higher rates for overtime. More serious is a decline in the efficiency of labor, because of the employment of undesirables and because crews cannot be driven at top speed when jobs are more numerous than men. The prices of raw material rise faster on the average than the selling prices of products. Finally, numerous small wastes creep up when managers are hurried by press of orders.

A second stress is the accumulating tension of investment and money markets. The supply of funds available at the old rates fails to keep pace with the swelling demand. It becomes difficult to negotiate new issues of securities except on onerous terms, and men of affairs complain of the "scarcity of capital." Nor does the supply of bank loans, limited by reserves, grow fast enough to keep up with the demand. Active trade keeps such an amount of money in circulation that the cash left in the banks increases rather slowly. On the other hand, the demand for loans grows, not only with the physical volume of trade, but also with the rise of prices, and with the desire of men of affairs to use their own funds for controlling as many businesses as possible.

Tension in the bond and money markets is unfavorable to the continuance of prosperity, not only because high rates of interest reduce the prospective margins of profit, but also because they check the expansion of the volume of trade out of which prosperity develops. Many projected ventures are relinquished because borrowers conclude that interest would absorb too much of their profits.

The group producing industrial equipment suffers especially. In the earlier stages of prosperity this group enjoys exceptional activity. But when the market for bonds becomes stringent and the cost of construction high, business enterprises defer the execution of plans for extending old or erecting new plants. As a result, contracts for this kind of work become less numerous as the climax of prosperity approaches. Then the steel mills, foundries, machine factories, lumber mills, construction companies, etc., find their orders for future delivery falling off.

The larger the structure of prosperity the more severe become these internal stresses. The only effective means of preventing disaster while continuing to build is to raise selling prices time after time high enough to offset the encroachment of costs upon profits and to keep investors willing to contract for fresh industrial equipment.

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 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 processes.

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 doubled straina sharp increase in the demand for loans and 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 on 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. Consumer's demand declines in consequence of wholesale discharge of wage-earners. With it falls the business demand for raw materials, current supplies, and equipment. Still more severe is the shrinkage in the investor's

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 consumer's 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 encourage 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.

75. SEASONAL VARIATIONS AND PANICS1

BY EDWIN WALTER KEMMERER

It has been found that the two periods of the year in which the money market is most likely to be strained are the periods of the "spring revival," about March, April, and early May, and that of the crop-moving demand in the fall; and that the two periods of easiest money market are the "readjustment" period, extending from about the middle of January to nearly the 1st of March, and the period of the summer depression, extending through the three summer months. Of the eight panics, four occurred in the fall or early winter (i.e., those of 1873, 1890, 1899, and 1907), and these four included two of the three really severe panics of the period (i.e., those of 1873 and 1907); three occurred in May (i.e., those of 1884, 1893, and 1901); and one (i.e., that of 1903), probably the least important one from the standpoint of the country as a whole, extended from March until well along in November.

The evidence accordingly points to a tendency for panics to occur during the seasons normally characterized by stringent money markets. This does not mean that the seasonal stringencies are the causes of the panics; it does mean that the months in which they occur are the weakest links in the seasonal chain, and that in periods of extraordinary tension the chain breaks at these links.

76. THE PERIOD OF DEPRESSION

A few facts and figures will indicate the extent of the present industrial depression. Bank exchanges at all the leading cities of the United States were $2,073,910,424 for the week ending January

I

Adapted from Seasonal Variations in the Relative Demand for Money and Capital in the United States, p. 222. (National Monetary Commission, 1910.) Adapted from an editorial in Moody's Magazine, V (1908), 151-54