Economics and the Public Welfare. Benjamin M. Anderson
wished them to give an example to the other banks in the country.4 However, the great banks got used to it during the war, and in the postwar boom they overdid it.
The Federal Reserve System should have held to the orthodox rule of keeping the rediscount rate above the rate to prime borrowing customers at the great city banks.5
Discounts at the Federal Reserve banks increased from the beginning of 1919 to the middle of 1920 about $750 million. Offsetting this in its effect on member bank reserves was the loss of gold of $336 million mentioned
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above, and the increase of money in circulation, which amounted to $534 million between May 1919 and May 1920. The net result of these conflicting forces was a steady increase in pressure on the money market, with rapidly rising interest rates. On balance the monetary factor was a restraining influence through the whole of 1920, and it was not the primary influence in causing the boom in 1919.
It may be observed here that following the postwar boom and crisis, the great city banks resumed their tradition that they did not rediscount except in unusual circumstances, even though it was profitable to do so. They were very reluctant to show bills payable to the Federal Reserve bank in their published balance sheets. This tradition held very strongly until 1928. When the Federal Reserve banks in 1928 began to tighten the money market by selling government securities, the member banks in New York began to rediscount again, not for the purpose of increasing their reserves or increasing their loans, but for the purpose of maintaining their reserves. Their loans and deposits did, in fact, go down in 1928, as we shall see later when we study the brokers’ loan episode. But the Federal Reserve System ought not to rely upon such a tradition on the part of the banks. They ought to keep their rediscount rates above the market.
The Equilibrium Theory. The general body of economic theory which guides the interpretations given to the more than three decades of the economic history covered in the present volume, and which finds its verification in that history, is based on the notion of economic equilibrium.6 This concept includes many elements. It includes the equilibrium of the industries among themselves. It includes the price and cost equilibrium. It includes the relation of international debts to the volume of international
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trade. It includes the position of the money market. It includes, not merely the quantity of money and credit, but also the quality of money and credit. It includes consideration of wages, rentals, and taxes, as well as interest, in the costs of production. It centers on the question of whether economic forces are working away from balance or toward balance. It is a flexible conception which puts emphasis at different times upon different factors of the situation, depending on which ones are doing unusual things.7
The Growing Economic Unbalance. The situation in 1920 was shot through with abnormalities, stresses and strains. The movement was in almost every case away from equilibrium.
1. Our export balance. The most striking abnormality from the standpoint of ordinary economic laws was that the United States, a creditor country, should have an enormous export balance. The world as a whole was heavily indebted to us, and under normal conditions this would have involved an excess of imports to the United States as foreign countries paid their debts to us with goods.
2. Gold movements. The second great abnormality of 1919-20 was that despite our tremendous export balance of trade we were losing gold heavily. The extent of this is indicated in the foregoing tables, and the reasons for it have been stated. We had an export balance with Europe only, and we could not draw on Europe for payments to the non-European world to pay for our import surplus from them.
3. Prices and gold. The net result of our foreign commerce during 1919-20 was that we lost both goods and gold. The loss of goods raised prices and encouraged speculation. The loss of gold tightened the money market.
4. Government expenditure. In the two years following the Armistice the government spent practically as much money as it had spent during the war itself. A large part of this was in liquidating canceled war contracts and in meeting other unavoidable expenses of postwar readjustment. But part of this governmental expenditure was for financing the shipment of goods to Europe, while the continuance of government shipbuilding after the Armistice created a surplus of unneeded ships at the same time that it led to shortages in other lines where the labor and resources could have been advantageously employed.
5. Industrial efficiency. One of the most striking abnormalities was to be found in the fact that the return of nearly four million men from the army and navy to industry in 1919 was accompanied by an actual decline in the physical volume of goods produced in 1919 as compared with 1918.
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Professor E. E. Day8 gave figures showing an increase in agriculture of 3.3 percent, a decline in mining of 18.3 percent, and a decline of manufacturing of 8.8 percent, with a decline in production generally of 5.5 percent. Professor Walter Stewart9 estimated the decline in the physical volume of production of 1919 as compared with 1918 at four percent. There was a great decline in the efficiency of labor in 1919 and 1920 accompanied by a rapid rise in wages. This usually comes toward the end of a boom. In a boom certain “marginal” or inefficient labor is employed which would have difficulty in finding employment in dull times, and is taken on often at full wage rates. A great deal of overtime work is engaged in, and overtime rates increase labor costs. Moreover, overtime beyond forty-eight hours a week, over a series of weeks, leads to a weariness on the part of labor. Shop discipline is increasingly difficult in boom times. The turnover of labor, moreover, is very rapid in such a period. Labor costs per unit of output were mounting rapidly.
6. Managerial efficiency. Toward the close of a boom managerial efficiency always goes down. Managers are harassed by rush orders, by a high labor turnover, by difficulties in getting materials in on time, and by a multiplicity of details which do not press them so hard in dull times. Moreover, profits look large and managers have less incentive for close economies. They find it easy to add increased expenses to selling prices. They are, moreover, easily persuaded by enterprising promoters with “ideas to sell,” to incur extravagant overhead expenses for advertising and other items from which the return may be doubtful. They cease to watch small economies.
7. Raw materials. Ordinarily prices of raw materials rise faster than prices of finished products in a boom time. Imported raw materials did not rise as fast following the latter part of 1919 as did the prices of finished products, but raw materials in the cases where foreign competition was absent rose very rapidly, and this was particularly true of building materials. In some cases local monopolies were able to push building prices to outrageous levels.
8. Money and interest rates. The year following April 1919 saw a steady rise in money rates and in long-time interest rates on investments, with a resultant sharp increase in the interest element in the cost of production. Businesses which had maturing bond issues were especially hard hit by this development, and there was a great increase in the volume of short time notes in this period, as businesses were unwilling to tie themselves up with long-time contracts to pay existing interest rates. Gold was leaving the
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country and undermining bank reserves at the same time that bank loans were expanding, as we have seen, at a rapid rate.
9. Rentals. In all growing cities, in view of the shortage of housing, rents rose rapidly during 1919 and most of 1920. As business leases expired during this period, new leases had to be taken on at much higher rentals, leading again to marked increases in costs of business production.
10. The railroad situation. The war had subjected our railroad system to a very great strain. Traffic was dislocated and equipment had got into bad condition. Railway wages were high and the efficiency of railroad labor was low. The postwar boom caught the railroads in such a position that it was not easy for them to bear the strain. More traffic was offered than they could handle, and railroad congestion grew at many points. This was one of the worst elements of the industrial disequilibrium. It led to interferences with production and marketing,