Economics and the Public Welfare. Benjamin M. Anderson
band. Europe holds one end, we hold the other. The tension in the rubber band represents the high prices of commodities. The tension has been growing. Suddenly Europe turns loose her end. Commodity prices drop in thirteen months from 248 to 141!
Europe turned loose her end, not because she did not continue to desire commodities, but because of the growing doubt all over the world as to her ability to pay, and also because of a growing exhaustion of the credit resources of those who wished to sell to her on credit.
Wholesale and Retail Prices. One of the first episodes, anticipating the general fall in raw materials and in the general average of wholesale commodity prices, was a cut of twenty percent in retail prices at John Wanamaker’s in New York on May 3, 1920. Wanamaker, moving first, cleaned out his inventory at high prices, and put himself in a strong financial position. Some other retailers followed. But the first general break was not in retail prices. Wanamaker’s acted in response to what was called a “buyers’ strike.” Public resistance to rising prices became a general subject of discussion, though it was probably more talked about than real.
Wholesale Prices Break from 248 to 141. The decline in commodity prices at wholesale was extraordinarily rapid. A peak had been reached in May 1920 at 248 percent of the 1913 prices according to the contemporary Bureau of Labor Statistics Index. By August 1921 this index had dropped to 141. In a single year, August 1920 to August 1921, the drop was one hundred points. American industry met this shock amazingly well. American agriculture suffered a great deal because of it. Agriculture in outlying countries, like Cuba and South America, was prostrated by it. Twenty-five-cent sugar ruined Cuba. Two-and-a-half-dollar wheat did grave damage to American agriculture. But the boom and the high prices and the
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great collapse left the general industrial situation in the United States pretty well intact.
Industry Stands Shock—Agriculture Badly Shaken—Different Financial Techniques. The explanation is to be found in the difference in financial technique between industry and agriculture. Industry rather generally was distrustful of the boom during the war and to a considerable extent even after the war. Industry used the boom as an opportunity to accumulate additional capital funds and to increase liquidity. The United States Steel Corporation, for example, increased its cash in banks, increased its holdings of marketable securities, and reduced its debt during the war, as well as increased its surplus and undivided profits very greatly out of earnings. It did not pay out all of its profits in dividends. The United States Steel Corporation was stronger in the summer of 1921 after the grand smash than it had been in the summer of 1914 before the war began.
Agriculture, on the other hand, to a great extent, had used the extraordinary wartime earnings as a foundation for rising prices of agricultural lands and increased mortgage debt on agricultural lands. This in part grew out of the conservative wisdom of agricultural communities. A wise investor will ordinarily buy the kind of thing that he knows and understands. The farmers knew land. With windfall profits they bought more land. Ultraconservatism in agricultural communities, on the part of old farmers who did not wish to expand, consisted in taking a first mortgage on some other man’s land where he knew the land and could watch it. Ordinarily such practices had proved wholesome and sound, but when widely practiced for several years of high profits, they inevitably made for a great rise in land values and a great growth in debt based on land values.
Land Speculation—Iowa. The center of the boom in agricultural lands was Iowa. Land values had long been unduly high in Iowa as compared with land in other states with the same earning power. In 1919 and 1920 they soared extravagantly.1
Temporarily Embarrassed Businesses. A great many industries were temporarily very hard hit and embarrassed. Inventory shriveled in value. A great many accounts and bills receivable proved to be difficult to collect. Industry itself, however, had accounts and bills payable, including notes due at the banks, which were maturing. Liquidity decreased with great rapidity. The banker giving credit is accustomed to attach high importance to the “current ratio,” that is to say, the ratio between quick assets and quick liabilities. Quick assets are cash in bank, accounts and bills receivable,
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and inventory. Quick liabilities are accounts and bills payable. The ratio required in different industries will vary with the general liquidity of the business and special circumstances connected with the business, but in general the banker likes to have a current ratio of 2 or 3 to 1. Current ratios declined with startling rapidity. One important company had a current ratio of 5 to 1 on December 31, 1919, and only 1 to 1 on December 31, 1920. Under such circumstances it became necessary for the banker to “look below the line,” that is to say, to consider the fixed assets and the fixed liabilities of the corporation as well as its quick assets and quick liabilities; to consider whether, taking all assets and all liabilities into account, the concern was solvent even though it might be temporarily frozen. Credit policy came to be centered on the question of solvency. Business policy for a great many corporations ceased to be concerned primarily with profits and came to be concerned primarily with solvency.
There were many strong corporations which rode serenely through this trouble without needing to call upon their banks for anything but routine loans, and some, like the United States Steel Corporation, which needed no loans at all. But most businesses needed to go to their bankers, and many of them came in fear and trembling.
Banking Policy, 1920-21. The main lines of bank credit policy pursued in this great crisis were admirable and very clean-cut. The banks themselves had taken advantage of the unusual profits of the war and the postwar boom to add to surplus and even to capital on a great scale. And they had, for the first time in a great crisis, the Federal Reserve banks to lean upon.
The trouble came, in general, to concerns which could give the banks commercial paper eligible for rediscount at the Federal Reserve banks. The Federal Reserve banks were in a strong position and extended credit, at a steep rate, to enable the bankers to meet borrowing demands. The first point in bank policy was that it was the business of the banks to extend credit to enable solvent customers to protect their solvency, but that if the customer were really insolvent, there was no use in throwing good money after bad. The second main point was that if the customer was to be helped at all he was to be helped adequately. If $50,000 was needed to save him he should receive a loan of $50,000 or else nothing at all. He should not be given an inadequate $30,000 loan. There was always the qualification in cases of this sort that if the customer were accustomed to borrowing from several banks he should not expect any one of the several to give him all that he needed, but should expect the banks rather to get together and divide up the burden, but in such a way that he would have adequate funds to protect his solvency. It was the business of the banks to enable their customers to mobilize their slow assets to meet their quick liabilities. It was no part of the duty of the bankers to validate the unsound assets of a really insolvent business.
Bank Creditor Committees. Solvency in many cases was a question of
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degree and a question of opinion. The bank credit men amassed in an extraordinarily short time all relevant information regarding virtually every business in the United States. And through the interchange of credit information this was available to all interested bankers. It became clear that there were many cases of well-managed businesses which, caught in the great disorder, would not be saved by temporary loans, but needed long-time help and would need it for an indefinite period. In some of these cases it could be seen that given time and unusual consideration, the business would finally pay out. In other cases it seemed probable that the business could never pay in full, but might in time work out at ninety or eighty or seventy-five percent. What was to be done?
The banks in this crisis developed a new technique designed to avoid the slow and wasteful process of the bankruptcy courts with the liquidation of “going businesses.” Bank creditor committees were formed. The businesses put themselves in the hands of the banks informally. Creditor banks agreed with one another to defer collection of the loans, insisting, as they did so, upon drastic economies in the debtor businesses. In cases where management was good, the banks knew very well that the management