Class, H^ Q^^Book- '^^^ -

Copyrigtit Vi"

COFffilGHT DEPOSIT.

A Century of Prices

An Examination of Economic and Financial Conditions asReflected in Prices, Money Rates, etc., During the

Past 1 00 Years, With a View to E tablishingGeneral Principles Which Mav Aid in

Interpreting the Present and Future.

By Ex Senator THEODORE E. BURTON,Chairman Board of Directors Merchants National Bankof New YorJc, Author of "Crises and Depressions," etc.;

And Ci. G. SELDEN,Managing Editor of "The Magazine of Wall Street,"

Author of '"The Machinery of Wall Street," etc.

The MAGAZINE OF WALL STREET42 BROADWAY

NEW YORK

i.:

lU'..

Copyright, 1919

By The Magazine of Wall Street

St?\^^^

INTEODUCTORY NOTE

'T^ HE chapters and graphs comprised in- this book first appeared in The Maga-zine of Wall Street and were widelycommented upon not only for their unnsualoriginality but for the practical bearing of

the principles developed upon the actualwork of the business man or investor.

History tells what happened, but thesegraphs, with the keen analyses which ac-company them, show why it happened, andexplain the great controlling principles of

business and finance in the straightforwardfashion of one business man talking to an-

other.

The authors require no introduction tothe American reading public. Ex-Senator

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Burton is one of the world's leading author-

ities on prices and their relation to econ-omic and financial conditions, and G. C.Selden is internationally known for his keenand thorough analyses of the effects ofeconomic factors on business and invest-ments.

The Magazine of Wall SteeetAugust, 1919

CONTENTS

Chaptee I.

PRICES AS AN INDEX OF ECONOMICAND INVESTMENT CONDITIONS

Why the study of statistics is called''dry"The value of the graphic methodof presentationInterpretation of econ-omic and financial conditions in the lightof the pastImportance of pricesMean-ing of the money rateWhy the commercialpaper rate is usedThe averaging ofpricesRelation hetween hond yields andbond pricesThe stock averageWhat ismeant by a ''weighted" average of com-modity pricesThe method of interpreta-tionThe permanency of general princi-plesInter-relations among the different

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factorsThe influence of warsThe gen-eral purpose of these chapters.

Chaptee II.

GREAT ECONOMIC FORCES SINCE 1790American conditions alone inadequate

for a broad viewWhy English prices arechosen^English commodity prices since1782Prices as a relationshipThe '* psy-chology" of pricesPronounced effects ofwars on commodity pricesEffect ofcheaper productionThe supply of moneyGold production^World's stocks of gold^Increased use of creditMinor changesin commodity prices now less violent thanformerly^The supply of capitalPrices

and yields of British consolsThe twomain elements in their price levelGrowthin the supply of capitalThe **flow" ofcapitalEffect of the accumulation of

liquid capital^How more money and

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credit raise commodity pricesWhy bondyields rise and fall with commodity pricesReal income versus money income

Post war price movementsPractical con-

clusions.

Chapter m.WHAT AMERICAN COMMODITY PRICES

SHOWCauses of war pricesEffect of currency

inflation in the Civil WarComparison be-tween the World War and the Civil War

Elements in Civil War currency prices

Difference between depreciated and ex-panded currencyDiffering relations withEuropean price levelCommodity pricesand our export tradeInternational ad-justment of price levelsHow our exportbalance depends upon relative price levelsEffect of large exports in stimulating

general tradePronounced influence of

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gold importsThe **major cycle"^Inter-balancesWheat and cotton.

Chaptee IV.

CAUSES OF CHANGES IN INTERESTYIELDS AND MONEY RATES

Relation between demand and supply ofcapitalCapital is the product of labor

Factors in the supply of capitalRapidity

of circulation of capitalCapital classified

according to rapidity of circulation^Im-

portance of distinguishing between fixed

and circulating capitalRise and fall ofbond yieldsWhy higher commodityprices increase the demand for capital

Diversion of capital into fixed forms

The disposition to saveMoney rates

Connection with bond yieldsCauses ofhigh ratesHow over-extended bank loansariseScarcity of credit down to 1874

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High rates of panic yearsIs ** tightmoney" a thing of the past?

Chapter V.

PRINCIPLES OF STOCK PRICESBy G. C. Selden

Relations with factors previously dis-

cussedRising commodities benefit indus-trials^How stockholders sometimes profitat the expense of bondholdersPanics af-

fect all securitiesThe **minor cycle"

Various explanations offered for recurrentdeclinesThe fundamental causeActionand reactionStrong and weak buyers

Speculation in trade channelsMutual in-fluence of stocks and business conditions

Features of the minor cycleStocks andthe money rateBull markets are basedon surplus fundsHow stocks forecastbusiness conditions.

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Chapter I.

PRICES AS AN INDEX OF ECONOMICAND INVESTMENT CONDITIONS

np HE study of statistics is commonly" accounted * * dry." Yet it is dry only be-cause dryly presented or imperfectly under-

stood. When statistics over a period ofyears are made quickly intelligible to theeye by graphic charts and diagrams, andwhen the great vital and controlling in-fluences which cause the rise and fall ofthese pictured lines are understood andvisualized, the subject becomes more fascin-ating to the business man than the most** gripping" novel of adventure. In these

chapters our effort is to present the sub-

ject in this intelligible and practical way,

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as business men talking to business men,

and an elaborate series of graphs has beenprepared for the purpose.The great practical importance of inter-

preting present and future economic andfinancial conditions in the light of the past

can hardly be over-estimated. In this field

it is most emphatically true that comingevents cast their shadows before. Theprime difficulty in the past has been the lackof adequate records, over a sufficiently long

period, of prices and other economic and in-dustrial statistics. That difficulty, however,is being gradually overcome. The com-pleteness and accuracy of current statisticsare improving year by year as their im-portance comes to be more generally recog-

nized; while the painstaking researches of

students have shed much additional lighton the price levels of the past and theircauses. The graphs which accompany

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these chapters not only bring together in

a convenient form the laborious researchesof others, but they contain additional mat-

ter, which is the result of the patient delv-ing of the statisticians who have assistedus in this work.

Comparative statistics of this characterafford a means of determining the trend ofevents. Rightly interpreted, they give awarning of coming changes which is of thehighest significance.*

* In this coimection it may not be amiss to mentionSenator Burton's confident prediction, in an addressbefore the American Investment Bankers' Associationat Denver, in September, 1915, that a period of highermoney rates and scarcity of capital was approachinga prediction that was naturally unwelcome, butproved strikingly correct; or Mr. Selden's forecast, inan article published in November, 1916, that the thenrising trend of bond prices would culminate early In1917 and that a considerable decline would follow

also opposed to the views of many bond men at thattime, but remarkably fulfilled in the outcome. Theseinstances are mentioned to show that studies of thischaracter, by some dubbed "theoretical," are not with-out a very direct and definite value.

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IMPORTANCE OF PRICESIn viewing economic and investment con-

ditions broadly over considerable periods,

prices (including the interest ratetheprice of capital) are perhaps more impor-tant, and certainly more all-inclusive, thanany other class of statistics.

Money rates, for example, are the resultof a country-wide and, under normal con-ditions, a world-wide demand and supplyof capital. Nearly every enterprise is aborrower. Every bank, and many other in-stitutions and individuals, are lenders.Every investor controls some fraction ofthe available supply of capital. Even thesmall accumulations of savings bank de-positors indirectly reach and affect themoney market. A general fall in the profitsof business men is immediately reflected intheir necessity for increasing their loans,

while a rise in their profits soon brings an

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increase in bank deposits and thus largerofferings of liquid capital and easier moneyrates.

In short, the movements of money rates,when properly understood, afford a sort ofcombined index to the whole industrial andinvestment situation, and similar principlesapply to the other factors here discussed.

It is important to distinguish betweenthe short term money rate, the longer termrate and the price of investment capital asshown by the average income yield on high-grade bonds. The rate for call money,which is dependent on the immediate sup-ply from day to day, is not broadly indica-tive of fundamental money market condi-tions; and to some extent the same is trueof time money. The money rate used inthe graph covering that field which ac-companies a succeeding chapter, is the ratefor prime commercial paper, usually of

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about six months' maturity. This term islong enough to afford considerable stabilityto the rate, and this form of credit is alsomost closely connected with industrial con-ditions. Moreover, it is possible to compilethis rate more accurately and from anearlier date than in the case of call or timemoney.

AVERAGE PRICESIn dealing with bonds, stocks, and com-

modities the only way to get a general viewis to average the prices of a large number.The price of any one bond, stock, or com-modity is likely to be influenced by specialcauses peculiar to itself. But by averaginga score of the principal bonds or stocks, ora hundred commodities, these minor or ex-ceptional variations are for the most part

eliminated, so that the movements of theresulting averages reflect general condi-

tions.

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In the case of bonds, the computation of

such an average is embarrassed by the fact

that every bond has a date of maturity,

when it will be redeemed at par value.Therefore a bond selling at a discountgradually rises to par, while a bond at a

premium gradually falls to par, regardlessof the demand and supply of capital. Soit is necessary to average, not the price of

bonds, but their yields to maturity as ob-

tained from the bond tables (or from the

tables arranged in graph form, which are

more convenient for most purposes).This average of bond yields is, in a broad

way, the reciprocal of bond prices ; that is,

its general movements are exactly opposite

to those of bond prices, since the higher the

price the lower the yield.

A graph showing this average of bondyields over a long period is really illumi-

nating, when taken in connection with

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similar graphs showing other importanteconomic factors for corresponding times.

Since stocks have no date of maturity, a

simple average of the prices of 20 to 50

different issues serves to compare the gen-

eral level of the market from year to yearor month to month.A similar method is followed in compar-

ing the relative planes of commodity pricesat different times. One widely used aver-age represents the total of the wholesale

prices of 96 different important commodi-ties on the first day of each month^theaverage of the twelve months being taken asthe average for the year.

Another method is to ^^weight" the pricesof the various commodities as nearly asmay be in proportion to the different quan-tities of them that enter into consumption.While there is no startling difference be-tween the general movements of a weighted

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and an unweighted average, the preferenceshould be given to the weighted average as

more scientifically compiled, and that formis used in our graph of American commod-ity prices since 1850.

METHOD OF INTERPRETATIONIn general, the method of interpreting

price movements must be historical. It is

clear that the same causes would producethe same effects upon prices in the future

as in the past. Exactly the same conditions

will never be repeated, but the effect of

each cause taken separately will neverthe-

less be the same.Moreover, there is a striking similarity

in the sets of conditions which are repeatedat different times. The man whom in ourchildhood we were taught to call the wisest

that ever lived, said that there is nothing

new under the sun, and as regards princi-ples his statement can still hardly be ques-

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tioned. The aeroplane is new, but its princ-iples date back to the later carboniferous

period, when enormous bats and reptilesswarmed the air. The wireless is new, butonly because we have just discovered theprinciple on which it is based. And thestudent of economic history, as he watchesthe interplay of forces which made theprices of the past, is much more surprisedat the correspondences he discovers than

at the differences.

Highly interesting, too, are the inter-relations among the various graphs pre-sented. We ^all find that, within limits,each sheds light on all the others. And thisfact is most important in enabling the ob-server to weave the whole into a well-in-formed and balanced view of the broadeconomic and financial situation.The historical value of these statistics,

also, should not be entirely ignored. To the

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A CENTUEY OF PRICES

reader who is of an observant and interpret-ing turn of mind, they give a better com-

prehension of the actual business condi-

tions of the past than could be obtained by

many hours of wading through the prosaicrecitation of isolated facts and events.When we see, for example, the extraordi-nary and what would today be called pro-hibitive rates which the business man oftenhad to pay for money in the '40s, '50s and'60s, we get a new and clearer comprehen-sion of the industrial conditions of those

times.

Among the influences which cause greatand lasting changes we shall find that warshave an outstanding importance. This is

because nothing else subverts conditions so

widely or so radically. We have only tocompare the Germany of today with theGermany of 1914 to see how far thesechanges may go ; and although America has

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not undergone any such vital or funda-mental disorganization, yet she has experi-

enced a transformation far greater than any

other in her history except the Civil War.

It is highly important to the banker, busi-

ness man and investor to appreciate thecharacter of that transformation and itsbearing upon our future.

It is perhaps unnecessary to add thatthese chapters deal with broad tendenciesand general principles. A minute exami-nation of minor fluctuations and of the iso-lated historical events which caused themwould be of little service to the businessman, however interesting it might be tothe student of history. We shall endeavorto dwell for the most part upon those fac-tors which can be of practical help in theinterpretation of the present and thefuture.

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CHAPTER II.GREAT ECONOMIC FORCES SINCE 1790

IT is desirable first to view the op-eration of economic and financial

forces in as broad a perspective as possible.

In that way a better grasp of principles isobtained.

For this broad view the records of Amer-ican conditions alone are inadequate. TheUnited States before the Civil War was anew, detached, undeveloped nation. Itsbanking system was crude. Its supply of

capital was trifling compared with itsnatural resources. Because of its great

area, the imperfect means of communica-tion and transportation then existing wereentirely insufficient to weld it into an eco-

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nomic whole. And the business records ofthat time are fragmentary and incomplete.England was the nation that, in the first

half of the last century, had reached thehighest industrial and financial develop-ment; and owing to her position as theworld market for capital, a position which

remained entirely secure until interfered

with by the great war, her economic recordsare more representative of world business

than any others available.The two graphs showing the ** Level of

English Commodity Prices" since 1782 andthe prices and yields of '* British Consols"since 1790, reflect in condensed form Eng-lish money market, investment and businessconditions for a century and a quarter.

COMMODITY PRICESTaking up first the level of commodity

prices, the primary fact must be recalledthat a price represents not an absolute or

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independent figure but a relationship^the

relation of the value of the article priced

to the value of gold or of whatever may bethe standard money of the time.

Prices must therefore be viewed from twoangles: The value of money on one side,and the value of goods or commodities onthe other side. The idea of the money-value of goods is familiar ; but its less fami-

liar reciprocal, the goods-value of money,is equally significant.

Commodity prices, therefore may risebecause commodities become worth moreor because money becomes worth less ; andthey may fall because goods can be pro-duced or manufactured more cheaply, orbecause money is growing scarcer in com-parison with the work it has to do, and istherefore becoming more valuable becauseit is in relatively small supply.

Both these factors are in constant opera

-

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tion, sometimes the one being more impor-

tant and sometimes the other. So the move-ments of the general level of commodity-

prices, like those of a sailboat crossing a

river, are always the resultant of two forces

acting at the same time.

Another influence of some importance as

affecting the temporay and minor move-ments of commodity prices is what mightbe called **the psychology of prices." Buy-

ers are more anxious to buy when other buy-ers are also anxious, and the same is true ofsellers. So when a buying or selling move-ment is once well started it often carries

prices beyond their natural level. Also,certain prices are so firmly established bycustom that they are very slow to respond

to actual changes in conditions. But these

factors are of minor importance in consid-ering the broad price movements of a cen-

tury.

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With these principles in mind, what arethe economic and financial changes reflectedby the movements of English commodityprices^which, it is to be remembered,

broadly represent the prices of the whole

commercial world?The first point to strike the eye is the

very great effect on prices of the NapoleonicWars, 1793-1815, and the World War,1914-1918. The highest price level of 1809was more than 80 per cent, above that of

1789, the year of the French Revolution,and the English price level at the end of1918 was approximately 125 per cent, above

that of July, 1914. In each case (and alsoin our own Civil War, as will be seen later)

high prices were due to a scarcity of prod-

ucts resulting from the great diversion of

labor power into actual fighting forces andinto war work and from the exceptionaldemands and wastes of war, together with

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A CENTUEY OF PRICES

a big inflation of currency and credit.No such tremendous advances in prices

would be possible without more money, ormore credit, or more of both. It takes twice

as much money or credit to handle a thous-and bushels of wheat at $2 a bushel, as at$1 a bushel, and the same with other com-modities. If a greater supply of money orcredit were not provided, the rise of prices

resulting from scarcity of goods would sooiicause ** tight money," a condition whichwould seriously hamper and disturb the all-important war production.In the late war both England and Amer-

ica endeavored to check the upward flight ofprices by a policy of price-fixing. The re-sults were not wholly satisfactory^notably

in the cases of coal and wheatbut on thewhole the experiment may perhaps be calleda success as compared with what might havehappened without such a policy. The only

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policy which could entirely prevent rising

prices in time of war would be a govern-

ment control so complete as to amount to

the theoretical socialistic state.

It will be noted that smaller wars, as the

Crimean War and the American Civil War(comparatively small so far as the effectson the world at large were concerned), hada similar though less important effect on

prices, and that a small price-boom fol-

lowed the Franco-Prussian War.In every case a decline from high war

prices soon followed, but the extent andseverity of the decline depended on numer-ous other conditions then entering the situ-

ation.

EFFECT OF CHEAPER PRODUCTIONThe next point to be noted is that down

to 1896 the broad tendency of prices hadbeen downward for 87 years, although thistendency had been interrupted by numer-

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ous sharp rallies and by advances which,

although of great significance at the time,

eventually proved to have been temporary.

If we take 1820 and 1900 as average years,not much affected by wars and represent-ing neither the highest nor the lowest prices

of those times, we note a decline from about

180 to 100, or about 45 per cent, of the high-

er figure.

The principal cause of this decline wasthe cheapening of production through im-

provements in machinery and in transpor-tation. The machine-made shoe is cheaperthan the hand-made shoe because less hu-man labor is necessary to make it. Wheatraised by the aid of the tractor, the harves-ter and the threshing machine, and movedto market over the railroad, is cheaper than

wheat sown and reaped by hand or by handtools and hauled by horses over rough ormuddy roads. And this transformation has

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extended throughout all industry.But why, it will be asked, in view of this

continuously cheaper production, did pricesrise from 1850 to 1873, nearly a quarter ofa century, and from 1896 to 1914, whenlarge-scale production was reaching itshighest development? It is true that both1850 and 1896 were periods of relative tradedepression; but that fact alone does notanswer the question. A more comprehen-sive reason must be sought.The answer lies at the other end of the

price-relationshipthe supply of money.For although the supply of goods may beincreasing, if the supply of money increasesstill faster, prices must soon rise.

In 1850 the worlds production of goldwas approximately $40,000,000 annually.Through discoveries in California and inAustralia, it rose to about $150,000,000 in1853, fell to $91,000,000 in 1874, and did not

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again rise above the high point of the '50suntil about 1893, when discoveries in theKlondyke and improved methods of miningresulted in another great increase, until

$466,000,000 was reached in 1912. Sincethat date production has been compara-

tively stationary.

A better view, however, is obtained byconsidering the world's stock of gold on

hand, since but little gold is consumed, inthe ordinary sense of that word. Thisstock is estimated to have been about $2,-200,000,000 in 1850; to have risen with rea-sonable regularity to about $6,000,000,000in 1896, and thereafter at a more rapid rateto perhaps $11,000,000,000 in 1916.

In addition to this increase in the supply

of gold, there has been a constant increasein the amount of credit based upon each dol-lar of gold, and credit serves the same pur-pose as money in the transaction of busi-

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ness. In the United States, more than 95

per cent, of all payments are made by bankchecks, which are a form of credit.

We conclude, therefore, that from 1850to 1873 the increase in the supply of money

and credit was, broadly speaking, morerapid than the increase in the supply of

commodities through cheaper methods of

production, so that prices rose (aidedsomewhat by three wars) ; that from 1873to 1896 the increased production of com-

modities got the upper hand, causing a gen-

eral decline in prices; while after 1896 a

further great increase in gold production

and in the use of instruments of creditturned the scale and brought higher com-modity prices.The reasons for many of the minor

changes in the level of prices are shownupon the graph. It is noticeable that these

minor changes have become less violent

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with the passage of time, a highly desirabledevelopment. If some plan could be in-

vented to keep the general level of com-modity prices stationary it would be an al-most inestimable boon, but apparently such

a plan would have to be world-wide in itsapplication. Several ingenious methodshave been suggested, but they seem to re-quire a much higher plane of world-organi-zation than has yet been attained.

THE SUPPLY OF CAPITALThe best index to the relative supply of

capital over such a long period as is here

considered, is to be found in the yield onthe British consolidated debt. Consols haveno date of maturity and have a longer con-tinuous record than any other security.Both prices and yields (the latter inverted)are shown on the graph for completeness,as the rate of interest has twice been re-duced.

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There are, of course, two main elementsin these pricesthe credit of the British

nation, and the relation between the de-mand and supply of capital for investment.From 1816 to 1914 British credit stood sohigh that changes in the yield on consols

were due almost entirely to variations in

the demand and supply of capital ; but theNapoleonic Warsi and the World War of1914 caused such a vast increase in the

British debt that national credit was some-

what affected, and consols fell for that rea-son as well as because of the rapid dissipa-

tion of capital in war. But there can be no

question that the main cause of changes inthe price of consols lies in the relative sup-

ply of capital in comparison with demand.

We have already noted that the broaddownward trend in commodity prices until1896 was due chiefly to the increase in theproductive capacity of labor through im-

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provements in machinery and in transporta-tion. The same influence caused an increasein the supply of capital compared with thedemand for it which was reflected in risingprices for consols from 1798 until 1896. Infact, after 1825, by which date British creditwas thoroughly re-established, the accumu-

lation of capital in excess of current needswas the principal cause of the rise in con-

sols.

This, among other considerations, led toa pretty general belief, in the late '90s, that

the interest rate on capital would continueto fall, or at any rate would not rise materi-ally. The reasoning seemed clear : Improvedmethods of applying labor caused greaterproduction of wealth, which in turn re-sulted in greater proportional accumulationof capital. This had caused rising bondprices and falling income yields for nearlya century. The presumption was exceed-

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ingly strong that the same causes wouldcontinue to operate and to produce a simi-lar effect.

The same causes did continue to operate

;

but as we have seen in discussing commod-ity prices, another very powerful influencecounteracted and overbalanced them fromabout 1896 onwardthe fact that the sup-ply of money and credit was increasing evenmore rapidly than the supply of goods, andthus forcing commodity prices upward.

THE FLOW OF CAPITALAt first thought it would seem that easier

money and credit should cause higherprices for consols and other similar secui'i-ties. Temporarily, they do have that ef-fect, because of the accumulation of de-positsor liquid capital^in the banks.

This liquid capital immediately tends toflow into securities and therefore raisestheir prices. But this is a temporary effectonly. Liquid capital very soon flow*

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through securities, and by means of gov-ernment, municipal, or corporate expendi-

tures, into concrete and tangible things. Infact, the securities are issued only for the

purpose of securing capital for expenditure

upon these concrete and tangible things.The capital which flows into consols, for

example, is not held idle by the British Gov-ernment. It is soon spent, for one purpose

or another, and the spending means theemployment of labor, the purchase of ma-terials and suppliesin short, the promptturning of liquid capital into tangible prop-

erty. Let us suppose that consols are sold

in order to erect a big government building.

Then the capital which is absorbed into theconsols is immediately converted into mar-

ble, bricks, structural steel, food, clothing

and supplies for workmen, etc. And this istrue of the capital which is invested in anyand all securities.

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Thus the offset of increased gold produc-tion and enlargement of credit facilities,although first felt in the money and creditmarkets, immediately passes through themand finds its more permanent manifestationin rising commodity prices.Bond yields must rise {and bond prices

fall) with any prolonged advance in com-modity prices. The bond investor, throughlong habit, thinks of his interest return in

terms of money ; but when he starts to makeuse of that interest return, what it will buyfor him depends upon the level of commod-ity prices. If commodity prices rise whilehis interest return remains stationary, hesoon finds that his real income has shrunk.His money income must rise with advanc-ing commodity prices, for exactly the samereason that the wages of labor must rise.

It is equally true that rising commodityprices reduce the supply of investment capi-

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A CENTURY OF PRICES

tal and thus raise its pricethat is, the rateof interest return on securities. We havejust seen that capital, as it accumulates,flows quickly through securities and intocommodities; so when the prices of thoseconnnodities rise, they necessarily absorb

more capital. In the example just men-tioned above, if the prices of building ma-

terials and labor double, it will take twice asmuch capital to construct the governmentbuilding.

The connection between bond yields, orthe price of investment capital, and thelevel of commodity prices is therefore verymuch closer than has been generally ap-preciated. And this is even more evidentfrom the record of history, as shown inthese graphs, than it from a priori reason-ing.

In comparing the two graphs, we see atonce that the graph of consols is, in a broad

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way, the reverse of the graph of commod-ity prices. Even in the irregularities of theNapoleonic Wars, which are only partlycomparable with modem conditions, lowconsols and high commodities roughly co-incided, and from about 1805 to 1896 thereverse correspondence is very plain. Butthe clearest demonstration of the principleis seen from 1896 to date, when a suddenturn in commodity prices was followedwithin two years by an equally sharpchange in consols, with an almost perfectreverse correspondence in the two price-lines down to the present time.

POST-WAR PRICE MOVEMENTSIt will be seen from these graphs that

every war which had a direct and importanteffect upon business conditions in Englandwas preceded or accompanied by a rise incommodity prices and a fall in consols, andthat after every such war (except the Boer

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War) commodity prices fell and consolsrose. Even following the Boer War thelong upward movement of commodity pricesthen in progres was checked for half at

dozen years, and the yield on consols forsome years showed a reactionary tendency,though without any highly significantchange.

Later graphs will show us that the sametendencies were strongly evident in the

United States during and after the CivilWar.We are fairly safe, then, in concluding

that this is a law of post-war price move-

ments, which may be modified, but rarely,if ever, nullified, by other influences, andthat there is now a very strong probability

of a gradually declining tendency in Eng-lish commodity prices and a rising tendencyin consols and similar securities for someyears to come.

42

A3

90 '35 1800 05 '10 '15 'ZO "25 '30 '35 '40 "45 '50 '55 'GO '65 "70 '75 '80 "85 "90 "95 1900 '05 '10 'IS 'II

English Comhoditv PricesThis continuous index of English commodity prices since 17iSi is (.with the exception of the la^ttwo years) from Todd's Mechanism of Exchange. It is based on Je\on's index down to 180(1, SauerlKcU's 1860-70, the British Board ofTrade index 1871-1''16, and. the Economist number for 1917 and 1918. the first, third and fourth having been recalculated to fit the third.These substitutions do not seriously alfect the value of the line as a continuous record.

fy-^^k- '(ifr\iAfi^^:

1790 1795 1800 1805 1810 1815 1820 I8Z5 1830 1835 1840 1845 1850 1855 I860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 I9Z0

w-

Brittsu Coxsols afford the lonee-" contimious securitv record obtainable. They have no dale of maturity. The interest rateJfr down to 18S8. 2.^^^ from 1 to IW.;. .' ,:; from I"'''' heini; rever.

CHAPTER in.

WHAT AMERICAN COMMODITY PRICESSHOW

\ S would naturally be expected, the'^~^ broad principles affecting the move-

ments of American commodity prices havebeen the same as those brought out in con-nection with English prices in the lastchapter.

In America as in Europe, great wars havecaused rapid advances in prices ; after thosewars prices have fallen, though not so rap-idly as they had previously risen. From1865 to 1897 the prolonged decline was inlarge part due to the effect of machineryand improved transportation in cheapeningproduction; increased gold production

47

A CENTURY OF PRICES

played an important part in the rise ofprices preceding the Civil War and follow-ing 1897; the influence of speculation in**boom" periods is plainly visible; and theexpansion of currency and credit has hadits due effect.On the other hand, there are marked dif-

ferences in the degree to which these sev-eral factors have entered the situation atdifferent times.

It is impracticable to compile any trust-worthy average of American commodityprices previous to 1850. Falkner^s Index,it is true, runs back to 1840, but owing tothe numerous interpolations and changesnecessary in the earlier years it has obviousdefects. Since 1850 commodity prices asshown in the accompanying graph afford areasonably accurate view of the broad trendof prices. During and following the CivilWar prices in currency are shown by the

48

A CENTURY OF PRICES

dotted line, while the continuous line showsprices in gold, then selling at a considerablepremium in currency.

CAUSES OF WAR PRICESIn this way we get a fairly accurate

measure of the effect of currency inflationin the Civil War, hut it is impossible tomake any similar comparison during theWorld War, from 1914 to 1918. Up to1917, when the United States entered thewar, the increase in our currency wasnearly all in gold'* gold inflation,'' it hasbeen called^because our big sales of warsupplies to Europe brought a flood of theyellow metal to our shores. In 1917 and1918 the currency increase was in the formof Federal reserve notes, the result of re-discounting of Grovernment and commercialpaper at the Federal banks, rendered pos-sible through the great change which hadbeen made in our banking system.

49

A CENTUEY OF PRICES

There was, therefore, an increase in the

volume of our currency and credit which,in its practical effects, amounted to infla-tion ; but there was no premium on gold bywhich to measure the degree of inflation asin the Civil "War. And of course anotherimportant difference lies in the fact that

the present currency inflation, in one formor another, is almost world-wide, while in

the Civil War it was confined to the UnitedStates.

We see at once, however, that the highCivil War prices were by no means entirelydue to the depreciation of the currency.

From 1863 to 1866 our prices in gold roseabout 47 per cent., although English prices

were nearly stationary in those years. This

advance compares with a rise of about 87

per cent in American prices from 1914 to1918and as we have just seen, the latteradvance was accompanied by a great in-

50

A CENTUKY OF PRICES

crease in outstanding currency, while dur-

ing the Civil War gold was hoarded to suchan extent that only about $25,000,000 is esti-mated by the director of the United StatesMint to have been in circulation after 1861.Comparing English and American (gold)

prices from 1849, the year of the Californiagold discoveries, to 1873, which was thehighest point of English prices between1840 and 1915, we find that the rise in eachcountry was almost exactly 83 per cent.

But from 1864 to 1872 American (gold)prices were relatively higher than those of

Englandfrom 1865 to 1867, much higher.This fact must be attributed almost entirelyto scarcity of goods resulting from diver-sion of labor and materials into the war andfrom special war demands and war wastes.The great rise in Civil War prices as ex-

pressed in currency^the dotted line on the

graph^was due partly to the increase in

51

A CENTURY OF PRICES

the volume of currency and partly to actualdistrust of the Government's ability to re-

deem its notes. Even though the Civil Wargreenbacks had been immediately redeem-able in gold, there must have been, if thesame quantity of them had been issued, agreat rise in prices; but in addition to this

inevitable rise, a further advance occurredbecause the relatively insecure financial po-

sition of the United States Government atthat time lowered the value of its notes.

During the World War this element ofdoubt as to the United States Govern-ment's credit did not exist. Therefore the

advance of American prices from 1914 to1918 was due almost entirely to the wardemand, which was permitted to expressitself in prices through currency and creditexpansion and the increase in our stocksof gold.

The war prices of 1918 reached substan-

52

A CENTURY OF PRICES

tially the same level as the currency prices

of 1865 ; but it would be entirely unsafe to

assume that prices will fall from that high

level as rapidly as they did in 1866 and

following years.

Two very important differences must beborne in mind: (1) The currency pricesof 1865 were made in a depreciated moneydepreciated as compared with gold. Thatwas not true in 1918. Our currency was

then greatly expanded, by imports of gold

and by the issue of Federal reserve notes

;

our outstanding bank credits were tre-

mendously enlarged; but the element of

depreciation as compared with gold did not

enter the situation at all.

(2) In 1865 our price level, as expressed

in our currency, was enormously above the

price levels of the rest of the world. Even

our gold prices, as we have seen, were rela-

tively higher than those of England. But

53

A CENTURY OF PRICES

our 1918 prices were relatively lower than

those of Europe. English prices of 1918were approximately 130 per cent abovethose of 1914, while our 1918 prices were

about 88 per cent higher than 1914.

After the Civil War our prices returnedto their pre-war level but, for the reasons

above outlined, that is not likely to happenafter the present war. The world haslearned to make its supply of gold safelysupport a larger amount of currency andcredit and the change will be to some extentpermanent. Therefore a higher level of

commodity prices is likely to be maintained,though not the extreme level created by thepinch of war.COMMODITY PRICES AND OUR EXPORT

TRADEIn comparing the graph of American

commodity prices with that of Englishprices shown in Chapter II, we see thatthere is a fairly close correspondence be-

54

A CENTUEY OF PRICES

tween the two, and that it tends to becomecloser with the passage of time.

This is not only because the same prin-

ciples necessarily apply to both, but also

because quicker and cheaper communicationbetween America and Europe leads, overa long period of years, to a readier ex-

change of goods.

Whenever our price level rises abovethat of other nations we become a relativelygood market in which to sell goods and apoor market in which to buy, so that ourimports increase and our exports decrease,and when our price level falls to a rela-tively low plane this condition is reversed.

But increased exports soon bring imports

of gold to pay for them, and the additionof this gold to our supply of currency tends

to raise our price level. In the same wayincreased imports cause us to send goldabroad to pay for the goods received, thus

55

A CENTURY OF PEICES

reducing tlie gold base of our currency andcredit and tending to reduce our price levelto the point where foreigners cannot getso great a profit by shipping us their goods,and therefore our imports fall off.

In this way our exports and imports ofmerchandise constantly tend to adjust ourprice level to the level which prevails inother countries. Prices throughout the

commercial world are a question of inter-national adjustment through exchange ofgoods and gold.

There is, however, a constant marginbetween what might be called the exportlevel and the import level. Foreigners willnot sell us goods until our prices are enoughhigher than theirs to cover the cost of

placing the goods in our hands, and we milnot sell them goods unless our domesticprices are enough lower than theirs so thatwe can afford to stand the cost of shipping

56

A CENTURY OF PRICES

the goods to them. Between these two pricelevels there must always be a margin, de-

pending on the cost of transportation, tar-iffs, and the rates of foreign exchange.

The question of the relation betweenAmerican and foreign price-levels and itseffect upon our exports, and through themupon our domestic business also, is one of

much interest. Our ^ ' export balance" fromyear to year reflects very clearly not only

this price-relationship but also the progress

of the ^^major trade cycle," as it is called

the broad swing of business activity fromprosperity to depression and back again,covering a period of something like twentyyears, which has been such a noticeablefeature of our trade since 1837.

The small graph herewith, showing theper cent of our export balance yearly to our

total foreign trade, in comparison with theratio of English to American commodity

57

^!

A CENTURY OF PRICES

prices, makes these relationships quicklyintelligible to the eye.*

As would naturally be expected, thelargest exports have usually occurred at

times when English prices were relativelyhigh compared with ours. The correspond-ence would be still closer but for the factthat during the most of this period our ex-ports consisted almost entirely of agricul-

tural products and were therefore depend-ent upon crop conditions as well as uponprices.

The export balance is shown in this form ratherthan in dollars in order to eliminate the change dueto the rapid growth of our. trade, thus affording a linewhich is fairly comparable one year with anotherthroughout the entire period. No scale is shown forthe line giving the ratio of English to American prices,ince it expresses merely a relationship and the fig-ures themselves have no significance. This line isobtained by dividing the English index numbers bythe American index numbers. The fact that Englishprices were lower, compared with those of America,from 1902 to 1914, than they were from 1882 to 184,was chiefly due to the great reduction in transporta-tion costs between the two countries.

59

A CENTURY OF PRICES

Those who are familiar with the businesshistory of the United States will imme-diately note, on looking over this graph,

that the high points of our export tradewere in each instance followed by greatprosperity, while small exports have,broadly speaking, accompanied periods ofrelatively poor general business. The prin-cipal reason why a large balance of exportsover imports has such an emphaticallystimulating effect upon our trade as a wholeis because it results in an inflow of goldfrom foreign countries. Our chief use forgold is in bank reserves, where it permitsan expansion of credit formerly equal toabout five times the amount of the gold and,under our new Federal bank law, to a gooddeal more than that ratio. Easy credit isthe life of trade ; hence the pronounced ef-fect of gold imports.

Down to 1877 we regularly imported

60

A CENTURY OF PRICES

more merchandise than we exported andsent gold abroad to pay for itbeing a gold-producing nation. But between 1872 and1878 a great change occurred. Our im-ports of merchandise gradually fell from$656,000,000 to $432,000,000, while at thesame time our exports increased from $469,-000,000 to $737,000,000. The result is shownin the sharp rise of the ** export balance"line on the graph. Large gold imports fol-lowed. From 1870 to 1875 our average ex-cess of gold exports was about $36,500,000

;

but from 1879 to 1881 our average excessof gold imports was $66,700,000 yearly. Itwas this gold in our bank reserves whichpermitted the rapid business expansion ofthat period.

Similar conditions followed the great in-crease in our exports of merchandise whichbegan in 1896, and again the great move-ment of 1915 and following years.

61

A CENTURY OF PRICES

THE MAJOR CYCLEThe small graph also defines clearly the

swing of the **major cycle" of prosperityand depression. Without attempting to godeeply into fundamental causes, we maynote that the year 1916 in the current cycle

appears to correspond closely to the years

1898 and 1878 in the two preceding cycles,after which in each case generally pros-perous Business conditions prevailed for

some years.

Moreover, we cannot leave out of our

calculations in this connection the very

large payments due this country from Eu-rope for interest and principal of indebted-ness incurred during the last few years. It

is a question just how these payments areto be met. But in any case they must cer-

tainly tend to increase our national incomeas compared with the years before the war.The graph showing wheat and cotton

62

A CENTURY OF PRICES

prices is less suggestive of general prin-

ciples than that covering the average of all

commodities. The two important factorswhich cause abnormally high prices forwheat in certain years are wars and cropscarcity. Their effect is plainly shown andthe reasons for it are self-evident in viewof what has been said in regard to the move-ments of commodity prices in general.The famine prices for cotton in the Civil

War were due to the blockade of Southernports

practically no cotton being raised

anywhere else in the world at that date.Since cotton is easily stored and can becarried over from year to year, speculationhas in recent years become a notable fac-tor in its price. Producers have madestrong efforts, by storing their cotton andby reducing the acreage devoted to it, tomaintain prices at a good level. Since fixedprices were not applied to cotton in the

63

A CENTURY OF PRICES

World War, it reflected fully the specula-tive spirit and the exceptional demands ofthe time.

64

j^^yr\jA.< 6

1845 1850 1855 I8G5 1870 1875 1880 1885 1890 1895 1900 1905 1910 1916 1920Z40| f M 1 1 1 1 ^^ 1 1 1 1 M < 1 1 1 1 1 M ' 1 1 1 1 1 1 1 M

r,^ Y^hrt^^

300

Z50

ZOO

150

545

I8Z0 1825 1830 1835 1840 1845 1850 1855 I860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 I9Z0300

250

200

150

IQO

50

75

50

25

trT

wmrr-5

WHEAT-No.2. AT CHICAGOi|

'I.

FTW""'" " "Alter the complefion of the Frie CjnaJ. A!hany rcciipied ihotr the arnr reblive position in the trade a> Chicago occupiet n>w, but theprice records " '', jh, jjm^ Capitol a few year. ago.

CHAPTER IV.

CAUSES OF CHANGES IN INTERESTYIELDS AND MONEY RATES

'T^ HE fact is obvious that the average* investment yield obtainable frombonds or loans must depend on the supplyof capital as compared with the demand forit. It is essential, therefore, in consideringthe changes shown on the graphs of bondyields and money rates, to examine the con-ditions atfecting capital during the periodcoveredo

**When people talk to me about moneyand capital," complained a member of theStock Exchange, ^^I begin to get a head-ache." To avoid such headaches it is neces-sary to understand thoroughly what capitalis, a point in regard to which even bankersof long experience are often hazy.

69

A CENTURY OF PRICES

To begin at the beginning, all capital is

the product of labor. It is labor-product

saved, set aside and stored up to aid in fur-ther production, instead of being used up

in current consumption. A farmer, for ex-ample, can spend his yearns surplus income

for a new piano, which is not capital unless

it can be shown that it will increase thetotal production of the farm; or he mayspend his surplus on a tractor, which iscapital because it will increase his product.

And if he lends his year's surplus to aneighbor, or turns it over to a bank, or in-

vests it in a bond, he is entitled to interest,

because in that case he is denying himself

both the piano and the tractor.

FACTORS IN THE SUPPLY OF CAPITALThe supply of capital available at any

time, therefore, will depend on a numberof considerations:

(1) The total amount of labor applied.

70

A CENTURY OF PRICES

To accumulate capital a nation must be in-

dustrious. A sluggish, unambitious popu-lation merely earns its living as it goes

along, without piling up any surplus.

(2) The efficiency of laborthe amountof the product in comparison with the labor

applied. This depends chiefly upon the

extent to which machinery is employed,but also upon the energy and faithfulnessof the workmen.

(3) What is being done with the labor-product; whether it is:

(a) Being used up for current consump-tionfor food, clothing, luxuries, pleasure

trips, etc.

(b) Being invested in tools, equipment,and improvements which will bring an im-mediate return in the form of increasedproduction.

(c) Going into improvements of a morepermanent character, which will be of public

71

A CENTUEY OF PRICES

or private benefit eventually, but will not

yield any early returns in the form ofgreater production.

The third consideration above mentionedbrings up another very important point,namely, the rapidity with which capitalcirculates when used in different ways.For very little capital is permanently fixedin one form.

The tractor wears itself out in creatingan increased product of other things; its

value is gradually transferred into those

other things ; the capital invested in it cir-

culates. The factory depreciates. The rail-road's rails, ties and roadbed have to beconstantly renewed. Its stations have to

be repaired frequently and finally becomeantiquated and have to be rebuilt.

Even the Eoman viaducts, perhaps themost permanent investment of capital inhistory, eventually fall into disrepair. The

72

A CENTURY OF PRICES

original investment in the Suez Canal, or

in New York's water works, might perhapsbe mentioned as permanently fixed, al-though additional expenditures are con-stantly necessary for maintenance andbetterments.

So the extent to which any particular useof capital depletes the general supply de-pends not only on the amount of capitalused but also on how long it is used. Thefarm tractor may, by increasing the far-mer's product, reproduce its value in a year.A new barn might not pay for itself,through increased production due to betterfacilities, in less than twenty years. Evenif the first cost of the two were the same,the barn would eventually require twentytimes as much use of capital as the tractor.

Capital may be roughly classified accord-ing to the rapidity with which it circulates,as follows;

73

A CENTURY OF PRICES

(1) Capital in the form of commodities.Some of these are luxuries, but most ofthem contribute toward further productionand are therefore capital. In this formcapital circulates rapidly.

(2) Capital invested in machinery orequipment, or in enterprises which will beimmediately productive, circulates less rap-idly, as a rule, than commodities, but more

rapidly than in the forms mentioned below.

(3) Investments in enterprises whichwill eventually yield a return, but only after

considerable delay.

(4) Expenditures for public benefit,such as court houses, schools, playgrounds,

baths, etc. These contribute indirectly to

the future productive capacity of the

people.

(5) Investments in enterprises which fail,or expenditures in war. This capital stopscirculating. In some cases a small part

74

A CENTURY OF PRICES

of it may, however, be salvaged.

An increased application of capital toany one of these five divisions will neces-sarily tend to deplete the current supply of

capital, and therefore to bring higher in-terest yields; but the effect in this direc-

tion will be far greater and more permanentif the capital goes into relatively fixed

forms, or into forms where its circulation isslow, than it will be when the capital is ap-plied where it will circulate rapidly.Hence the great importance of distin-

guishing between fixed and circulatingcapital.

RISE AND FALL OF BOND YIELDSIn Chapter II, in discussing the relation

between the level of English commodityprices and the yield on consols, we notedthe close correspondence in the general

trend of the two. In comparing the graphof U. S. Corporation Bond Yields with that

75

A CENTURY OF PRICES

of American Commodity Prices (discussedin Chapter III), we find tlie same broad cor-

respondence.

We are now in a position, after refresh-ing our memory as to the nature of capital,to define more accurately the reasons for

this correspondence. The superficial reasonwhy bond yields rise with rising commod-ity prices is that the investor, finding his

real income shrinking although his moneyincome is unchanged, demands a higherrate of interest, but he would not be ableto obtain this higher rate if it were not for

the fact the supply of capital is smaller

in comparison with the demand for it. Andthe reason why higher commodity prices sogreatly increase the demand for capital isthat they bring a nearly proportional in-

crease in the cost of capital investments in

all of the five divisions above enumerated.

The capital which, at any one time, exists

76

A CENTURY OF PRICES

in the form of commodities, is only a small

part of the total capital of the conntr^^ and

circulates rapidly. Therefore a rise in the

prices of commodities wonld have only a

moderate effect toward increasing the de-

mand for capital. But all investments ofcapital (nsnally after passing through the

form of securities, as previously explained)

are first expended on materials and labor

that is, on commodities and on wages,which roughly follow changes in the price-

level of commodities, though usually lag-

ging behind somewhat.

If, for example, the price-level of com-

modities has risen 50 per cent, the cost of

a new courthouse, or a new railroad, or a

mine, or a subway system, will also befound to have risen nearly 50 per cent; so

that the amount of capital required for in-

vestment in relatively fixed forms rises in

rough proportion with the rise in commod-

77

A CENTURY OF PEICES

ity prices. It is this increase in the cost

of fixed forms of investment which rapidlydepletes the supply of investment capital

and therefore raises its price, which is bestexpressed in the form of the average yieldon bonds.

During a period of falling commodityprices the situation is, of course, exactly

reversed, so that bond yields tend to followcommodity prices downward.DIVERSION OF CAPITAL INTO FIXED

FORMSAnother important element affecting the

demand and supply of capital is the rela-tive extent to which capital is diverted intofixed forms, especially those expenditures

which contemplate a somewhat remotepublic benefit ; or into investments in enter-

prises which prove failures, or the cost ofwars.

The Panama Canal, the New York State

78

A CENTURY OF PRICES

barge canal, the New York City subwaysystem, are examples of undertakings thathave absorbed great quantities of capitalfrom which only a trifling immediate returncan be expected. Municipal and State ex-penditures for varied improvements haveincreased rapidly in recent years, and how-ever desirable such investments may bewith a view to the longer future, immediatecash returns from them are apt to be small.And added to these factors came the tre-

mendous depletion of the whole world'scapital in the war.

It is a question, also, whether the peo-ple's disposition to save has not grownless within the last two decadeswhetherthe average man does not now save asmaller percentage of his income than hesaved in the first years of the twentiethcentury. If so, this tends to cut off thesupply of capital at its source.

79

A CENTURY OF PRICES

These several influences tend to act in

harmony. Rising commodity prices in-crease profitsas measured in moneyandinfuse the public in general with a spirit ofliberality in expenditure, so that costly im-

provements are more readily undertaken,

living expenses grow at the expense of sav-

ings, and the people are more prone to in-vest in doubtful speculations or fake stocks.

In time of war, also, great expenditures of

capital coincide with a rapid rise in com-

modity prices.The great fall in bond yields from the

period of the 70s to 1900 was partly due tothe better standing and stronger protectionof our corporation bonds as a whole in the

later years ; but it was also largely due to

the great increase in production of goods

as a result of improvements in machineryand transportation. When labor producesmore goods it is naturally easier to accumu-

late capital.

80

A CENTURY OF PRICES

MONEY RATESMoney rates and bond yields mutually in-

fluence each other, since both represent the

return on the use of capital; but since theterm ^*money rates'^ is applied only toloans for short periods, changes in these

rates are chiefly dependent upon temporaryconditions, while changes in bond yields arechiefly dependent upon conditions of a morepermanent character.

A comparison of the two graphs showsthat sharp changes in money rates are sym-pathetically reflected in the minor move-ments of bond yields, but that money rateshave very little to do with the broad sweepof the bond market.Rates on call money and 30 or 60-day

loans have in the past fluctuated so quickly

as a result of temporary conditions thatthey are of little value for comparison overlong periods. Commercial paper affords the

81

A CENTUEY OF PEICES

true that commercial paper affords thebroadest and best index to general moneyconditions.

Unusually high money rates and theminor and temporary upward swings inbond yields are commonly due to an over-extended condition of bank loans^that is,a scarcity of credit accommodation. Scar-city of credit means that borrowers mustpay a higher price for it, so money ratesrise. And if a higher rate of interest is ob-tainable from short loans than from bonds,capital is temporarily attracted away fromthe bond market, and owners of bonds aretempted to switch into commercial paper ortime loans, so that bond prices fall andyields rise.

This condition of overextended bankloans may be due to too great optimism inbusiness circles, which leads business mento branch out too widely and too rapidly.

82

A CENTURY OF PRICES

and thus to use up an undue proportion ofthe credit available; or it may be due toevents which arouse a widespread feelingof fear as to the future, so that there is a

general desire to call in loans and contractcredits. Before long the first condition isvery apt to precipitate the second, but the

second does not necessarily imply the first.

Thus in 1857, 1873, 1893 and 1907 the pri-mary cause of high rates was overexpan-sion. But in 1861 fear was aroused by thebeginning of the Civil War ; in 1890 by theBaring failure; in 1896 by danger to thegold standard; in 1914 by the outbreak ofthe World War ; and in none of these caseswas any special overexpansion in evidence.The high money rates reached in most of

the years previous to 1874 reflect in a very

interesting way the scarcity of credit andliquid capital in those times. The highfigures were usually reached in the fall,

83

A CENTURY OF PRICES

when the crops were being moved. Condi-tions of doing business when an averagerate of 10 per cent must be paid for moneyare entirely different from those when theaverage rate is 5 per cent. Before and dur-ing the Civil War any firm had to earn largeprofits in order to stay in business, and theconstant wide fluctuations in rates intro-duced an element of uncertainty now hap-pily absent.

The extreme high rates of panic years,as in 1857, 1861 and 1873, simply mean thatduring the panic periods money was prac-tically unobtainable. Failures were so nu-

merous that even the highest class two-

name commercial paper was subject to sus-picion. Yet that suspicion was not the chief

cause of the high rates. The real reasonwas the absolute lack of loanable funds.

We have today very little conception ofconditions such as those of the panic of

84

A CENTURY OF PRICES

1857, for example. Tlie newspapers at that

time reported that in some instances 2%per cent a day was bid for call loans. Lead-ing banks and old, conservative businesshouses were falling right and left like nine-pins. For loans of four to six months on

prime commercial paper 3 per cent a monthwas offered, and doubtless higher rateswould have been paid if there had been aprospect of bringing out the money. One

of the market reports stated that the moneymarket was in a state of ** anarchy." Gold

commanded 8 per cent premium at Balti-more, and the general disorganization ofbusiness was far beyond anything known tothe present generation.

Under the improved banking methodsnow in use it is to be expected that fluctua-

tions in money rates will be much nar-rower than in even the recent past. Com-mercial paper rates during the war were

85

A CENTURY OF PRICES

successfully stabilized at or below 6 per

cent, and while it is possible that periodsof rapid expansion may sometimes carrythem temporarily over that figure, it ishighly probable that extremely high ratesfor time money and commercial paper willno longer be a recurrent feature of the mar-kets.

86

J By t.uS eerrpy^^^^^^f^-^t

I8G5 1870 1875 1885 1890 1895 1900 1905 1910 1915 I9Z0

I; NM VitiDsThis graph is drawn iruin 'ujr :..::..._; . .., ..^.,,..^. .-.;^;.,:,: < j,-

/ (ZcJ(Jh /^rtc*

the cntic r'>r of capital and .he h..hobtained previous t" I'*"- *l"-'l ^" m

> carry the graph back to themonev was unobtainablelight on our financial hiiory.

CHAPTER V.

PRINCIPLES OF STOCK PRICESBy Gr. C. Selden

A T first glance the accompanying graph"^"^

of stock prices since 1860 presents an

appearance of lawless irregularity. But on

further examination it proves to be one of

the most interesting of the various graphs

we have discussed.First, what is the relation of stock prices

to the other main factors discussed in pre-ceding chapters?

Comparison with commodity prices(Chapter III) shows at once that there isno such general correspondence betweenstocks and commodities as we found toexist between bond yields and commodities.

91

A CENTUEY OF PRICES

Nevertheless a sharp rise in commodityprices has a strongly bullish influence on

the stocks of companies which are free toadvance the prices of their products in ac-

cordance with demand. In recent year^this has not included railroads and publicutilities; for while those companies havebeen granted advances in rates, the ad-

vances have not been sufficient to keep upwith rising costs of operation.

RISING COMMODITIES BENEFITINDUSTRIALS

But owners of industrial stocks have

benefited not only from the general infla-tionary effect of rising commodity prices,but they have also benefited further andvery greatly at the expense of bondholders.

Suppose, for example, that an industrial

company is capitalized at $300,000, of which$100,000 consists of 6 per cent bonds^mak-ing the annual interest charge $6,000

and

92

A CENTURY OF PRICES

$200,000 is in the form of stock on which 6per cent, or $12,000, is being earned an-nually. Now let us suppose that a greatrise in commodity prices occurs, whichdoubles this company^s cost of production

and also doubles the selling price of itsproducts. It is evident that its profitsin

dollars^will also be doubled.

The bondholders do not share in this in-creased profit. Their return is fixed at$6,000. But the company's profits appli-cable to its securities have increased from$18,000 to $36,000. So $30,000 is now leftfor the stock, or 15 per cent on the $200,000outstanding. And this without any changein the company's per cent of profit on itsoutput.

This shows us one of the principal causesof the growth in the profits of industrialcompanies during the period of rising com-modity prices which began with 1898, and

93

A CENTURY OF PRICES

wMch from 1915- to 1918 was such a con-trolling factor in our whole economic life.The same principle must necessarily oper-ate in any great advance in commodities,while a sharp decline in commodities willcut down the earnings on stocks with cor-responding rapidity.In the case of a company which, in addi-

tion to bonds, has preferred stocks on

which the dividend return is limited to afixed per cent, the effect on the earnings for

the common stock is even more marked.If, as is sometimes the case, three-quartersof a company^s earnings on a low-price

basis were required for bonds and pre-ferred stocks, a doubling of commodityprices should multiply the earnings for thecommon stock by five.

PANICS AFFECT ALL SECURITIESIn comparing bond yields and money

rates with stock prices, we see that panics.

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A CENTURY OF PEICES

even of a relatively minor character, affectall three. Bond and stock prices fall andmoney rates rise. The effect on bonds istemporary and in the case of minor panicsunimportant.The years of high money rates1860,

1865, 1873, 1882, 1890, 1893, 1896, 1907,

1914^have also included a sharp fall in

stocks, with the single exception of 1882.

In that year the high rates were due to the

constant absorption of money by the U. S.Treasury, rather than to general economic

conditions.

On the other hand, there were consider-able declines in stocks in 1884 and 1903without much effect on commercial paperrates. In both cases the panicky conditionswere practically confined to Wall Street,and call money was sharply affected

reaching 3 per cent a day in 1884*^butsince commercial conditions were good,*A few loans were reported as haying been made

at 5 per cent a day.

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A CENTURY OF PRICES

mercantile borrowers were able to postponetheir requirements until tbe pinch in WallStreet was over.

THE MINOR CYCLEFrom the standpoint of general prin-

ciples, the most interesting point connected

with stock prices is the comparatively reg-ular swing noticeable since 1884, which hascome to be called **the minor cycle." Anexamination of the graph shows that lowprices for stocks, accompanied in most cases(but not all) by relatively high moneyrates, have occurred every three or fouryears with an astonishing degree of reg-ularity. These years have been as follows

:

1884, 1887, 1890, 1893, 1896, 1900, 1903,

1907, 1910, 1914, 1917.

In between these low points there hasbeen in each case an upward surge in stockprices. In most instances there have beenabout two years of rising prices and one

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A CENTURY OF PRICES

year of decline. The reason for this willappear later.

A regular swing of this character, oc-curring throughout such a long period, in-

dicates the strong probability of some gen-

eral law. And this probability is increasedby the great variety of explanations ad-vanced for the recurrent declines.

The panic of 1884 was alleged to be dueto the Grrant & Ward failure, accompaniedby the collapse of the Marine Bank and fol-lowed by a few other bank failures. Forthe decline of 1887 only the most general

reasons could be assigned, such as over-

expansion, over-extension of mercantile

credits, etc. The drop of 1890 was assumedto be the reflection on this side of theBaring failure in London.

The panic of 1893 was a mystery to cur-rent commentators. Later judgments haveattributed it to a variety of reasons, of

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A CENTURY OF PRICES

which the Government's continued heavycoinage of silver and dwindling supply ofgold perhaps carry the weight of the mostauthority. The decline of 1896 was imme-diately due to the fear that the pendingelection would result in a silver basis forour currency.

The low prices of 1900 were mostly con-fined to railroad stocks. The industrialswere then feeling the benefit of rising com-

modity prices. The movement was gener-ally considered a reaction from excessivespeculation. The bear market of 1903 waslabeled the ** undigested securities panic,"and thought to be due to the over-issue ofindustrial stocks.

In 1907 came a **money panic," again dueto over-expansion. For the moderate de-cline of 1910 falling railroad earnings andthe Government's intention to prosecute

leading corporations under the Sherman

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A CENTURY OF PRICES

anti-trust law were assigned as reasons.

The low prices of 1913 were due to generaldepression and were followed by the warpanic in 1914. The great decline of 1917was in part due to our entrance into the

war and the prospective great demands forcapital for war purposes.

In nearly every instance over-expansion,

over-extension of loans, over-speculation,

or over-something-else, has been mentionedas one of the causes contributing to the de-

cline. Is it not at least probable that these*'overs" are the main cause of the minorcycle, and that the special events of the timeare contributing factors which makegreater or smaller a decline which wouldhave occurred in any case!

THE FUNDAMENTAL CAUSEThe fundamental cause of the minor cycle

is the law of action and reaction, the build-ing up process and the falling down process.

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A CENTURY OF PRICES

At low prices, stocks are mostly in thehands of courageous, outright investors,who cannot easily be frightened into sell-ing. As prices rise, more and more stockspass into the hands of buyers for profitonly. The higher quotations go, the morethe public comes into the market. Nothingso strongly stimulates speculative purchases

as the spectacle of rising prices.

Buyers at high prices are necessarily of

a weaker classweaker in judgment andtherefore weaker in resources^than buyersat low prices. After a prolonged and exten-sive advance, a great volume of stocks be-comes lodged in the hands of these weakholders, while many of the stronger classof investors have realized at the high prices

and transferred their funds into morestable securities, such as bonds or shortterm notes.

Eventually these weak speculative hold-

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A CENTUEY OF PRICES

ers have bought all they want, or some of

them become discouraged, or some unfavor-able event dampens their ardor. They thenbegin to sell out on each othersince prices

are too high to attract the genuine investor

for income.

For such a situation there is no cure ex-

cept a decline to a level which will attractthe stronger class of buyers. So we nexthave the downward swing of the cycle. Howfar the fall must go depends mostly on thesupply of liquid capital, which is roughlyindicated by money rates.

During the rise, with the public active inthe market, there is a great deal of shifting

from one holder to another, accompaniedby reactions, temporary slackening of ac-tivity, and renewed advances. Investorspart with their holdings gradually, as eachbecomes satisfied with the prices to be ob-tained. But the decline consists mostly of

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A CENTURY OF PEICES

weak holders letting go to other weak hold-ers. For that reason the fall is more rapid

than the advance.

In the meantime much the same thing isoccurring in many lines of industry. Specu-lation is by no means confined to stocks

^*the instinct of anticipation" is general.

Buyers of goods try to purchase not only

at the cheapest place but very often at the

cheapest time also. The bargain sale at-tracts the housewife because she believesthe goods are cheaper than they were lastweek or may be next week. She is a specu-lator, though she doesn't realize it.The morning newspaper would seem to

be something which no one would try tobuy at the cheapest time. Yet some com-muters who have to pay an extra cent fora paper at their station buy only one toread on the train, waiting to buy anotherat the regular price in the city.

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A CENTURY OF PRICES

In the larger affairs of business, almost

every purchaser tries to buy as far aheadas possible when he thinks prices will rise,and to delay buying as long as possiblewhen he thinks they will fall. Rising prices,unless already very high, bring increased

orders, but buying falls off on decliningprices until it is believed that the bottomhas been reached.

In this way the spirit of speculation,unrecognized, or at any rate not called bythat name, permeates all business, and theminor cycle in a modified form is a featureof industry as well as of the stock market.

Any chart of steel prices, unfilled steel or-ders, pig iron production, or bank clear-ings plainly shows the modifying effect ofthe cycle.

The importance of this in the presentdiscussion lies in the mutual influence

which the stock market and general busi-

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A CENTURY OF PRICES

ness conditions exert upon each other. Awidespread willingness to buy in any in-dustry tends to increase its prosperity, for

the time being. Its prosperity tends to-

ward higher prices for the stocks of com-panies in the industry. And rising pricesfor the stocks tend to encourage business

men to extend their undertakingssince

many of them realize that the stock market,properly interpreted, is a valuable indica-

ion as to future conditions.

Each dog in a pack of hounds runs fasterand longer because he sees the others run-ning ; and with all our intellectual develop-ment, this primary instinct remains. Wecatch each other^s enthusiasm or depres-sion. In any market where the spirit ofspeculation existsand it would be hardto name any where it is wholly absent

rising prices once started tend to continue

rising until they are obviously too high, and

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A CENTURY OF PEICES

falling prices tend to fall until they are

obviously low. And that is the main partof the story of the minor cycle.

FEATURES OF THE MINOR CYCLEThe relation of money rates to the swing

of stocks in the minor cycle is of interest,,

but is not so direct or decisive as might at

first be thought. It has usually been the

case after a bull movement in stocks, that

when prime commercial paper at New York,after a period of lower rates, advanced to

a 6 per cent basis, the advance in stock

prices proved to be practically over. Thenmoney has remained around the 6 per cent

basis, or in some cases higher, during the

downward swing of the stock cycle. Afterthe completion of the liquidation in stocks,

the money rate has usually dropped, within

a few months, to around a 4 per cent, basis,

or in some instances lower.

The highest money rate has corresponded

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A CENTURY OF PRICES

rather closely with the lowest prices forstocks, falling gradually as stocks beganto rally, remaining for a time near a 4 percent level, and then rising to 6 per cent asstocks reached their top. Theoretically, itmight seem that the lowest money rateshould correspond with the highest pricesfor stocks; but that is not the case, for

speculation, once under way, carries stockprices upward even though the money raterises at the same time.

Another reason why money rates andstock prices do not move more in harmonyis because, so far as the demand for moneyis concerned, stock speculation is the tail

to the kite^the kite being the money re-quirements of general business. Whenbusiness really needs money, it takes itaway from the stock market. A bull mar-ket in stocks is based on surplus funds,which at the time are not needed for otherlines of business.

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A CENTURY OF PRICES

It would, however, be a mistake to sup-pose that the structure of a bull marketwill not topple over until the money raterises sharply. It sometimes falls of itsown weight, so to speak, while money re-mains cheap. This occurred in the autumnof 1916, when the highest prices for stockswere made on a 3 3-4 per cent rate for com-mercial paper, and the rate did not rise to6 per cent until after the low prices of De-cember, 1917, were past.The Federal Reserve System, with its

easy rediscounting, will prevent extremelyhigh money rates and may have the effect ofreducing the general average of rates some-what. It will not, however, seriously reducethe supply of money available for stockmarket purposes as compared with the past.Nothing else is so mobile as credit. Loan-able funds will seek the best rates assurely as water seeks its level.The minor cycle in industry is more

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A CENTURY OF PRICES

clearly and promptly reflected in the un-filled orders of the U. S. Steel Corporationthan in any other statistics now available.These follow the swings of the stock mar-ket quite regularly, keeping three to sixmonths behind stocks at the high and lowturns. For that reason the minor cycle instocks is decidedly helpful in forecastingcoming conditions in the steel industry,with which other trades also strongly sym-pathize.

108

nil .,1 lalkutr', iiiJt.x ul tuiii.iiucJiU i.riti.-.-.. as l-rti.alurt ii,g.i down to iiSiS). Down to 1850 Hic figuro uik.ii vmicii ii

frasnicnlary. In ISW Dun s anil 1 alkncr's indices wire practically the same, and from that point to date- Uun ,avcraKc of wliolcsalc prices of all important commodities. The various indices compiled l.y different aiilhorilic^ ,ho only mmor varia-tions in tlie general trend. Dnrinn and after the Civil War the dotted line show.* prices in the depreciated currency of the ijiriwl, anjlhe continuous line shows the equivalent in gold. The gold prices are not siricllj comiarable with prices before and alter this |>rio

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