But it is impossible to keep selling prices rising for an indefinite time. In default of other checks, the inadequacy of cash reserves would ultimately compel the banks to refuse a further expansion of loans on any terms. But before this stage has been reached, the rise of prices is stopped by the consequences of its own inevitable inequalities. These become more glaring the higher the general level is forced; after a time they threaten serious reductions of profits to certain business enterprises, and the troubles of these victims dissolve that confidence in the security of credits with which the whole towering structure of prosperity has been cemented.

In certain lines in which selling prices are stereotyped by law, by contracts for long terms, by custom, or by business policy, selling prices cannot be raised to prevent a reduction of profits. In other lines prices are always subject to the incalculable chances of the harvests. In some lines the recent construction of new equipment has increased the capacity for production faster than the demand. for the wares has expanded under the repressing influence of high prices. The unwillingness of investors to let fresh contracts threatens loss not only to the contracting firms but to the enterprises from which they buy materials. Finally the success of some enterprises in raising prices fast enough to defend their profits aggravates the difficulties of the men who are in trouble.

As prosperity approaches its height, then, a sharp contrast develops between the business prospects of different enterprises. Many are making more money than at any previous stage in the business. cycle. But an important minority faces the prospect of declining profits. The more intense prosperity becomes, the larger grows this threatened group. In time these conditions bred by prosperity will force radical readjustment.

Such a decline of profits threatens consequences worse than the failure to realize expected dividends. For it arouses doubt about the future of outstanding credits. Business credit is based primarily upon the capitalized value of present and prospective profits, and the volume of credits outstanding at the zenith of prosperity is adjusted to the great expectations which prevail when affairs are optimistic. The rise of interest rates has already narrowed the margins of security behind credits by reducing the capitalized value of given profits. When profits begin to waver, creditors begin to fear lest the shrinkage in the market rating of business enterprises which owe them money will leave no adequate security for repayment. Hence they refuse renewals of old loans to enterprises which cannot stave off a decline in profits, and press for settlement of outstanding accounts.

Thus prosperity ultimately brings on conditions which start a liquidation of the huge credits which it has piled up. And in the course of this liquidation prosperity merges into crisis. Once begun the process of liquidation extends rapidly, partly because most enterprises called upon to settle put similar pressure on their own debtors, and partly because news presently leaks out and other creditors take alarm.

While this financial readjustment is under way, the problem of making profits is subordinated to the more vital problem of maintaining solvency. Business managers nurse their financial resources rather than push their sales. In consequence the volume of new orders falls off rapidly. The prospect of profits is dimmed. Expansion gives place to contraction. Discount rates rise higher than usual, securities and commodities fall in price, and working forces are reduced. But there is no epidemic of bankruptcy, no run upon banks, and no spasmodic interruption of ordinary business proc

esses.

Crises, however, may degenerate into panics. When the process of liquidation reaches a weak link in the chain of interlocking credits and the bankruptcy of some conspicuous enterprise spreads unreasoning alarm, the banks are suddenly forced to meet a double strain-a sharp increase in the demand for loans and in the demand. for repayment of deposits. If the banks meet both demands, the alarm quickly subsides. But if many solvent business men are refused accommodation at any price, and depositors are refused payment in full, the alarm turns into a panic. A restriction of payments by banks gives rise to a premium upon currency, to hoarding of cash, and to the use of various unlawful substitutes for money. Interest rates may go to three or four times their usual figures, causing forced suspensions and bankruptcies. There follow appeals to the government for extraordinary aid, frantic efforts to import gold, the issue of clearing-house loan certificates, and an increase in bank-note circulation as rapidly as the existing system permits. Collections fall into arrears, workmen are discharged, stocks fall to extremely low levels, commodity prices are disorganized by sacrifice sales, and the volume of business is violently contracted.

There follows a period during which depression spreads over the whole field of business and grows more severe. Consumers' demand declines in consequence of wholesale discharge of wageearners. With it falls the business demand for raw materials, current supplies, and equipment. Still more severe is the shrinkage in the investors' demand for construction work of all kinds. The contraction in the physical volume of business which results from these shrinkages in demand is cumulative, since every reduction of

employment causes a reduction in consumers' demand, thereby starting again the whole series of reactions at a higher pitch of intensity.

With this contraction goes a fall in prices. For when current orders are insufficient to employ the existing equipment, competition for business becomes keener. This decline spreads through the regular commercial channels which connect one enterprise with another, and is cumulative, since every reduction in price facilitates reductions in other prices, and the latter reductions react to cause fresh reductions at the starting-point.

The fall in prices is characterized by certain regularly recurring differences in degree. Wholesale prices fall faster than retail, and the prices of raw materials faster than those of manufactured products. The prices of raw mineral products follow a more regular course than those of forest or farm products. Wages and interest on long-time loans decline in less degree than commodity prices. The only important group of prices to rise is high-grade bonds.

The contraction in the volume of trade and the fall in prices. reduce the margin of present and prospective profits, spread discouragement, and check enterprise. But they also set in motion. certain processes of readjustment by which the depression is

overcome.

The prime costs of doing business are reduced by the fall in the prices of raw material and of bank loans, by the marked increases in the efficiency of labor which comes when employment is scarce, and by closer economy by managers. Supplementary costs are reduced by reduction of rentals and refunding of loans, by writing down depreciated properties, and by admitting that a recapitalization has been effected on the basis of lower profits.

While costs are being reduced, the demand for goods begins. slowly to expand. Accumulated stocks left over from prosperity are exhausted, and current consumption requires current production. Clothing, furniture and machinery are discarded and replaced. New tastes appear among consumers and new methods among producers, giving rise to demand for novel products. Most important. of all, the investment demand for industrial equipment revives. Capitalists become less timid as the crisis recedes into the past, the low rates of interest on long-time bonds encourages borrowing, and contracts can be let on most favorable conditions.

Once these forces have set the physical volume of trade to expanding, the increase proves cumulative. Business prospects become gradually brighter. Everything awaits a revival of activity which will begin when some fortunate circumstance gives a fillip to demand, or, in the absence of such an event, when the slow growth

of the volume of business has filled order books and paved the way for a new rise in prices. Such is the stage of the business cycle with which the analysis begins, and, having accounted for its own beginning, the analysis ends.

C. THE ANTECEDENTS OF CRISES

102. The Causes of the Panic of 18937

BY W. JETT LAUCK

But what was the local and the true cause of the crisis of 1893 in this country? It cannot be said to have been due to a scarcity of money in the United States at that time. During the entire period 1878-93 the amount of money in circulation more than doubled. Consequently the money supply was ample. On the other hand, it cannot be maintained that the crisis of 1893 was caused by an extension of the mercantile credits such as brought about the disastrous collapse of 1873, for business houses and industrial establishments during the period 1891-93, instead of extending, were curtailing their operations, and were arranging their plans in the expectation of a breakdown in the financial machinery of the country. They could not have engaged in any extended or hazardous activities if they had been inclined to do so, for the reason, as already seen, that very little, if any, foreign capital was obtainable for investment in the United States after 1891, and American capital likewise refused to enter into doubtful financial or industrial undertakings. So far as the withdrawal of foreign and domestic funds, however, brought about industrial and business disaster, it was not a direct cause of the crisis, but only the result which flowed out of the operation of the primary and fundamental cause.

This cause to which the crisis of 1893 is directly and wholly attributable consisted of a widespread fear, both at home and abroad, that the United States would not be able to maintain a gold standard of payments. The very nature of the crisis itself bears out this conclusion. It was essentially a monetary crisis, and its typical feature consisted in the numerous failures of banks and financial institutions. Moreover, the precipitation of and the recovery from the crisis furnishes additional evidence to bear out the foregoing claim. The beginning of the crisis was marked by the decline of the Treasury gold reserve, on April 22, below the $100,000,000 limit; the ending of the resultant industrial and financial chaos dated

'Adapted from The Causes of the Panic of 1893, 118-121. Copyright by Hart. Schaffner & Marx (1907).

from the assurance, on August 28, of the repeal of the Silver Law of 1890.

The apprehension in 1893 as to the fixity of the gold standard of payments arose indirectly out of the silver agitation and legislation during the period 1878-90, and was directly traceable to the operation of the Sherman Silver Purchase Law of 1890. For seventeen years, 1878-90, the gold standard of payments was constantly threatened, and the crisis of 1893 was practically the culmination of this long period of uncertainty. Under the operation of the Silver Act of 1878, the country received a serious shock to its confidence in the fixity of the gold standard. During the two years, 1884-86, when the silver issues of the country became redundant, the distrust in the ability of the Treasury to maintain gold payments became so great that gold was withheld in the payments of customs duties, and silver certificates were worked off on the Treasury. Additions to the Treasury's supply of gold were thus cut off, and the gold reserve declined to $115,000,000. As a consequence, apprehension as to the maintenance of gold payments became widespread, and a panic was narrowly averted. As it was, the stream of silver was only prevented from overflowing the Treasury by the action of the Treasury officials in employing artificial devices to create a vacuum in the circulation.

The advocates of the free coinage of silver, however, held the balance of political power during the first session of the Fifty-first Congress, and as a result of their agitation the Sherman Law was passed, which almost doubled the amount of silver obligations annually issued by the Government. The currency of the country soon became redundant, and silver certificates and Treasury notes. were used in the payments of public dues, while gold was hoarded. Consequently the Treasury gold reserve rapidly declined, and fear for the maintenance of the standard again arose. Foreign investors and exporters saw the danger in the situation even before the people of this country, and began to withdraw the funds which they had invested in this country during the period 1886-90. Moreover, they called for the payment of trade balances in gold. Gold was, therefore, demanded for export. But the banks in the United States were hoarding gold, and gold for export could practically be obtained only by the presentation of legal-tender notes at the Treasury for redemption. This operation caused a further inroad upon the Treasury gold reserve. Larger amounts of funds were drawn from the country, and increasing amounts of gold flowed out of the Treasury in the redemption of legal-tenders. The limit was finally reached on April 22, 1895, when the gold reserve fell below the danger-line.