THE YALE REVIEW

A QUARTERLY JOURNAL FOR THE SCIENTIFIC DISCUSSION OF ECONOMIC, POLITICAL, AND SOCIAL QUESTIONS.

EDITED BY PROFESSORS IN

POLITICAL SCIENCE AND HISTORY

YALE UNIVERSITY,

NEW HAVEN, Conn.

The REVIEW is edited by Professors HENRY WALCOTT FARNAM, EDWARD GAYLORD BOURNE, JOHN CHRISTOPHER SCHWAB, IRVING FISHER, GUY STEVENS CALLENDER, HENRY CROSBY EMERY, CLIVE DAY, ALBERT GALLOWAY KELLER.

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Copyright, 1907, by

The Editors of the Yale Review, New Haven, Conn.

THE

YALE REVIEW.

FEBRUARY, 1908.

SOME LESSONS OF THE PANIC.

CONTENTS.

Causes assigned, p. 341; economic and psychological factors, p. 342; effect of increased gold supply, p. 343 ; major and minor causes, p. 345; the Treasury and the banks, p. 346; lack of responsibility among bankers, p. 348; difficulties of a central bank, p. 349; possibilities of the clearing house, p. 350; character of bank currency, p. 351; the Aldrich bill, p. 352; summary, p. 353.

THE recent panic has illustrated principles with which stu

dents of economics have long been familiar and has served to emphasize again many of the weaknesses in our present monetary and banking system which have formed the subject of agitation for many years past. It has also presented certain novel features of its own and it has brought out certain phases of the problem of financial reform which hitherto have received relatively scant attention. It is not the purpose of the following pages to enter into any careful analysis of either the causes or the course of the panic, or to attempt any comparison of various methods proposed to lessen the intensity of such a phenomenon in the future. It is desirable, however, now that the immediate stress is over, to sum up in our own minds some of the more important lessons to be learned from our most recent experience and at least to hope that we shall profit by them more than from the lessons of the past.

Like every panic, that of 1907 has been attributed to many causes and as a matter of fact it has been the result of many causes. Roughly speaking, the causes which have been assigned by the public may be summed up under the following heads:

1. A premeditated plot on the part of unscrupulous financiers to topple over the structure of credit for their own ultimate advantage.

2. The weakening of confidence through the action of President Roosevelt.

3. Our inelastic currency system.

4. Reckless banking on the part of individual banks and trust companies.

5. Extravagant expenditures and the destruction of capital by war and natural catastrophes.

6. General over-expansion of credit due to undue confidence in investment for the future.

7. The increased gold supply.

These causes are not necessarily distinct and, barring the first of them, probably each has played some part. It may be said of them, however, that considered from any fundamental point of view their importance in bringing about the present situation is in inverse ratio to the order in which they have been given here. Of the first two it is not necessary to speak at all. One thing is certain and that is that the causes of the panic lie much deeper than the action of any nefarious clique on the one hand or the expressions of opinion, on the other hand, of any person however powerful. That the causes of the panic are of a very different nature would suggest itself to any reader from the fact that by both business men and economists in this country and abroad the panic had been predicted for at least a year before on the basis of the statistical showing of those factors which the past has proved to be the crucial tests in such matters. It would be interesting, if space allowed, to review the character of some of these predictions and see how far either the science of economics or the farsightedness of practical business men have shown themselves capable of accurate prediction in detail. We must, however, content ourselves with merely noting that the leading economists and the shrewdest men in the world of practical finance have both found natural reasons for what has happened. On the other hand, it should not be forgotten that among these "natural" reasons the psychological factor has been as important as the economic factors. There was nothing in the economic

situation to warrant any such financial collapse as took place at the critical moment. To be sure there was over-expansion in the sense that the country was going ahead at a faster pace than its capital resources or credit facilities would allow, and the economic factors were such that contraction and a readjustment of values was inevitable. But there has rarely been a time when such expansion seemed more justifiable nor could it be called a period of reckless plunging. The readjustment needed was scarcely of an heroic nature, and the extent of the actual collapse was due to unreasoning fear when the reaction once started. The very name "panic" indicates that this psychological element is one that can be counted on to appear at a certain point. Its importance can hardly be exaggerated, but here we may take it for granted and devote our attention to the more strictly economic forces.

There can be no question but that any fundamental analysis of the situation must take us back to the great increase of the gold supply in the last ten years, the consequent depreciation of the money standard and general rise in prices. This, though commonly overlooked by the public at large, has been widely emphasized by expert writers. The effect of the depreciation of gold on the level of prices and interest rates has undoubtedly been at the bottom of that general over-expansion both in the field of speculation and in the field of industrial investment which are commonly taken as the starting point for occurrences of this kind.

It may be worth while to summarize briefly what would be the natural effects of a great increase in the supply of the standard metal:

1. First, there would be a rise in prices due to the depreciation of the standard in which prices are expressed, since a fall in the value of gold and a rise in the level of gold prices are simply two ways of expressing the same phenomenon.

2. This rise in prices would naturally be accelerated by speculation which is always set in action by the chances of gain in a rising market.

3. In the same way a depreciation of the standard should bring about a rise in interest rates, since if creditors are to be repaid in a depreciated metal they must receive higher rates to keep their capital investment intact.

4. As a result the values of securities yielding a fixed money income should fall, since there would have to be a readjustment of values on the basis of the new rate of capitalization.

5. But the increase in interest rates and its effect on the prices of securities would occur only in case the process of depreciation was actually recognized by the men of the money market. Although the effect must be ultimately felt, it is the conclusion of both common sense and actual experience that the movement would be retarded by the failure of money lenders to recognize the change in time. Thus of the two normal effects of a depreciating standard, a rise of prices and a rise of interest rates, the former would be exaggerated and the latter minimized by the psychological character of the business world. The inevitable result is an ultimate readjustment at the cost of much greater strain.

Such is the analysis, in elementary form, of what was to be expected from such a fundamental natural cause as the increase. in the gold supply.1 The course of business in recent years shows admirably the working of these forces, together with the influence of certain more artificial factors to be noticed in turn. The rise of prices is of course a matter of daily comment. It is evident enough that it is the combined result of the increasing supply of gold and of the speculation which that engenders. That there has been a general change in the interest rate is no longer disputed. Only a few years ago banks were concerned over the question of how low interest rates could go and assumed altogether too readily that the rate of interest on such gilt-edged securities as standard municipal bonds might be taken as fairly permanent barring temporary fluctuations. Many banks invested in such long-time securities on a 3 or 32 per cent. basis, congratulating themselves on their conservatism in securing the integrity of their capital assets even at the expense of a small annual return. The error of their forecast is revealed to-day in the prices which such securities bear and in the fact that new securities of equal soundness may now be purchased on better than a 4 per cent. basis.

1 The best treatment of this subject, both theoretically and inductively, is to be found in the writings of Professor Irving Fisher. See especially The Rate of Interest, 1907.