Mr. Justice Brandeis has been widely quoted. "The people of the United States," he said, "are now confronted with an emergency more serious than war. Misery is widespread, in a time, not of scarcity, but of overabundance. The long-continued depression has brought unprecedented unemployment, a catastrophic fall in commodity prices and a volume of economic losses which threatens our financial institutions."

The economic losses both of the World War and the present depression, in their full volume and extent, are incalculable, but it is not only of such losses that Mr. Justice Brandeis was speaking. The gravity of the present situation lies not merely in the widespread suffering, vast as that is, but in the questions it excites concerning the fundamental strength and character of our economic structure and in the series of decisions which must be made, indeed are now in process of making. These decisions are much more difficult than those of war. In war the chief problem is clearly set and calls for immediate action, unifying in its effect. In such a depression as this the problem is infinitely complex, decisions are beset by doubt, action seems always too late or has effects contrary to what were expected, and disunion and disruption have spread as each centrifugal force, seeking to strengthen itself, weakens the whole. War stimulates the full expansion of productive energy, but the deep depression cripples every economic process and discourages even the most sanguine business leaders. There are many confusing prescriptions offered from all sides. But no one, however skilled, really knows the character of or the specific cure for what some practitioners diagnose as a wasting disease.

Whether or not a phenomenon regularly recurring, though at unequal intervals and with varying intensity, may properly be called a disease is questionable. A continuous succession of wave-like fluctuations, each with its phases of rising business activity, boom, recession and depression, may more properly be regarded as the result of the normal functioning of a competitive economy. Multitudes of business men, each making his individual calculation of gain in a future market, but each affected by the contagious movement of contemporary business hopes or fears, unconsciously coöperate in creating the fluctuations known as business cycles. In this ebb and flow, however, there is more than the repeated concurrence of a mass of individual plans and expectations. Physical determinants are clearly present in other types of contemporary fluctuations, such as those affecting agriculture and the short seasonal swings. Monetary and other technological factors enter largely into the long secular trends. All the different types of fluctuations interact. It is possible, in the present instance, that a business cycle has been intensified by an agricultural cycle and by greater seasonal fluctuations, and then prolonged by the impact of a longer downward-moving secular trend in prices. There are also to be considered the stresses and strains which may result when the normally uneven operation of the economic forces in the business cycle, never fully balanced, develops from time to time a state of acute disequilibrium. And, in addition to these and many other disturbing factors, come the irregular influences named by the economists, rather inadequately, as "random perturbations," such as cyclones, earthquakes, widespread visitations of disease, and wars. The economists find the analysis of business cycles no simple thing, and the present deep depression, transcending in depth and extent the usual amplitudes and intensities of business cycles, is still more difficult to explain.

It is generally recognized, however, that the World War has had serious effects upon the economic conditions of the post-war period, such as the depletion of man-power, the stimulus to over-capacity of some essential industries, including American agriculture, the forcing process in the industrial development of regions cut off from their former sources of supply and of the newly-created states, the widespread monetary disorders, and the staggering burden of internal debts and foreign obligations. The World War left deep wounds, but they could be healed. As Sir Arthur Salter has just pointed out in his admirable book, "Recovery, the Second Effort," the war—except in Russia—meant not the destruction but the dislocation of the economic structure. This seemed to be demonstrated by the remarkable economic recovery in the decade after the war, and especially after 1924, even in ravaged Europe. But now we are wondering whether this recovery was not simply a respite rather than a cure.

The range of the great depression is unprecedentedly wide. Past crises have affected many countries simultaneously; but, despite the growing economic international interdependence, even in previous major crises some important countries have been little affected. The timing of the business cycles as between countries has not been parallel, nor their incidence equal. At the close of 1929, when the crash came in the United States, about half the countries for which statistical evidence is available were already suffering a decline in prosperity. But thereafter the process continued, with brief deceptive pauses, until after the middle of 1931 the disastrous, deepening depression had become world-wide. The depression is also unprecedentedly deep. Experience as measured in statistics of prices, production, foreign and domestic trade, and unemployment, shows nothing comparable in intensity. The United States has suffered bitterly during former depressions, notably in the years following 1837, and 1873, and 1893, but it then had free land to absorb its unemployed and an expanding European market for its increased agricultural production. During those former crises banks failed and specie payments ceased to an extent which the present experience has not equalled, but this was the habitual behavior of a young and rapidly growing country. Finally, after the crisis of 1907, when the banks had again been prostrated, the Federal Reserve System was created to put an end to an intolerable weakness. Now, despite strong banks in the leading countries, despite a productive equipment in materials and men unmatched in the world's history, deep business depression is universal.

That the World War and the World Depression are intimately linked, as fundamental cause and ultimate effect, is beginning to be realized. There are other coöperating causes of our present distress, some antedating the war and some coming in its wake; but the war accentuated the prior trends of change and was largely responsible for the later dislocations. The economists in 1930 at first looked for the familiar signs of a business cycle. There seemed in 1929 to be no such accumulation of inventory in the hands of producers as in 1920, but in the form of goods bought on credit, installment purchases, housing and the like, a great inventory was being carried by consumers. In many lines of productive activity, both industrial and agricultural, it appeared that an excess capacity was facing a saturated market. "Cumulative disequilibria" of various sorts were seen to have strained the economic system: the increase in the consumer's spending power had not kept pace with the increase in productive power, the wage-earner's income had not grown as rapidly as that of the entrepreneur, and the flow of savings toward investment in capital goods and in durable consumption goods was exceptionally great. The technological advance had been more rapid than the growth of the market demand for new or cheaper products, so that, despite the great mobility of the working population, there was a steady increase of unemployment. These and similar unbalancing elements, it was thought, went far to explain the break in the economic mechanism with its slackening business activity and increasing unemployment. But as the depression was prolonged and intensified through the first half of 1931 it became clear that changes of greater range and longer duration were operating than those ordinarily engendered by business cycles. The economists looked farther afield. They noted the shift in monetary gold supply and the demonstrable alterations in the money markets of the world; the declining birth rate; the rise in the standard of living and the changes in habits of consumption tending to make the market more sensitive to fluctuations; the increasing mechanization which was revolutionizing agriculture and affecting many other industries; the development of large-scale organizations in industry, banking and labor; and the spread of price agreements and market controls which tended to introduce dangerous rigidities into the flexible system of free competition.

Then came the collapse of the Austrian Kredit Anstalt in May 1931, the breakdown of the German financial system in June, England's abandonment of the gold standard in September, followed promptly by many other countries, the cessation of international lending, and the further and alarming deepening of depression everywhere. The factors producing business cycles and the changes in long-time trends have exerted their influence upon the depression, but the specialists in the study of business fluctuations, after arraying the factors and weighing those which are measurable, acknowledge that their accustomed methods of analysis are inadequate. A more incalculable force seems to be at work. The situation suggests that the credit economy, not alone of nations as separate units but of all, is involved; and that recovery demands both separate and common efforts.

"We have still inadequately realized," writes Sir Arthur Salter, "how deeply the foundations of the system of credit have been undermined." The World Depression reveals many related causes at work, but it now is evident that the break in the stream of credit should be especially emphasized and carefully studied. The sapping process, undermining credit, goes back to the war, to the huge unproductive debts which it created and which, by the financial illusions engendered, have been continually extended. The war was fought with determination through four interminable years; and the confidence of all its participants was buoyed up, and in turn supported an enormous inflation of credit. The exaltation of war made possible the incredible toll it exacted. Unmindful of post-war consequences, the contestants piled mountainously high their demands upon the future and thus mobilized for war's exigent present the productive resources of the world. To the people of the United States especially the war revealed possibilities of credit expansion which seemed boundless; the whole world shared in the illusion, but not so riotously in the exploitation of it. The military contribution of the United States in the war's concluding year was of decisive character, but the country's primary function was the furnishing of supplies, in the first two years paid for largely by shipments of gold from Europe and the repatriation of American securities, and in the last two supported by great domestic credits, which financed the production of war materials both for the American armies and for their associates.

The war fervor, aided and inflamed by energetic organization, placed government bonds in the hands of millions of people who never before had possessed such instruments of credit. They were not thereby educated in the use of credit; they simply received a new vision of its possibilities. The basis was thus laid for the vast and credulous post-war market for credit which culminated in the portentous speculation of 1928 and 1929. Great enterprises learned that they could distribute their shares and bonds by direct sale to the public, and smaller enterprises were recapitalized by busy investment houses to float new securities in a national market canvassed by high-pressure bond salesmen. Despite the heavy inflow of gold to the United States, particularly during the first half of the decade, despite the easy money policy of the Federal Reserve Board, especially in 1927, and despite the large repayments by the United States Treasury of the principal of the domestic debt, prices of commodities did not rise. Instead, after 1924, they showed a slight tendency downward, in consonance probably with the more pronounced price-fall outside the United States. It was perhaps because the pressure for a rise was checked in this section of the elastic tissue of the price system that it burst forth with such redoubled vigor in the stock market. Here was presented the greatest scene in the history of speculation. Stock values were pyramided again and again as they soared to heights out of all rational relationship to earnings present or prospective. The mania spread in unexampled breadth; where millions had bought Liberty Bonds, tens of millions now were buying shares or speculating on margin at the new brokerage offices springing up everywhere.

Below these paper values, the easy credit was stimulating actual production. American economic progress during the postwar period was rapid but uneven. Certain regions, whose old staple industries or agricultural products were in competition with the new mechanization or with virgin land, lagged in the race; but the pace was set by relatively new industries like the electrical or chemical industries, with the giant automobile industry far in the lead both in methods of mass production and in volume of mass sales. The construction industry in all its branches, and the machine-tool industry, especially in its export trade, grew amazingly. Spending (though toward the close it showed signs of "sales resistance," even though reinforced by abundant consumers' credit) seemed on the whole to be holding its place with production. Public spending by governmental agencies—federal, state and municipal—likewise mightily increased. The fructifying stream, attracted by high interest rates, overflowed in foreign loans, which in turn financed the growth in exports. Foreign states, towns and business concerns, especially those of Germany and Latin America, sought, or were sought by, the American investment houses and banks, until the total volume of private post-war loans surpassed, or on a net reckoning fully equalled, the public war loans.

All this was the work of credit, of which the war had taught the lesson of apparently unlimited expansion. Credit on the great scale is a modern invention, an instrument of immense power, comparable with the prime-movers in the physical field for whose introduction through the industrial revolution it had prepared the way. Together these new powers are transforming the world. But the engineers of credit know far less about the limitations and control of their new organ than the engineers of steam and electricity do about theirs. Credit is a social force, operating upon masses of people through its own specialized institutions. It has become robust and resilient and yet sensitively flexible, adjusting itself to daily repeated shocks. Its outer limits of expansion and contraction are not ordinarily reached and tested, and hence in part the reason for our lack of scientific knowledge. Nevertheless, as historical experience if not yet economic theory has demonstrated, it has limits in both directions. Its essential form is that of a continuous stream of debts, constantly renewed, flowing where profitable enterprise beckons. Since these debts or advances rest upon a conglomerate of human estimates of future gains, some near and more certain, others distant and more speculative, wastage is inevitable, and so long as it is not excessive this does not check the stream. It flows confidently on and draws new volume from its watershed of supply.

The continuous and excessive waste of credit by unproductive use was initiated by the war, and has been continued under the habit inherited from the war of drawing freely upon the future for the immediate enhancement of productive power and of living standards. Credit has been used in unprecedented volume, but it has also been abused, in a manner not indeed different in kind but enormously increased in degree as compared with earlier experiences. When finally (as in the time of John Law's great speculative venture, a period of inflated credit in many respects like our own) the realisateurs commenced to cash in on their paper gains, the swollen stream contracted and for the first time the great body of investors became aware that it was fed by inadequate earnings. Then panics began. The domestic and foreign capital which had been drawn into the maelstrom by the lure of high call-rates was hastily withdrawn. The stream of American credit which had been diverted to the speculative market suddenly left the foreign debtors stranded, and their distress today adds to the depression. Abroad some of the unproductive debts cannot pay their interest; at home extravagantly invested funds, supplied by credit, fail to pay dividends or rent. Investors widely come to feel that the public trust which credit implies has been betrayed and their confidence abused. People complain of the paradox that poverty appears in the midst of abundance. It is no paradox; abundance is freighted on credit and credit stretched beyond its limits of safety must withdraw.

While America has been experiencing the elation and suffering of excessive overconfidence, bred from the war's extravagance and its after-effects, Europe has not been immune. She was left shattered by the war. The monetary systems of combatants and neutrals were tottering. Some of these systems succumbed utterly, in the case of others the fall was checked. But by the middle of the post-war decade order had been restored, the bulk of the work of reconstruction seemed to have been accomplished, and Europe was turning hopefully to the modernization of her industries and to the redemption of her pledges, expressed or tacit, to make her lands fit for heroes to live in. The strong desire for social betterment, running from peasant land allotments to recreation facilities, was matched, on the part of peoples who had during the war seen money poured out like water, by a belief that a material improvement in the conditions of life was attainable. The same miraculous rock could be tapped again; and in fact the stream of credit did again flow. Furthermore, since the menace of social upheaval is a reality in Europe (where an example lies close on her eastern border), her rulers feel that measures of social amelioration are more than desirable: they are necessary. The debts for reconstruction added to the war debts were crushing, but in many countries they have been greatly alleviated by the devaluations of currency, shifting part of the loss to the rentier class and the recipients of fixed incomes. When the currencies had been re-stabilized new hope made possible new credits.

But it now becomes apparent that the war left a legacy of fundamental insecurity to the continent of Europe. To the manifestly continuing political insecurity has been added a persistent undercurrent of economic insecurity, which has made itself felt in repeated emergencies and in various ways. The nervousness of European investors, great and small, has been shown in the more conspicuous episodes of the successive "flights" from the mark, the franc or other currencies; it has been allayed for periods, but still has been instant to take alarm. Largely for this reason the flow of capital from country to country has tended to be spasmodic and unpredictable; investors have sought security by shifting funds from one financial centre to another without primary regard to differences in interest rates. They have thus contributed to impede the quasi-automatic operation of the mechanism of foreign exchange which before the war, when security was taken for granted, affected national price levels and regulated the international movements of goods and gold.

In the quest for security, especially during the respite afforded by the relative improvement in economic conditions for a few years after 1925, many countries, anxious to stabilize their disordered currencies, adopted an equivalent for the gold standard. Their equivalent was the gold exchange standard which permitted them to place bills of exchange in their portfolios instead of gold bullion in their vaults. This gave them rights to call on gold held in the great Central Banks, but the innovation not only laid an increased load of responsibility on the Central Banks, especially during periods of sudden emergency, but it acted as another impediment to the normal regulating flow of foreign exchange. Meanwhile the Central Banks were sweeping up gold from private holdings, and much of this, together with the newly-mined monetary gold (because of the abnormally functioning forces of the period) flowed into two great reservoirs—before 1925 mainly to the Federal Reserve System of the United States, and since that date the larger portion to the Bank of France. By the end of 1931 a substantial part (probably a fifth) of the banking reserves of the world was in the exposed form of foreign exchange, the "cushion" of domestic circulating gold had everywhere disappeared, and about three-quarters of the world's monetary stock of gold had been so withdrawn as to intensify the downward movement of world commodity prices. Monetary security was sought, but on an unstable basis; and since England, the first establisher and maintainer of the gold standard, has departed from it, monetary insecurity and difficult experimentation with "managed" currencies have again returned.

The effort to maintain stability in the agitated post-war world has been the underlying motive forthe renewal of the great movement not merely toward large-scale business organizations but toward combinations, cartels and similar agreements for the maintenance of prices or the division and control of markets. The combination movement has been long-continued, for in industry it commenced its first great operations in the eighties and nineties of the last century, after the railroads had shown the way; it is world-wide; it is paralleled by an analogous growth of social organizations in many other fields, such as labor and agricultural and consumers' coöperatives; it shows variety, adaptiveness, and increasing strength; in short, it is an organic development of revolutionary importance. For it has begun to modify profoundly the system of free competition and the social attitudes which accompanied that blindly "automatic" system. A free system which in a community of small competitive producers worked satisfactorily for the mass of consumers, since it furnished its products at the lowest price compatible with adequate remuneration to the more efficient producers and ruthlessly discarded the less efficient, was bound ultimately to force the strongest or most adaptable producers to increase their scale of operations. And the larger and better organized these operations become, the more inevitable it is that the small group of great producers, accustomed to order and discipline in their factories, should combine to regulate the disorderly, crisis-ridden market. It seems apparent that this tendency toward a planned economy, already initiated each in its own sphere by a growing number of the great industries, sponsored governmentally by the necessities of the Great War, and now filling men's minds, should proceed further. It obviously faces great difficulties both in organization and in public control; and stability, if it is gradually attained, is likely to entail a slowing up of technical progress and a degree of social regimentation for which perhaps the public's mind is already being prepared. The process of re-adaptation of the economic system is likely to be long and full of unexpected disappointments, but the successes and failures of the various nations already experimenting with economic planning will be instructive.

Meantime, the post-war developments of industrial planning have served to add to our present difficulties rather than to aid in solving them. They have taken mainly the form of stabilizing, by price or market agreements, a number of the great raw material producers, some of them with governmental aid and supervision, like the Brazilian valorization schemes or the Stevenson plan for rubber, others, like the international organization of copper producers, by private agreements. Some of them failed or were in process of failure before the depression, some have succumbed or seem about to succumb under the pressure of the disastrous fall in prices. Only two great raw material industries, both practically monopolies, nickel and sulphur, have thus far maintained prices in the face of serious decreases in production. There is evident danger of intensifying the stresses and strains in the system of prices if the fixity of great sections increases the fluctuations of the unorganized remainder, but the danger would be much less if the attempt were made to obtain stability by intelligent and timely price adjustments instead of to obtain rigidity by price maintenance. The great difficulty of a price maintenance policy, supposing all the producers, national and international, to be combined, is not only its possible repercussions on the price system and therefore the economic system in general, but its almost certain inability to restrain producers from overproductions and to check the entrance of new competitors into the profitable field, not to speak of the competition of substitute commodities. By mistaking rigidity for stability most of the post-war so-called stabilization plans have thus far failed to give the security so ardently desired.

If in this outline of some of the economic consequences of the World War in their bearing on the World Depression only cursory mention has been made of reparations and war debts, it is because they have become matter even more for political than for economic discussion. The two payments, while theoretically distinct, are in European opinion and practice so closely connected as to form practically one problem in two phases—receiving from Germany in order to pay to the United States. Since the cessation of American lending to Germany and since the rise of nationalist propaganda, Germany has come passionately to believe, and her political leaders declare, that an end must be made of reparation payments. Indeed, it seems highly probable that no government could stand which proposed to continue these payments. In the interest not merely of European but of world appeasement and of the economic recovery which depends thereupon, some settlement must promptly be arrived at. An extended moratorium, which in any case must be granted, seems likely only to prolong the disquiet, not to allay it. France, pressed by her own economic insecurity, may prefer to take the best obtainable terms which Germany can now offer rather than run the risk of another Ruhr occupation and the even graver risk of thereby unsettling further an economic world already in peril. The United States, then, must come to grips with the related problem of the war debts. Will it prefer a radical revision of the debts to meet the radically changed position of the debtors, or will it prefer a futile and embittered altercation, charged with national animosities? A reasonable end to the debt problem would not, indeed, at once stop the World Depression, but it would be a great step toward the appeasement which is necessary for recovery. The steady exacerbation of international feelings resulting from a settlement of reparations and debts which was not a settlement reveals in a clearer light the fundamental error of continuing the economic war after peace had been signed. It has only added continuously to post-war insecurity.

What has especially aggravated the European feeling about the war debts has been the American tariff. This has been held responsible for the relative decline in the imports from the European debtors to the United States. Supplementary causes may be found for the general decline in imports of European commodities into the United States, from the 48 percent of total imports in 1913 to the 30 percent of recent years. And there has been an offset, which should be taken into account, in the increase of expenditures by American tourists abroad. But the fact remains that the narrowly nationalistic policy of the United States, as exemplified again in the tariff of 1930—inexcusable from an economic point of view and definitely harmful from a broader national standpoint—has been one of the great complicating and accelerating factors in the cumulation of abnormal unbalances and rigidities which brought the world to the Great Depression.

A time must come when the United States as a powerful world state and a great creditor nation, hence vitally interested in world trade and world prosperity, will face the realities of its new position. It will realize that a policy of self-sufficiency is not only impossible, but that a policy which presupposes it to be possible is stultifying and impoverishing. To say, as one frequently heard it said, that because the value of American exports is less than 10 percent of the total American production, we may therefore go our own way regardless of foreign trade or international responsibilities is to misinterpret the plain facts. The whole network of domestic prices and domestic credit in the United States is bound indissolubly with the system of world prices and with the stream of world credit. A dislocation anywhere in the fabric is now felt everywhere. The World War affirmed the international political responsibilities of the United States; the World Depression demonstrates the economic interdependence of the United States with other states. It cannot be a hermit nation.

  • EDWIN F. GAY, Professor of Economic History in Harvard University; Director of the Bureau of Economic Research, New York; former President of the American Economic Association
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