PROMOTION AS THE CAUSE OF CRISES

SUMMARY

Two groups of crisis theories, 748. - Failures the chief phenomena in the crisis, 749.- Promotion activity the cause of prosperity, 750.— Relation between promotion and failures, 752. Newly-promoted concerns fail, 752.- Old concerns fail because of competition of new, 755. All kinds fail because of inability to cope with dynamic conditions, 756. The part of credit in the cycle, 761. — Exhaustion of loanable funds, 761. — Falling reserve ratios or falling reserves, 762. — Gold movements before crises, 763.- Break down of credit not the main cause of crises, 764. — Crisis failures include insolvent as well as solvent concerns, 765. — Promotion the cause of crises, 766.

THEORIES of crises may be divided into two chief groups. One holds that industry is normally in a condition of stable equilibrium and that a crisis is the disturbance of this equilibrium by unpredictable causes. The second maintains that industry is normally unstable and that its equilibrium is eventually ruptured by steadily operating and cumulative forces.1 This article falls in the second group. It will attempt to show that even when prosperity is not interrupted by extraneous causes such as natural calamities (crop failures, fires, floods, and so on) or by political disturbances, threats of war, and the like, active promotion, the cause of rising prosperity, still sets in operation forces which lead to a financial crisis, tend to check promotion activity, and cause a return to a condition of depression such as characterized the beginning of the period.

It is often said that industrial depression and financial disturbance are but different phases of a given situa

1 Jones, Economic Crises, ch. I, gives a good discussion of the theories of industrial equilibrium; cf. also Taylor, Kinetic Theory of Crises, University of Nebraska Studies, January, 1904.

tion. But just how the depression and the financial phenomena are related remains to be satisfactorily explained. It is proposed, as just stated, to show that crisis and depression are the logical sequence of the business activity of the preceding period. Before entering on such an explanation, it is necessary to make clear the essential features of the financial crisis, on the one hand, and of the industrial depression, on the other.

The financial crisis, I maintain, is a situation in which a larger number than usual of debtors are unable to meet their obligations, primarily because industry and finance have failed to yield returns as large as the estimates upon which borrowings or subsequent expenditures were based, and secondarily because of a contraction of credit. Many writers are inclined to lay sole stress upon the failure of firms which suspend because they cannot obtain the customary credit accommodations - a phenomenon here classed as secondary. While such failures are strikingly prominent and very numerous during panic times, it should be recognized that the chief failures are those of genuinely insolvent concerns which have not made good during the preceding period of rising prosperity. In fact, the panic stage is very often precipitated by the failure of a prominent firm or firms. The crisis of 1837 in the United States was preceded by failures in the fall of 1836 of English firms doing business with this country. In 1857 the panic began with the failure of the Ohio Life Insurance and Trust Company. The difficulties of 1873 commenced with the failure of the New York Warehouse and Security Company and the banking house of Kenyon, Cox & Company. In 1884 trouble began with the failure of the brokerage firm of Grant & Ward and the Mercantile National Bank. The failure that

1 Cf. Taussig, Principles of Economics, vol. i, p. 400. Hull, Industrial Depressions, however, says there is no relation between the two.

marked the turning point of prosperity in 1893 was that of the Philadelphia and Reading Railroad. In 1907 one of the initial episodes was the failure of the Mercantile National Bank owing to its furtherance of copper enterprises and speculation.

On the industrial side of the crisis cycle the dominant factor is the condition of promotion. If many new enterprises are being started the increased demand for capital goods means heavy orders placed with producers, a greater demand for labor, enlarged profits, increased railway earnings, and so on. The increased demand for capital goods is reënforced by heavier demands for consumption goods, and general rising prosperity is the result. Good times, therefore, are due to the investment of the social savings. If investment slows up all the phenomena of business depression appear. Professor Commons 2 says that "over-production" is mainly the "under-consumption " of wage earners. But is it not more nearly the case to say that "over-production" is the "under-consumption " of investors?

However much writers disagree as to what causes the transition from good times to bad, there is an increasing unanimity of opinion that rising prosperity is due to promotion activity, and depression to a relative inactivity in investment. Taylor brings this out clearly in his chapters on crises in The Credit System, as does Mitchell in Business Cycles. Burton takes a similar position.

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1 See my article, “Analysis of the Crisis Cycle," in Journal of Political Economy, October, 1913. Races and Immigrants, pp. 156-157.

Professor Mitchell and I, each working independently, have reached conclusions regarding crises and the general cyclical movement of business which are in substantial agreement. He recognizes this in his book (p. 603). Under date of May 3, 1913, Professor Mitchell wrote me: "From your April article I infer that we have stated the problem in much the same way, applied similar methods of analysis, and reached much the same results. But I think you have discovered several points which have escaped me, and that you will find the interest in your results heightened rather than diminished by the appearance of my book. That surely ought to be the case. If you and I are really working by scientific methods our investigations ought to bring us out at the same conclusions, and that we confirm one another ought to be a matter of interest to those who are taking economic theory with seriousness."

Crises and Depressions, p. 306.

1

He says that the important feature in the occurrence of crises and periods of depression " is the increasing proportion of expenditures in preparation for increased production, manifesting itself in the formation and prosecution of new enterprises and the building on a large scale of railroads, ships, and factories, and the providing of other means to meet increased demands. At times these expenditures for increased production attain an unusual proportion as compared with the ordinary expenditures for annual consumption or support." Tougan-Baranowsky says: "Pendant les phases de prospérité, on crée le nouveau capital fixe de la société. Toute l'industrie sociale prend une orientation particulière: la fabrication des moyens de production passe au premier plan. La production du fer, des machines, des instruments, des navires, des matériaux de construction devient bien plus considérable qu'auparavant." Two writers of works less scientific than those above cited have come to the same conclusion. Hull 2 states that" what we call booms result almost entirely from the great periodic increase in the volume of construction, and what we call industrial depressions result almost entirely from the great falling-off in the volume of construction." Johannsen says: "An augmentation in the rate of new constructions brings with it an augmentation of the country's business activity; and an increase in this activity, in turn, will increase the demand for new constructions; the one factor constantly invigorating the other. The governing factor, however, and the one that starts this reciprocal action, must be found in enterprise and new constructions." But what is the relation between promotion, the dominant element in the industrial phase of the crisis

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1 Les Crises industrielles en Angleterre, p. 271.

2 Industrial Depressions, p. 105.

A Neglected Point in Connection with Crises, p. 7.

cycle, and failures, the essential factor in the financial phase of the cycle? An answer to this question is necessary before a working theory of crises can be said to be evolved. It is not enough to say that the failures are due to miscalculations in business. That does not explain why there should be more miscalculations at one time than another; nor does it show the relation between the industrial and financial phases of the crisis. The problem put in another form is: to what extent has promotion been a factor in bringing about these extra failures which constitute a crisis?

1

Analysis of any crisis situation shows that the two phenomena, promotion and failures, are closely related. Yet the relationship is more complex than writers admit who say that the failures are due merely to overinvestment, or improvident investment, or exhaustion of capital, or some one factor. Not one class, but a considerable number of classes of failures directly or indirectly connected with promotion activity may be marked out. I have outlined three of the most important.

First, there are the failures of the newly-promoted concerns because of miscalculations in promotion. Here is found the much-talked-of anarchy of production. Investment is often carried too far in a given line and the market finally becomes overstocked with the particular commodity or service produced by these new conOr, it happens that promotion is premature; as for example in railway building before our crises of

cerns.

1 Professor Taussig, Principles of Economics, vol. i, pp. 410-411, gives recognition to the complexity of the crisis situation. He says: "In sum, the causes of industrial depression seem to be reducible to various kinds of maladjustment, all connected with the intricate division of labor and the long stretch from production to consumption. There is likely to be maladjustment in the planning of some particular kind of capital, railways, or electric enterprises, or textile mills. There is likely to be maladjustment in a greater addition to the total community's capital than is justified by the total of its available savings. There is excess or deficiency in the stocks of dealers and middlemen. There is accentuation of the whole series of misfits because of the psychological factor."