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available for bank reserves; second, that personal credit is based on the probable amount of future incomes and probable future value

of property.

Suppose, for example, that business conditions are prosperous and promise to continue so, and that there is a plentiful supply of money in the bank reserves. Expected prices and expected profits are large, expected interest payments seem certain. The power to get this future income depends, however, upon the possession of land, capital goods, franchises and other privileges, the established business relations that give rise to "good-will values," or upon the possession of income-yielding securities, such as mortgages, bonds, stocks, etc. Under such conditions, these things command good prices in the market and may easily be hypothecated, either formally or implicitly, in order to secure purchasing power, bank credit. The bank credit thus created is put into further investments of capital and into the creation of further business opportunities. These things serve in turn, so long as their incomeyielding power seems certain, as the basis of further extensions of bank credit, and thus the process of business expansion continues in a cumulative fashion. An extensive period of increasing prosperity of this kind is, however, scarcely possible unless the supply of money is increasing; for bank reserves as well as the amount of expected personal incomes condition the supply of purchasing power.

Any one of a number of things may be sufficient to precipitate a panic under such conditions. The whole business structure may fall to pieces through sheer topheaviness. That is, so much production to-day is indirect, so large a share of productive effort is devoted to forwarding in indirect ways the production of goods that will be ripe for human use only in the comparatively distant future, that the mere operations of supply and demand among business men themselves may maintain prosperous business conditions for some time. But in the long run the maintenance of the values of producers' goods and privileges depends on the demand, and hence on the income, of ultimate consumers. Wages do not usually rise as rapidly as prices in periods of business expansion. This simple fact may in itself keep the average purchasing power of consumers

from expanding rapidly enough to furnish a solid support for the growing structure of capital values.

Crop failures may precipitate a panic by diminishing the purchasing power of those engaged in agriculture, and, possibly, by reducing exports and thus necessitating the taking of gold from the bank reserves to ship to Europe in payment for our imports. When the credit situation is at all strained the failure of one important bank may be enough to precipitate a panic. The bank's creditors are prevented from meeting their own obligations; the solvency of others is in turn dependent upon them, and thus losses in expected and often already hypothecated income are transmitted from firm to firm and from industry to industry in a constantly widening circle.

In fact, whatever may be the immediate cause of a panic, it is bound to grow, in a condition of inflated capital values, with tremendous rapidity. The collapse of credit leads to forced sales of property in order that credit obligations may be met. These lower property values, lessen the security on which credit is founded, and render banks less able and less willing to make loans. Moreover, the hoarding of money, which is apt to be a feature of a panic, has a destructive effect on bank reserves. In a serious panic the liquidation of obligations has to work itself out. Then the industrial process starts afresh, with lowered values, and with property rights shifted, in some measure, to creditors.

Crises seem to be unpreventable so long as competition and the credit system dominate in industry. Yet there are some recent developments that may make them less frequent, and possibly less serious.

The “integration of industry," whereby a whole series of productive processes, from the production of the raw material to the sale of the finished product, are brought together under one management, decreases the number and complexity of credit relations between producers, and tends to prevent the undue expansion of those parts of the productive process that are farthest removed from the consumer. The strong position of the steel industry in the United States is a case in point. The improvements in the bargaining power of wage earners resulting from their organization

have enabled them partly to prevent the widening of the gap between wages and prices in prosperous times, as recent American statistics show. On the other hand, crop failures are and always will be a factor of uncertainty. The lack of an elastic currency is also an element of danger, but this can and should be remedied.

The Economic Effects of Changes in the Value of Money. It has already been suggested that an increase in the amount of money available for bank reserves leads to the expansion of credit, stimulates business, and as a result usually increases prices, temporarily, at least. The same results are achieved, although in not the same way, by a depreciation in the value of money, such as comes from a sudden change in the standard of value, or from the introduction of irredeemable paper money as the medium of exchange. Without understanding the exact process we know that prices are gradually increased under such conditions, there being an unmistakable tendency to adjust them to the change in the "dollar" or other unit of the medium of exchange. The rising prices stimulate business by increasing profits. Profits are increased because most of the expenses of production are incurred before the goods are sold, so that the rise in prices increases the margin between prices and the expenses of production, and because, moreover, some of the expenses of production do not usually rise as rapidly as do prices. An expansion of business activity of the kind already described is apt to be the result, and this is not generally soon restrained by insufficient bank reserves, for depreciated money is usually, though not always, money that is coined or issued in large quantities.

That periods of prosperity induced in this way are inevitably short-lived and usually end in severe crises does not make them any the less real. Nor should the fact that such artificial conditions of business enterprise are apt to be accompanied by excessive

1 1 Possibly the effect upon other prices of the increased prices (measured in the depreciated money) that have to be paid for imported commodities and that are received for exported commodities is the key to this problem, just as it was undoubtedly the chief cause of the rise of prices to fit the bullion value of coins from which seigniorage had been taken. This is the explanation of the rise of prices under the greenbacks suggested by Professor W. C. Mitchell, the historian of that movement.

speculation and other unhealthy features blind us to the fact that they accomplish some good. The encouragement given to venturesome undertakings leads to the trial of new methods of production, to the development of new natural resources, to undertakings of vast proportion, to a general freeing of industrial organization and methods from the restraints of habit and tradition. The foundations of modern large-scale industry in the United States were laid in the period between the Civil War and the panic of 1873. The period of state bank note inflation preceding the panic of 1837 was a period in which the industrial map of the United States was almost wholly changed, and, in the long run, for the better.

A rapid increase in the supply of standard money may have a similar effect. A tremendous expansion of international trade followed the gold discoveries in California and Australia. In the sixteenth century, increases in the supply of the money metals, economic writers are agreed, hastened the fall of the mediaval economic system. The almost unparalleled development of industry and industrial organization in the United States since 1897, must, with its good features as well as its bad, be attributed in part to the increased supply of gold.

Business prosperity, however, does not always coincide with the real economic welfare of the masses of the people. If prices are rising faster than money wages, real wages are obviously declining. A period of falling prices is very apt to be a period of increasing well-being for those whose incomes are wages or salaries, although here we have to remember that even if daily or weekly wages do not fall so rapidly as prices, an increase of unemployment may affect total yearly incomes adversely.

The Standard of Deferred Payments. The relation of changes in the purchasing power of money to long-time debts and credits has been suggested in another connection. If prices increase, the principal of a loan represents less purchasing power at time of repayment than at the time the loan was made. If prices decrease, the reverse is, of course, true. In periods of cheap money agitations the additional burdens imposed upon debtors in a period of decreasing prices are emphasized. An important function of

money, then, is found in its use as a standard of deferred payments.1

As Professor Irving Fisher has shown, there is a partial compensation for the injustice worked to debtors or creditors by changing money values in the fact that the interest rate varies inversely with the value of money. If the value of money is increasing and promises to continue to increase, money lenders are forced by competition to offset the expected increase in the value of a loan by accepting a lower interest rate. When the value of money is decreasing, the expected decline in the value of the principal causes a higher rate of interest to be charged. So far then as the increase in the value of the principal is discounted in the interest rate at the time when a loan is made, to that extent is the debtor's claim of injustice unfounded. The decline in the interest rate as prices decrease makes it possible, moreover, for debtors to pay off their old obligations with money funds borrowed on more favorable terms. We may expect that less emphasis will be given to the question of the standard of deferred payments in future periods of declining prices, because American farmers are becoming in increasing numbers lenders rather than borrowers of money. Corporation bonds are taking the place of farm mortgages as the most significant form of long-time credit instruments.

Index Numbers. Changes in the purchasing power of money are indicated statistically by the use of index numbers. The prices of a number of important commodities in some one year, or their average prices for a term of years, are taken as the basis of the computation. The price of each commodity in each year covered

1 From the analysis in the preceding chapters it should be clear that money serves also as (1) the medium of exchange and measure or denominator of value, (2) the standard of value, (3) the basis of bank credit. The first of these functions is performed by all money; the second function only by standard money and bullion; the third by all money that can be lawfully used in bank reserves. Legal tender money, and, if there are differences in the value of different kinds of money, the cheapest legal tender money, serves as the standard of deferred payments. Before the development of credit facilities one's purchasing power did not depend so much on his property as on his own stock of ready cash. An important early function of money was, accordingly, that of a store or reserve of value or purchasing power.

2 Cf. the table on p. 240.

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