Gold Output and Higher Cost of Living
AT the end of June, 1907, statistical tables, through which is struck a rough average of the prices of all commodities used in every-day life, showed that the cost of living stood, on that basis of reckoning, at the highest level in more than thirty years. At no time since the early months of 1877 had prices of such necessaries reached the level of the past midsummer. Taking the most familiar of these “index numbers,” the average compiled by the London Economist at regular intervals, during forty-five years, from the prices of forty-seven representative commodities in London and Manchester, it will be found that cost of the articles which goto make up daily expenditure, such as food, clothing-material, wood, hardware,leather, coal, and household utensils generally, had increased 13½ per cent since the beginning of the present year, 24¾ per cent since the middle of 1906, 36½ per cent since the middle of 1905, and no less than 56 per cent since the end of June, 1897, exactly ten years before.
The specific calculations, at these various dates, I shall have occasion to cite later on, and to compare with other previous periods of high prices. For the present, it is sufficient to point out how revolutionary a change in the conditions of ordinary life is shown on the face of the calculations. They will probably cause no great surprise; for no topic of discussion has become more familiar, of recent years, in every civilized community of the world, than the rise in cost of living. The portrayal of that movement in actual averages and percentages has a peculiar interest for two reasons: it makes possible, first, some rough calculation by the individual as to how far increase in income has kept pace with the average increase in rates of expenditure, and how far comforts of life have been cut off from those whose income has remained unchanged. What is still more to the point, it shows at once that the upward movement of prices has increased very greatly in rapidity during the past two years. Of the past decade’s entire rise in average prices, no less than 61 per cent has been achieved since June, 1905, and considerably more than half of this 61 per cent has occurred since June, 1906. This is a fact which may well cause serious thought. It is a problem which personally concerns, with greater or less unpleasantness, every member of the community; and when it is considered that the averages cited above take no reckoning of rent or cost of land, which have gone up in equally startling proportions, the importance of the questions, what is the cause of this extraordinary movement, and what is to reverse or arrest it, is manifest.
It has long been customary to ascribe such rise in prices and cost of living, in a general way, to what we call prosperity; and in point of fact, though the advent of prosperity is hailed by the community at large as a welcome turn in the situation, the woman who defined prosperity as “larger bills at the end of the month ” was not wholly astray from the facts. In the greater demand for necessaries and luxuries, which accompanies the increased business profits and increased employment of labor in a prosperous season, we certainly have one fundamental cause of the rise in prices. This rise, indeed, may readily be seen to play the part both of cause and effect; for as increased profits of trade and labor cause, thus indirectly, higher prices through the use of the expanded incomes, so the higher prices, in their turn, cause still greater profits to manufacturer and laborer. One might suppose, if he reasoned out this situation in the abstract, that such a process would go on repeating itself forever. The experience of practical life, however, teaches him that it does not; that prolonged rise in prices begins at some point to cut down the purchases of people who do not appear to have got their proportionate share of the supposed increase of income; that this reduced consumption occurs at the moment when the high range of prices has induced extensive new production, and that a reverse movement, usually after no very long interval, and usually of no great violence, occurs in the market for commodities. The familiar ebb and flow of prices — often occurring in alternate years, affecting now one set of articles and now another — is the result. Both the upward and the downward movement, within moderate limits, are taken as part of the ordinary vicissitudes of life.
It is familiarity with this frequent alternating movement, scattered irregularly over a wide range of articles, and rarely of long duration, which lends to the present persistent, rapid, general, and continuous rise in prices its formidable aspect. With such results before them as we have seen to be summed up in the London Economist’s averages, it is not strange that economic scholars, financiers, and the average practical business man, should ask if there is not some other underlying force at work. Most of those who are at all familiar with the principles of political economy end by vaguely ascribing the phenomenon to expansion of the money supply through increase in gold production. Supposing that the world’s gold output has increased, the simple formula of the average man is this: Prices are the measure of commodity supplies in money; if the money supply increases, there will be more of money in proportion to existing commodities than there was before; therefore, increase in the money supply means higher prices. Knowing, as a matter of fact, that gold production has greatly increased during the past ten years, he ascribes the phenomenon of prices to that cause.
It is partly the purpose of this article to show whether his inference is right or not; but it has also another purpose. Even if increased gold production were admitted as the single cause of the past decade’s rise of 50 per cent or thereabouts in cost of living, the man who pays the bills will not be much better off, so far as concerns his ability to deal with the situation, than he was before. What he really needs to know is, exactly through what means this cause produced that result, and what may be judged of the future from the past. In the discussion of these questions, I shall endeavor to avoid the technicalities of the economic schools, and to trace the movement, in this and in other similar periods, through the familiar processes of every-day life. John Stuart Mill’s more or less qualified assertion that “if the whole money in circulation was doubled, prices would be doubled,” may command assent as a philosophic principle, but the practical man has the right to know something more, — for instance, exactly how the doubled supply of money finds its way into markets where prices are determined; who gets the new money, and how; who spends it, and for what; whether he buys more than before, or only pays higher prices for the same amount; why supplies do not increase sufficiently, in response to such higher prices, to beat down prices to the level presumably fixed by the original ratio between supply of commodities and supply of money; and, most important of all, to what conditions the present prolonged upward movement is leading, and how it is to end.
In the first place, what of the actual facts of prices and gold output in the present situation ? This is the course of the world’s annual gold production, in the decade past; the figures being those of the United States Mint:—
| 1906 | $400,000,000 |
| 1905 | 377,135,000 |
| 1904 | 347,087,300 |
| 1903 | 327,702,700 |
| 1902 | 296,737,000 |
| 1901 | 262,492,900 |
| 1900 | 254,556,300 |
| 1899 | 306,724,100 |
| 1898 | 286,879,700 |
| 1897 | 236,073,700 |
| 1896 | 202,251,000 |
| 1895 | 199,304,000 |
That is to say, in a dozen years the world’s gold production has almost exactly doubled. During the same period, the Economist’s index number of commodity prices, as of January 1, has been reported as follows: —
| 1907 | 2,499 |
| 1906 | 2,322 |
| 1905 | 2,136 |
| 1904 | 2,197 |
| 1903 | 2,003 |
| 1902 | 1,948 |
| 1901 | 2,126 |
| 1900 | 2,145 |
| 1899 | 1,918 |
| 1898 | 1,890 |
| 1897 | 1,950 |
| 1896 | 1,999 |
The middle months of the year 1897 included the lowest figure, in the average of commodity prices, reported in the whole series of calculations; the figure of July, that year, was 1,885. It is this decade, therefore, which concerns us in the present inquiry. So far as the figures go, the assumed simultaneous rise, in annual gold production and in cost of living, is a verified fact.
This brings us fairly to the question, exactly how, if at all, does increased gold production operate to force prices of commodities to a higher level ? This practical aspect of the inquiry appealed strongly to Professor J. E. Cairnes, of London, after the discovery of gold in Australia and California, the world’s enormously increased annual production as a consequence, and the subsequent increase in prices of commodities. The gold discoveries occurred in 1848. In the decade ending with 1850, the world’s average annual gold output was $38,194,000; in the next five years, the annual average, by the Soetbeer estimate, was $137,775,000, and it reached, by some estimates, the figure of $182,500,000 for one year of the last-named period. The course of prices, during the decade from 1847 to 1856, was traced by the French economist Levasseur, with the result that a rise of 67.19 per cent was found to have occurred in natural products, of which increase the investigator ascribed 20 per cent to results of war and scarcity, and 5 per cent to speculation, leaving 42.19 per cent to be accounted for, in his judgment, as increase from some other cause. Manufactured goods he reckoned to have advanced 14.94 per cent, of which 7 per cent, or nearly one half, was due to war, scarcity, or speculation.
In 1859, Professor Cairnes undertook an inquiry as to just how this rise in prices actually happened. The discovery of gold in Australia was, he pointed out, “an occurrence by which a common laborer was enabled, by means of a simple process requiring for its performance little capital or skill, to obtain about a quarter of an ounce of gold, in value about one pound sterling on an average, in the day;” and this he declares to be “the fundamental fact from which the remarkable series of events which we have lately been contemplating took its rise, and to which the whole movement following upon the gold discoveries is ultimately traceable.” These events, in Professor Cairnes’s judgment, followed much in this way: Since labor in Australia rushed to the mines, the non-mining part of the country had to bid for labor, in order to retain its services, something not much below labor’s value in the gold-fields. Now, common labor had previously, in Australia, commanded three to five shillings per day; twenty shillings was now the average, first at the gold-diggings, then, of necessity, in the cities; and even when the gold-diggings lost their first productiveness, ten shillings could still be had.
This rise in wages necessitated either a great advance in the price of the goods made by such high-priced labor, or else the virtual abandonment of industries which could not afford to pay the wages. But when thus abandoned as native industries, their output was replaced by importations into Australia from abroad, easily paid for by the new gold output of the colony. The influence, at first exerted only on the Australian community itself, thus extended presently to the rest of the producing world. Directly, prices of commodities were raised through the larger demand by possessors of the new wealth obtained by them in the mines; indirectly, they were raised through reduction of supplies, due to abandonment of production because of higher wages. In brief, the equalizing process spread by irregular steps throughout the world, affecting first the commodities “which fall most extensively within the consumption of the productive classes, but more particularly within the consumption of the laboring and artisan section.” Naturally, also, the first effect in the way of enhancement of prices fell upon countries most closely connected, through trade relations, with the gold-producing community.
So much for Professor Cairnes’s first explanation of the means by which increased gold output raises prices. His secondary explanation has to do, less with the personal actions of the ordinary purchaser or laborer, than with the machinery of the banking system. The gold-producing community has satisfied its new requirements and established its scale of wages on the new basis, and, in so doing, has profoundly influenced the trade and prices of other nations. It has done this, obviously, through parting with its gold. Does the gold, thus exported to outside markets, have any influence of its own on prices, apart from the new commercial status of the mine community? Professor Cairnes thus traces its operation in a country where the credit system has been developed:-
“Let us consider for a moment what becomes of a sum of coin or bullion received into England. I do not now speak of that moving mass of metal which passes (so to speak) through the currency of the country, — which, received to-day into the vaults of the Bank of England, is withdrawn to-morrow for foreign remittance, — but of gold which is permanently retained to meet our genuine monetary requirements. Of such gold a portion — great or less, according to circumstances — will always find its way into the channels of retail trade; and so far as it follows this course, its effect in augmenting the circulation will be, as in India, only to the extent of its actual amount. But a portion will also be received into the banks of the country, where, either in the form of coin or of notes issued against coin, it will constitute an addition to their cash reserves.
“The disposable cash of the banks being thus increased, an increase of credit operations throughout the country would in due time follow. The new coin would become the foundation of new credit advances, against which new cheques would be drawn, and new bills of exchange put in circulation, and the result would be an expansion of the whole circulating medium greatly in excess of the sum of coin by which the new media were supported. Now credit, whatever be the form which it assumes, so long as it is credit, will operate in purchases, and affect prices in precisely the same way as if it were actually the coin which it represents.
“So far, therefore, as the new money enables the country to support an increase of such credit media, — to support them, I mean, by cash payments,— so far it extends the means of sustaining gold prices in the country; and this extension of the circulating medium being much greater in proportion to the amount of added coin, the means of sustaining gold prices will be in the same degree increased. Thus, supposing the ratio of the credit to the coin circulation of the country to be as four to one (and the proportion is greatly in excess of this), the addition of one million sterling of coin would be equivalent to an increase in the aggregate circulation of four millions sterling, and one million sterling of gold would consequently, in England, for a given extent of business, support the same advance in gold prices as four times that amount in India.”
This analysis of the operation of gold production on prices has remained the standard of economic criticism on the subject, during the period of nearly half a century since Professor Cairnes first grappled with the phenomena of the gold discoveries and price inflation of his period. It will therefore be interesting to apply his explanation to the course of events since prices began to rise in 1897. The first difficulty which will arise to mind, in fitting the scheme of Professor Cairnes to the events of the past few years, is that the new demand for commodities, by the inhabitants of a gold-producing community, can scarcely exert the influence to-day which it did in the decade after 1850. This is so for two reasons. The richest gold mines of the world — notably in the Transvaal, where annual production has risen from £8,597,000, or $42,500,000, in 1896, to £24,580,000, or $122,500,000, in 1906 — are worked by costly machinery and at great depths. The miner whose pick dislodges a nugget in the mountainside, and who thereby is raised in a day from poverty to riches, is rapidly becoming a mere picturesque tradition of the industry. By far the greater part of the world’s new output comes from immensely expensive plants, installed by engineers for the benefit of the shareholders in heavily capitalized jointstock companies. Therefore the beneficiaries are in the main the investors in a distant country, to whom the quarterly dividend check is sent when the gold shipped to London has been “sold” to the foreign banker or to the Bank of England.
Even so, there might theoretically remain Professor Cairnes’s supposition of wages so high as to divert the laborer from other productive industry to the mines, and consequently force up in all branches of trade the price both of labor and of finished product. But here, too, modern conditions do not square with those of 1850. Not only has use of machinery reduced to a minimum the employment of human labor in the mines, relatively to the output, but in a great part of the world, the bulk of the labor employed is of the lowest order, and is paid proportionately. Not least among the problems just now before the British government is that of dealing with the Transvaal labor question; the difficulty of obtaining Kaffir hands to work under the white “ contractors ” having been met only through importation of Chinese coolies, at wages which no white man would accept.
Obviously, the gold diggers of such a community are not in a way to force up wages elsewhere, as did Professor Cairnes’s Australian miners, through the attraction of labor from other industries to their own. And while conditions in the mines of Colorado and the Klondike are not in all respects identical with those in South Africa, nevertheless their difference from the state of things in the Californian and Australian gold fields of the fifties is sufficient to make application of Professor Cairnes’s first explanation, to the present rise in prices, very difficult. The new demand for labor in the present-day gold fields, and the consequent new expenditure by the community for necessaries or luxuries, could not approach, as an influence on the whole world’s market, the new demand for labor arising from the extension of profitable farming in Northwestern Canada or in Argentina.
But we have seen that, although part of the rise in prices, traced in the Australian episode, originated from diversion of labor from other industries to the mines, part also was the result of demand for commodities from the possessors of the newly mined gold. Now some one gets the new gold to-day, as in 1850, and whoever gets it cannot actually use it except through spending it, either directly for his personal wants, or indirectly by lending it to other people who will spend it. Let us see how this part of the situation compares with 1850. One thing is clear, that the first real possessors of the new gold output of to-day are by no means exclusively, or even chiefly, residents of the community where the gold is mined. Where a mine prospect is capitalized into stock distributed on investment markets, as is generally the case in the Transvaal and in America, increase in the gold output goes to the shareholders. When, as is also very commonly true, the stock has been sold at a price which makes the mine, even with an increased output, an investment of very ordinary character, the profits will have been reaped by the fortunate or unscrupulous promoter. In either case, some man or group of men wall have much more money to spend than they had before; but the point to notice is, that their expenditure will not operate as did the expenditure of the Australian miners as analyzed by Professor Cairnes.
A substantial part of the new wealth of the mine proprietors to-day will doubtless go into more lavish outlay for the comforts or luxuries of the owners; but to this there is a natural limit, and the bulk of it wall unquestionably flow into other investments. The experience of every market is, that the men who have grown suddenly rich from gold-mine operations become large investors or speculators on the Stock Exchange. The result of such purchases is, of course, to drive up prices of securities, and this is one logical explanation of the rapid rise in stocks which accompanies or promptly follows great increase in gold production. In the period under examination, it will be found by the records that the price of investment stocks advanced with violence, long before the prices of commodities in general had moved on a similar scale.
To the extent that the wealth derived from the increased gold output is invested in stocks and bonds, and has its effect on stock exchange prices, it cannot directly influence prices of commodities. Indirectly, however, there is one way in which such investment purchases may affect commercial markets. Increased facility of floating new railway or industrial securities, on the basis of such enlarged investment demand, leads to the starting of new enterprises, to the employment of more wage-earners, and therefore to a larger aggregate income accruing to the community as a whole. This greater income will result in larger purchases, and the resultant larger demand for necessaries and luxuries of life may result in higher prices. The qualifying consideration is, how far such a tendency to raise prices, through increased demand, will be offset through the very increase in supply of manufactured articles to which this ability to start and finance new enterprises contributes.
When we undertake to apply to the present day the second part of Professor Cairnes’s analysis, — the influence of the increased gold supplies on bank reserves and hence on facilities for credit,— conditions in the financial world are such that we find ourselves at once on firmer footing, Whatever the beneficiaries of the new gold do with their increased wealth, there is one thing which they or their agents do with the gold itself. They bring it to a government assay office or mint, or sell it outright to a bank, receiving either currency or drafts available in the money market. These credits they deposit in their banks, which thereby obtain the title to the gold itself. The gold thus finds its way into bank reserves, and becomes a basis whereby the limit of credits allowed by the banking institution is extended.
Deposit liabilities of national banks in cities of the United States, and therefore the loans which create such liabilities, are restricted by the law requiring cash reserves amounting to 25 per cent of such deposits. The Bank of England traditionally maintains, in cash, forty per cent or thereabouts of its deposit liabilities. Loans cannot be increased without increasing deposit liabilities, because the borrower’s purpose is to establish such a deposit credit for himself. If, therefore, gold holdings of the banks are rapidly increased, there is at least an opportunity for expansion of loans, under the strict provisions of the law, in a very much larger ratio even than the expansion of reserves. What has actually happened in this regard, during the period since 1897, may be judged from the following items of the comparative statements of certain institutions, in the middle of each of these two years: —
GOLD RESERVE
| 1897. | 1907. | Increase. | |
|---|---|---|---|
| New York Associated Banks 1 | $90,496,000 | $200,792,000 | $110,296,000 |
| National Banks of the United States | 193,686,000 | 423,236,000 | 229,550,000 |
| Bank of England | 125,976,000 | 118,404,000 | 7,572,000 2 |
| Bank of France | 400,965,000 | 554,600,000 | 153,635,000 |
LOANS
| New York Associated Banks | $532,708,000 | $1,126,539,000 | $593,831,000 |
| National Banks of the United States | 1,966,891,000 | 4,631,143,000 | 2,664,252,000 |
| Bank of England | 176,867,000 | 204,461,000 | 27,594,000 |
| Bank of France | 216,845,000 | 366,035,000 | 149,190,000 |
From such a loan expansion, involving liberal granting of credit to all sorts of applicants, three familiar consequences follow: first, the launching of new enterprises, with the consequent increased demand on labor; second, increase of individual expenditure through the enlarged facilities of credit; third, and by no means least, the equipping of merchants or speculators, in markets of every sort, with such borrowed capital as will enable them not only to buy commodities for the rise, but actually to hold these commodities off the market until the consumer yields to the higher price exacted. Supposing the gold to continue flowing, in constantly larger quantities, into bank reserves, — the banks being naturally eager to employ in profitable loans their new facilities, and being able to do so because their gold reserve expands along with their deposits, — it is not at all difficult to see what influence the process may exert on price of commodities. Nor is it hard to understand one problem which frequently perplexes investigators of this question, — why increase in wealth through development of a new and prosperous farming region, and increase in bank deposits as a result of that new wealth, do not act equally on prices of commodities. The reason for the difference between the case of such depositors and that of depositors of gold is that the farmer’s banking credit, taking the whole financial world together, brings no increase in reserves, and therefore, if loans are already expanded to the legal limit, cannot lead to increase of bank loans in the aggregate. But the gold producer’s transaction with his bank increases not only deposit liabilities but cash reserves, and therefore extends the basis prescribed for the institution’s loans.
This brings us back to the pregnant question, What is to stop the rise in prices and the increase in cost of living, if the world’s gold output continues to increase ? That such an advance has never, in the past, gone on indefinitely, — that, indeed, the upward rush of prices has been checked at the regular intervals which we call our “ cycles of prosperity,” — are facts established by the unvarying experience of the markets, and illustrated clearly by the same series of “index numbers” of commercial prices, to which I have already referred. This is the London Economist’s annual average as of January 1, during the whole period since the new gold of Australia and California began to affect the markets: —
| 1851 | 2,293 | 1880 | 2,538 |
| 1852 | 1,863 | 1881 | 2,376 |
| 1853 | 2,167 | 1882 | 2,435 |
| 1854 | 2,445 | 1883 | 2,342 |
| 1855 | 2,357 | 1884 | 2,221 |
| 1856 | 2,459 | 1885 | 2,098 |
| 1857 | 2,645 | 1886 | 2,023 |
| 1858 | 2,612 | 1887 | 2,059 |
| 1859 | 2,304 | 1888 | 2,230 |
| 1860 | 2,426 | 1889 | 2,187 |
| 1861 | 2,727 | 1890 | 2,236 |
| 1862 | 2,878 | 1891 | 2,240 |
| 1863 | 3,492 | 1892 | 2,133 |
| 1864 | 3,787 | 1893 | 2,121 |
| 1865 | 3,575 | 1894 | 2,082 |
| 1866 | 3,564 | 1895 | 1,923 |
| 1867 | 3,024 | 1896 | 1,999 |
| 1868 | 2,682 | 1897 | 1,950 |
| 1869 | 2,666 | 1898 | 1,890 |
| 1870 | 2,689 | 1899 | 1,918 |
| 1871 | 2,590 | 1900 | 2,145 |
| 1872 | 2,835 | 1901 | 2,126 |
| 1873 | 2,947 | 1902 | 1,948 |
| 1874 | 2,891 | 1903 | 2,003 |
| 1875 | 2,778 | 1904 | 2,197 |
| 1876 | 2,711 | 1905 | 2,136 |
| 1877 | 2,715 | 1906 | 2,322 |
| 1878 | 2,529 | 1907 | 2,499 |
| 1879 | 2,225 |
It will be seen, from a survey of these tables, that the general level of prices rose violently and almost continuously from 1852 to 1857; declined steadily, but with much less rapidity, from 1857 to 1859; advanced to greater heights than ever before, between 1859 and 1864; declined continuously from 1864 to 1871; rose between 1871 and 1873; went down again between 1873 and 1879; advanced in the next year, and then declined until 1886; rose in the next five years; declined from 1891 to 1898 (the low level being in the middle of 1897); and from then on, save for the interval of 1901-03, has been once more advancing.
Now the downward movement in prices which began with 1857 occurred when both gold and silver production were at their maximum. The decline between 1873 and 1879 was accompanied by a heavy increase in the world’s gold output — it was estimated by our Mint at $90,750,000 in 1874, and at $119,092,000 in 1878. The lowering of prices between 1880 and 1886 came in a period of nearly stationary gold production. Most impressive of all, the period between 1891 and 1898, marked by an almost continuous decline in commodity prices, was also marked by a rise in the annual gold output from $130,650,000 to $286,879,000, not one year of the series failing to record a substantial increase over the year before. Taking all due account of the demonetization of silver in 1873, — which had not the slightest effect on this country’s circulating medium, whose effect on Europe’s has, in my judgment, been greatly exaggerated, and which cannot, except by the largest strain of inference, be assumed to have influenced the period 1891-1898, — these facts ought to be sufficient to show that something else than decrease in production of the precious metals has been able in the past to reverse the upward movement of commodity prices.
What is perhaps even more to the point, in discussing a practical question, is the present position of the markets. Admittedly, annual gold production is increasing now as rapidly as it has increased in the past four years; yet the essence of the extraordinary financial situation, which prevails to-day in every money market of the world, is that demand on investor’s capital and on bank resources has so far outrun supply as to bring to a halt the whole machinery of finance. From all financial centres comes the story that the requirements of trade, especially as represented by incorporated industry, are greater than the available resources of the world can meet. The case of our own railway industry, which has for six months been unable to raise on first-class long-term bonds the money needed to pay for necessary improvements, — many of which had been made already, on the basis of notes-of-hand to the contractor, — is a conspicuous instance, and is fairly typical.
The logical result of such a situation would no doubt be immediate curtailment in trade activity and in prices of commodities, since it is the abnormally high scale on which both are operating which has created the embarrassment. But to cut down with sudden violence either volume of trade or prices of manufactured articles would go far towards touching commercial credit. Capitalization of incorporated companies, and current debt of individual producers, have been adjusted to the volume of trade anticipated from the experience of later years; instantaneous contraction would leave the indebtedness while removing the means of paying it. On the other hand, a cut in prices of finished products, on a similar scale of violence, would create a situation where the manufacturer, who had paid high prices for his raw material of manufacture, would find his anticipated profits converted into staggering losses through the diminished returns from his manufactured goods. This is unquestionably why, at the present moment, capital on all the markets of the world is being withdrawn from investments in our loans upon securities. That is the ready market for conversion, and the capital withdrawn is at once applied to the needs of trade. The inevitable result is the world-wide fall in prices for securities, good and bad alike, which has been the characteristic incident of the past half-year, and the offer of abnormally high interest rates by Stock Exchange operators, as a means of inducing lenders not to take their capital away. This withdrawal of capital from the Stock Exchange, unpleasant as its own immediate effects have been, is clearly the price which the community at large is paying for the averting of industrial calamity. It is when the field of Stock Exchange speculation and investment no longer offers opportunity for such wholesale withdrawal of capital without upsetting credit, or when the pressing indebtedness of industry has reached a magnitude which will make even diversion of capital from the Stock Exchange to general trade an inadequate resource, that we have to face commercial panic.
But taking the present extraordinary situation as it is, we have a right to ask, in view of our previous examination of the supposed effect of increased gold production on prices and prosperity, how such a state of things should be possible at this time, when increase in gold production has not been checked at all. The answer to this, as to the same question similarly put in 1857 and 1890, is, in my judgment, that the action of new gold supplies on prices, through the medium of bank loans expanded in response to the new gold reserves, has reached, for the time at any rate, its limit. A bank which goes on expanding loans when the whole world’s available capital resources are tied up, will do so at its own very serious peril; if the policy is practiced by the whole community, break-down of credit and collapse of the whole supporting structure of prices are invited. A loan is sound when the security which lies behind it is such that the borrower can pay it at maturity, through use of outside capital, or that the bank, if the borrower default, can rely on outside capital to take over the security. But if real capital is already under such a strain that such recourse is doubtful or impossible, then expansion of loans is a policy which will hardly commend itself to the prudent banker.
In these days of intimate relations in international finance, it is the habit of markets, whose own capital resources show signs of no longer satisfying home demands, to borrow the capital of outside markets. Our own extravagant “boom” of 1901 was largely built up through use of European capital, and a season of somewhat prolonged depression followed when the loans had to be repaid. The still more unpleasant strain of 1903, created through the exhaustion of capital and credit facilities in this country, and leading, as the similar phenomena have done this year, to forced liquidation on the Stock Exchange, was eventually relieved through the use of capital transferred from England and Germany. Those nations were, and continued to be, in a position to provide it. Last winter, when the American market as a whole was approaching another situation of the kind, recourse was had again, and on a quite unprecedented scale, to foreign capital. By the time the European banks had provided for what seemed to be our needs, they had themselves exhausted the capital resources of their markets; they could lend no more to America, and in fact began, somewhat peremptorily, to call in what they had loaned already.
They were in fact confronted by an exactly similar situation in half the active industrial markets of the world. From France, Germany, Austria, Egypt, and South America, came a chorus of complaint that home capital was inadequate for the commitments of industry and speculation. Recourse was had to credit, and there set in, to support the resultant bank position, so urgent an international demand for gold that reserves of the world’s oldest and greatest institutions decreased at the very moment when their maintenance was most needed. The quite inevitable sequel was a season of worldwide liquidation,— converging, however, on the markets for securities, which fortunately have thus far been able to surrender without catastrophe the capital required.
What is to be the end ? In particular, what is the bearing of these phenomena of the day on the question, how long the rise in prices and increase in cost of living is to continue to perplex the householder ? These events in high finance are linked inextricably with such homely problems as the paying of higher rents and higher charges for food, clothing, and household utensils, by the clerk whose annual salary has not been increased. For the present, the most obvious fact of the situation is that the general rise in prices has been checked. It has been arrested through precisely the process which we have just been tracing, — through inability of the world’s supply of capital to sustain any longer the loans by which commodities, like securities, were being held indefinitely for a continued advance in price. Commodities in which a sudden scarcity of supply may have occurred will possibly continue to advance, even in the face of this shortage of capital resources, — the world’s deficient wheat crop may bring about such a movement in this season’s price of grain; it has done so with wheat, even in years of commercial panic such as 1857 and 1890. But for the general run of commodities, a halt is inevitable; something more than a halt has already happened in highly speculative markets such as that for copper, which has declined substantially, notwithstanding trade statistics which appeared to demonstrate that supplies were inadequate to meet the trade demand. The simple truth of this episode was that, while consumers did have use for all available supplies, they dared not pay the former price with capital so scarce and credit conditions what they were. In greater or less degree, markets for other commodities will be subject to similar influences.
Whether the receding movement will or will not be long-continued, depends on the question, whether the credit situation is to be soon unraveled, and how. On the one hand, an experience of this sort is certain to bring a warning as to the use of credit, and as banks grow more circumspect in providing resources for the holding-up of commodities to an exorbitantly high level, the tendency should be for such prices to relax. The mass of consumers who, as the expression is, are “living on borrowed money,” will be forced to cease or reduce their purchases, as a result of the credit situation. An abnormal and excessive demand, which has played its part in the extravagant rise of prices during the past few years, should by this process be cut off.
At the same time, the difficulty in procuring credit, on the former scale, should lead manufacturers and producers with expensive plants to seek the line of least resistance through a competitive lowering of commodity prices. We have already seen how great a part of a rise in prices, even when sustained by increased gold production, results from the use of credit pure and simple, to hold off the market great supplies of commodities until a high price is bid for them. A process of readjustment, such as seems now to be fairly foreshadowed, may result in a considerable easing of the strain in cost of living. In so far, however, as inadequacy of existing supplies of capital is the fundamental cause, it must not be forgotten that accumulation of capital goes on perennially. If its use in trade, and its absorption in speculation and company promotion, are kept down to a smaller level than of late, supply will again overtake demand. This happened after the disturbances of 1903, and it may easily happen again.
If, however, inflation of prices in every market, absorption of capital on a scale of unthinking recklessness, and use of ill-secured credit to make good deficiencies in the supply of ready capital, are resumed on the scale of the past few years, it is highly probable that not even constantly increasing gold production will save the markets which have indulged in such excess from a complete and prolonged collapse. The strain upon capital and credit may be eased sufficiently to restore equilibrium in financial and commercial markets; but if the strain continues beyond a certain point, a breakdown of credit follows, and with it, forced liquidation of the whole position on which the existing level of prices was built up. This was the history of the periods immediately preceding 1857 and 1873.