WEBVTT NOTE Money and the Business Cycle 1 00:00:00.000 --> 00:00:04.720 Money and the Business Cycle by Gottfried Haberler 2 00:00:04.720 --> 00:00:06.240 Section 1 3 00:00:06.240 --> 00:00:09.440 If I speak of the business cycle during this lecture, 4 00:00:09.440 --> 00:00:14.240 I do not think only or primarily of such financial and economic earthquakes 5 00:00:14.240 --> 00:00:18.400 as we have experienced during the last few years all over the world. 6 00:00:18.400 --> 00:00:22.880 It would perhaps be more interesting to talk about these dramatic events 7 00:00:22.880 --> 00:00:26.560 of speculation broker's loans collapse of the stock exchange, 8 00:00:26.560 --> 00:00:37.060 Wholesale bankruptcies, panics, acute financial crises of an external or internal sort, gold drains, and the economic and political repercussions of all this. 9 00:00:37.060 --> 00:00:50.060 I shall, however, resist the temptation to make what I have to say dramatic, and shall try instead to get down to the more fundamental economic movements which underlie those conspicuous phenomena which I have indicated. 10 00:00:50.060 --> 00:01:00.060 For a complete understanding of the business cycle, it is absolutely indispensable to distinguish between a primary and fundamental and a secondary and accidental movement. 11 00:01:00.060 --> 00:01:10.060 The fundamental appearance of the business cycle is a wave-like movement of business activity, if I may be allowed to use for the moment this rather vague expression. 12 00:01:10.060 --> 00:01:28.060 The development of our modern economic life is not an even and continuous growth. It is interrupted not only by external disturbances like wars and similar catastrophes, but shows an inherent discontinuity. Periods of rapid progress are followed by periods of stagnation. 13 00:01:28.060 --> 00:01:37.060 The attention of the economists was first caught by those secondary and accidental phenomena, glaring breakdowns and financial panics. 14 00:01:37.060 --> 00:01:48.060 They tried to explain them in terms of individual accidents, mistakes, and misguided speculations of the leaders of those banks and business firms which were primarily involved. 15 00:01:48.060 --> 00:02:02.060 But the regular recurrence of these accidents during the 19th century brought home to the economists that they had not isolated accidents before them, but symptoms of a severe disease which affects the whole economic body. 16 00:02:02.060 --> 00:02:09.060 During the second half of the 19th century, there was a marked tendency for these disturbances to become milder. 17 00:02:09.060 --> 00:02:15.940 Especially, those conspicuous events, breakdowns, bankruptcies, and panics, became less numerous, 18 00:02:15.940 --> 00:02:20.660 and there were even business cycles from which they were entirely absent. Before the war, 19 00:02:20.660 --> 00:02:25.780 it was the general belief of economists that this tendency would persist, and that such dramatic 20 00:02:25.780 --> 00:02:31.060 breakdowns and panics as the 19th century had witnessed belonged definitely to the past. 21 00:02:31.700 --> 00:02:36.900 Now, the present depression shows that we rejoice too hastily, that we have not yet 22 00:02:36.900 --> 00:02:43.060 got rid of the scourge of the capitalist system. But nevertheless, so much can be and must 23 00:02:43.060 --> 00:02:47.720 be learned from the experience of the past. If we want a deeper insight into the inner 24 00:02:47.720 --> 00:02:52.620 mechanism of our capitalistic system, which makes for its cyclical movements, we must 25 00:02:52.620 --> 00:02:57.460 try to explain the fundamental phenomenon, abstracting from these accidental events which 26 00:02:57.460 --> 00:03:03.160 might be absent or present. If we disregard these secondary phenomena, the business cycle 27 00:03:03.160 --> 00:03:08.520 presents itself as a periodic up and down of general business activity, or to put it 28 00:03:08.520 --> 00:03:13.480 now in a more precise form of the volume of production. The secular growth of production 29 00:03:13.480 --> 00:03:18.320 does not show a continuous uninterrupted trend upward, but a wave-like movement around its 30 00:03:18.320 --> 00:03:23.080 average annual increase. It does not make a great difference whether the downward swings 31 00:03:23.080 --> 00:03:28.400 of these business waves are characterized by an absolute fall of the volume of production, 32 00:03:28.400 --> 00:03:31.360 or just by a decrease of the rate of growth. 33 00:03:31.360 --> 00:03:35.960 In this lecture, I am not concerned with the ingenious devices which statisticians have 34 00:03:35.960 --> 00:03:40.840 invented to isolate the cyclical movements from other periodic or erratic movements on 35 00:03:40.840 --> 00:03:44.640 which they are superimposed, or which are superimposed on them. 36 00:03:44.640 --> 00:03:49.700 I assume first that we have such a thing as a business cycle, which is not identical with 37 00:03:49.700 --> 00:03:55.220 seasonal movements within the year and erratic irregular disturbances caused by wars, periods 38 00:03:55.220 --> 00:03:57.460 of government inflation and the like. 39 00:03:57.460 --> 00:04:01.980 It is necessary to state this because even the existence of the phenomenon under consideration 40 00:04:01.980 --> 00:04:03.300 has been doubted. 41 00:04:03.300 --> 00:04:09.500 Secondly, I assume that we have been able to isolate this movement statistically. 42 00:04:09.500 --> 00:04:14.700 Our chief concern will be with the explanation of this movement and especially with the role 43 00:04:14.700 --> 00:04:19.900 of money in the widest sense of the term, including credit and bank money. 44 00:04:19.900 --> 00:04:21.220 Section 2. 45 00:04:21.220 --> 00:04:24.020 There is hardly any explanation of the business cycle. 46 00:04:24.020 --> 00:04:35.020 I hesitate a little to say theory of the business cycle, because many people have developed a certain prejudice against this term, in which the monetary factor does not play a very decisive role. 47 00:04:35.020 --> 00:04:38.780 The following consideration shows that this must necessarily be so. 48 00:04:38.780 --> 00:04:51.220 Still abstracting from the previously mentioned accessory phenomena, one of the most outstanding external symptoms of the business cycle is the rise of prices during prosperity and the fall of prices during depression. 49 00:04:51.220 --> 00:05:21.220 On the other hand, there is an increase of the volume of production during the upward and a decrease during the downward swing, but not only more commodities are produced and sold, but also in other branches of the economy there is an increase in transactions, e.g. on the stock exchange, therefore we can safely say there is a considerable increase of the volume of payments during the upward swing of the cycle and a distinct decrease of this volume during depression. Now, it is clear that in order to handle 50 00:05:21.220 --> 00:05:30.220 In order to handle this increased volume of payments, an augmentation of the means of payment is necessary, means of payment in the widest sense of the term. 51 00:05:30.220 --> 00:05:32.220 One of the following things must happen. 52 00:05:32.220 --> 00:05:36.220 A. An increase of gold and legal tender money. 53 00:05:36.220 --> 00:05:38.220 B. An increase in banknotes. 54 00:05:38.220 --> 00:05:42.220 C. An increase of bank deposits and bank credits. 55 00:05:42.220 --> 00:05:50.220 D. An increase in the circulation of checks, bills and other means of payment, which are regularly or occasionally substituted for ordinary money. 56 00:05:50.220 --> 00:05:57.300 Money, e. an increase of the velocity of circulation of one or all of these means of payments. 57 00:05:57.300 --> 00:06:02.980 I do not claim that this enumeration is exhaustive or quite systematic. It is largely a matter 58 00:06:02.980 --> 00:06:07.800 of terminological convenience, as one likes to express oneself. One writer prefers to 59 00:06:07.800 --> 00:06:13.560 call bank deposits, on which checks may be drawn, money, bank money, credit money. Other 60 00:06:13.560 --> 00:06:18.880 writers restrict the term money to legal tender money, and speak then of bank deposits as 61 00:06:18.880 --> 00:06:22.640 as means to save money or to make it more efficient in making payments by increasing 62 00:06:22.640 --> 00:06:27.300 its velocity of circulation. Still others have an aversion against the term velocity 63 00:06:27.300 --> 00:06:33.800 of circulation and prefer to speak of changes in the requirement for money and means of payment. 64 00:06:33.800 --> 00:06:38.400 Without going more deeply into these technical details, it is, I hope, clear that there must 65 00:06:38.400 --> 00:06:43.500 occur in one way or another during the upward swing of the cycle an expansion of the means 66 00:06:43.500 --> 00:06:49.300 of Payment and, during the downward swing, a corresponding contraction. No serious theory, 67 00:06:49.300 --> 00:06:55.100 no explanation of the cycle, can afford to overlook, disregard, or deny this fact. Differences 68 00:06:55.100 --> 00:07:00.580 can arise only a.) in respect to the particular way in which the expansion takes place, whether 69 00:07:00.580 --> 00:07:05.440 it is primarily an increase in the quantity of credit money or legal tender money or gold, 70 00:07:05.440 --> 00:07:11.560 or just of the velocity of circulation of one of these, and b.) as to the causal sequence. 71 00:07:11.560 --> 00:07:16.280 As to the causal relation, broadly speaking, two possibilities seem to be open. 72 00:07:16.280 --> 00:07:22.400 One, one might assume that the impulse comes from the side of money, that the circulation 73 00:07:22.400 --> 00:07:27.240 is expanded by a deliberate action of the banks or other monetary authority, and that 74 00:07:27.240 --> 00:07:32.340 this sets the whole chain of events going, or two, one may hold the opinion that the 75 00:07:32.340 --> 00:07:37.360 monetary authorities take a passive role, that the initiative comes from the commodity 76 00:07:37.360 --> 00:08:07.320 The theories of the first group, which maintain that the 77 00:08:07.320 --> 00:08:13.320 The active cause of the cycle lies on the side of money, may be called monetary theories of the business cycle. 78 00:08:13.320 --> 00:08:23.320 In a wider sense, however, we may include in the group of monetary theorists also all those who admit that the impulse might also come from the commodity side, 79 00:08:23.320 --> 00:08:34.320 but hold that an appropriate policy of the monetary authorities, an effective and elastic regulation of the volume of the circulating medium, can forestall every serious disturbance. 80 00:08:34.320 --> 00:08:39.840 As you all know, the most frequently recommended criterion for such a policy is the stabilization 81 00:08:39.840 --> 00:08:44.920 of the price level in the one or other of the many meanings of this ambiguous term. 82 00:08:44.920 --> 00:08:50.200 You will all agree that it is impossible to discuss this problem exhaustively in one hour, 83 00:08:50.200 --> 00:08:53.900 so I shall confine myself to pointing out the insufficiencies of this type of monetary 84 00:08:53.900 --> 00:08:58.240 theory and of its recommendations for the remedy of the business cycle, which center 85 00:08:58.240 --> 00:09:00.800 around changes in the price level. 86 00:09:00.800 --> 00:09:05.360 I shall try then to indicate a more refined monetary theory of the cycle, which has been 87 00:09:05.360 --> 00:09:09.120 developed in the last few years, although it is not so well known in this country as 88 00:09:09.120 --> 00:09:15.120 it deserves to be. This refined theory seems to explain some features of the cycle, especially 89 00:09:15.120 --> 00:09:20.840 of the last one, which are not entirely compatible with the cruder form of the monetary approach, 90 00:09:20.840 --> 00:09:26.000 which identifies monetary influences with changes in the general price level. 91 00:09:26.000 --> 00:09:30.760 The traditional monetary theory, which is represented by such well-known writers as 92 00:09:30.760 --> 00:09:37.360 the Swedish economist Professor Kissel and Mr. Hawtrey of the English Treasury, regards 93 00:09:37.360 --> 00:09:42.080 the upward and the downward swing of the business cycle as a replica of a simple government 94 00:09:42.080 --> 00:09:48.400 inflation or deflation. To be sure, it is, as a rule, a much milder form of inflation 95 00:09:48.400 --> 00:09:55.760 or deflation, but at the root it is exactly the same. Mr. Hawtrey states this quite uncompromisingly 96 00:09:55.760 --> 00:10:01.840 in his famous dictum, the trade cycle is a purely monetary phenomenon, and is in principle 97 00:10:01.840 --> 00:10:06.280 the same as the inflation during the war and the deflation, that is to say the reduction 98 00:10:06.280 --> 00:10:11.120 of the amount of circulating medium, which was deliberately undertaken by certain governments 99 00:10:11.120 --> 00:10:16.260 to approach or to restore the post-war parity of their currencies. 100 00:10:16.260 --> 00:10:21.360 Hawtrey recognizes and stresses, of course, the difference in degree between the two types 101 00:10:21.360 --> 00:10:26.880 of Inflation and Deflation. Namely, that the expansion and contraction in the course of 102 00:10:26.880 --> 00:10:32.000 the business cycle is chiefly produced by maladjustment of the discount rate, which is 103 00:10:32.000 --> 00:10:37.560 not the way in which a government inflation is brought about. It is today an almost generally 104 00:10:37.560 --> 00:10:42.500 accepted doctrine that a lowering of the discount rate by the banking system, especially by 105 00:10:42.500 --> 00:10:47.080 the central banks, induces people to borrow more so that the amount of the circulating 106 00:10:47.080 --> 00:11:16.080 I know, of course, that this fair statement needs some qualifications. I trust, however, that before so competent an audience, it will suffice to say that this is literally true only if the influence of the change in the discount rate is not compensated by any other force which changes the willingness of businessmen to borrow. 107 00:11:16.080 --> 00:11:25.080 But given all these other circumstances, that is to say Ceteris Paribus, a change in the discount rate will have the indicated effect on prices. 108 00:11:25.080 --> 00:11:39.080 In any given situation there is one rate which keeps the price level constant. If the rate is forced below this equilibrium rate, prices have a tendency to rise. If the rate is raised above the equilibrium rate, prices tend to fall. 109 00:11:39.080 --> 00:11:58.360 Now, according to Mr. Hawtrey, there is a tendency in our banking system to keep the interest rate too low during an upward swing of the cycle, then prices rise, we get a credit inflation, and sooner or later the banks are forced to take steps to protect their reserves, they increase the rate and bring about the crisis and the depression. 110 00:11:58.360 --> 00:12:12.860 There is no time here to go into details, to discuss the ingenious explanation which Mr. Hattry offers for the fact that banks always go too far, that they swing like a pendulum from one extreme to the other, and do not stop at the equilibrium rate. 111 00:12:12.860 --> 00:12:20.360 The reason which Mr. Hattry gives for this is different from the one which Professor Irving Fisher and other writers of this group have to offer. 112 00:12:20.360 --> 00:12:25.860 What they all have in common is that the disturbing factors act through changes in the price level. 113 00:12:25.860 --> 00:12:33.360 It is through changes of the price level that expansion and contraction of credit and money act upon the economic system, 114 00:12:33.360 --> 00:12:40.360 and they all believe that stability of the price level is the sufficient criterion of a rational regulation of credit. 115 00:12:40.360 --> 00:12:45.860 If it were possible to keep the price level stable, prosperity would never be followed by depression. 116 00:12:45.860 --> 00:12:50.360 If the price level is allowed to rise, and the inevitable reaction to come, 117 00:12:50.360 --> 00:12:56.080 Now, it would be possible to end the Depression and to restore equilibrium if one could stop 118 00:12:56.080 --> 00:12:57.940 the fall of prices. 119 00:12:57.940 --> 00:13:03.040 Let me now indicate briefly why this explanation seems to me insufficient, or to put it in 120 00:13:03.040 --> 00:13:08.080 other words, I shall try to show that a. the price level is frequently a misleading guide 121 00:13:08.080 --> 00:13:12.840 to monetary policy, and that its stability is no sufficient safeguard against crises 122 00:13:12.840 --> 00:13:19.200 and depressions, because b. a credit expansion has a much deeper and more fundamental influence 123 00:13:19.200 --> 00:13:42.200 The principle defect of those theories is that they do not distinguish between a fall of prices which is due to an actual contraction of the circulating medium and a fall of prices which is caused by lowering of cost as a consequence of inventions and technological improvements. 124 00:13:42.200 --> 00:13:46.920 I must, however, mention that this particular criticism does not apply to Mr. Hawtrey, who 125 00:13:46.920 --> 00:13:51.880 by a peculiar interpretation of the term price level, recognizes this distinction, although 126 00:13:51.880 --> 00:13:55.120 he does not seem to draw the necessary conclusions. 127 00:13:55.120 --> 00:14:00.120 It is true, if there is an absolute decrease of the quantity of money, demand will fall 128 00:14:00.120 --> 00:14:05.320 off, prices will have to go down, and a serious depression will be the result. 129 00:14:05.320 --> 00:14:10.840 Normal conditions will return only after all prices have been lowered, including the prices 130 00:14:10.840 --> 00:14:16.800 of the factors of production, especially wages. This may be a long and painful process, because 131 00:14:16.800 --> 00:14:22.400 some prices, e.g. wages, are rigid, and some prices and debts are definitely fixed for 132 00:14:22.400 --> 00:14:27.000 a long time and cannot be altered at all. From this, however, it does not follow that 133 00:14:27.000 --> 00:14:32.560 the same is true if prices fall because of a lowering of costs. It is now generally accepted 134 00:14:32.560 --> 00:14:37.960 that the period preceding the present depression was characterized by the fact that many technological 135 00:14:37.960 --> 00:15:00.960 The natural thing, in such a situation, would be for prices to fall gradually, and apparently such a fall of prices cannot have the same bad consequence as a fall of prices brought about by a decrease of the amount of money. 136 00:15:00.960 --> 00:15:10.960 We could speak, perhaps, of a relative deflation of the quantity of money relative in respect to the flow of goods in opposition to an absolute deflation. 137 00:15:10.960 --> 00:15:21.960 Especially those writers who stress the scarcity of gold as a cause for the present depression are guilty of overlooking the radical difference between an absolute and a relative deflation. 138 00:15:21.960 --> 00:15:28.960 A scarcity of gold could result only in a relative deflation which could never have such disastrous results as the present depression. 139 00:15:28.960 --> 00:15:33.960 Of a more indirect way in which the smallness of the annual output of gold has perhaps to do with, 140 00:15:33.960 --> 00:15:40.960 I do not venture to say is the cause of the acuteness of present depression and the vehemence of the price fall. 141 00:15:40.960 --> 00:15:42.960 I shall say more later. 142 00:15:42.960 --> 00:15:54.960 Now, as I have said already, during the years 1924 to 1927 and 1928, we experienced an unprecedented growth of the volume of production. 143 00:15:54.960 --> 00:16:01.360 Commodity prices, on the other hand, as measured by the Wholesale Price Index, were fairly stable, as everyone knows. 144 00:16:01.360 --> 00:16:08.860 From this it follows, and direct statistical investigations have verified it, that the volume of the circulating medium had been increased. 145 00:16:08.860 --> 00:16:17.560 We could say there was a relative inflation, that is, an expansion of means of payment, which did not result in an increase of commodity prices, 146 00:16:17.560 --> 00:16:25.760 because it was just large enough to compensate for the effect of a parallel increase of the volume of production. 147 00:16:25.760 --> 00:16:33.160 There is now an obvious presumption that it was precisely this relative inflation which brought about all the trouble. 148 00:16:33.160 --> 00:16:41.760 If this were so, and it seems to me that it is very probable, it would be plain that the price level is a misleading guide for monetary policy, 149 00:16:41.760 --> 00:16:45.520 and that there are monetary influences at work on the economic system 150 00:16:45.520 --> 00:16:50.480 that do not find an adequate expression in a change of the price level, 151 00:16:50.480 --> 00:16:54.320 at least as measured by the wholesale price index, and in fact, 152 00:16:54.320 --> 00:16:58.160 there are such very far-reaching influences of certain monetary changes 153 00:16:58.160 --> 00:17:03.360 on the economic system. They may express themselves in a change of the price level or not, 154 00:17:03.360 --> 00:17:07.520 which have been wholly overlooked by the traditional monetary explanation, 155 00:17:07.520 --> 00:17:11.200 although the external symptoms of this influence have been well recognized, 156 00:17:11.200 --> 00:17:21.160 Section 4 These changes which I have in mind, and shall 157 00:17:21.160 --> 00:17:26.760 now try to analyze, are changes of what I shall call the vertical structure of production, 158 00:17:26.760 --> 00:17:30.800 brought about by changes in the supply of credit for productive purposes. 159 00:17:30.800 --> 00:17:36.220 If we have to analyze an economic system, we can make a horizontal or vertical cross-section 160 00:17:36.220 --> 00:17:37.220 through it. 161 00:17:37.220 --> 00:17:48.060 A horizontal cross-section would exhibit different branches or lines of industry as differentiated by the consumption goods which are the final result of these different branches. 162 00:17:48.060 --> 00:17:54.920 There, we have the food industry, including agriculture, the clothing industry, the show industry, etc. 163 00:17:54.920 --> 00:18:03.760 Industries which produce producers' goods, say the iron and steel industry, belong simultaneously to different branches in this horizontal sense, 164 00:18:03.760 --> 00:18:09.760 Because iron and steel are used in the production of many, or of all, consumers' goods. 165 00:18:09.760 --> 00:18:17.760 The old statement that a general overproduction is unthinkable, that we can never have too much of all goods because human wants are insatiable, 166 00:18:17.760 --> 00:18:22.760 but that serious disproportionalities might develop in consequence of a partial overproduction, 167 00:18:22.760 --> 00:18:27.760 this statement relates principally to the horizontal structure of production. 168 00:18:27.760 --> 00:18:51.520 Disproportionality, in this sense, means that for one reason or another, the appropriate proportion of productive resources devoted to different branches of industry has been disturbed, that e.g. the automobile industry is overdeveloped, that more capital and labor has been invested in this industry than is justified by the comparative demand for the product of this industry and for other industrial products. 169 00:18:51.520 --> 00:18:57.160 I hope it is now pretty clear what I mean by horizontal structure and horizontal 170 00:18:57.160 --> 00:19:03.200 disproportionalities of production. We make, on the other hand, a vertical cross-section 171 00:19:03.200 --> 00:19:08.240 through an economic system if we follow every finished good ready for consumption up through 172 00:19:08.240 --> 00:19:13.480 the different phases of production, and note how many stages a particular good has to pass 173 00:19:13.480 --> 00:19:20.040 through before it reaches the final consumer. Take, e.g., a pair of shoes and trace its 174 00:19:20.040 --> 00:19:24.800 Economic Family Tree. Our path leads us from the retailer via the wholesale merchant to 175 00:19:24.800 --> 00:19:28.900 the shoe factory, and taking up one of the different threads which come together at this 176 00:19:28.900 --> 00:19:34.620 point, say a sewing machine used for the fabrication of shoes, we are led to the machine industry, 177 00:19:34.620 --> 00:19:40.460 the steel plant, and eventually to the coal and iron mine. If we follow another strand, 178 00:19:40.460 --> 00:19:45.780 it leads us to the farm, which bred the cattle from which the leather was taken. And besides, 179 00:19:45.780 --> 00:19:50.300 There are many intermediate stages interpolated between these major phases of the productive 180 00:19:50.300 --> 00:19:56.180 process, namely the various transportation services. Every good has to pass through many 181 00:19:56.180 --> 00:20:01.200 successive stages of preparation before the finishing touches are applied and it eventually 182 00:20:01.200 --> 00:20:07.780 reaches the final consumer. It takes a considerable length of time to follow one particular piece 183 00:20:07.780 --> 00:20:12.180 through this whole process, from the source of this stream to the mouth where it flows 184 00:20:12.180 --> 00:20:16.120 goes out and disappears in the bottomless sea of consumption. 185 00:20:16.120 --> 00:20:20.700 But when the whole process is once completed, and every one of the successive stages is 186 00:20:20.700 --> 00:20:26.700 properly equipped with fixed and circulating capital, we may expect a continuous flow of 187 00:20:26.700 --> 00:20:28.460 consumers' goods. 188 00:20:28.460 --> 00:20:33.700 Now, in the equipment of these successive stages of production, the capital stock of 189 00:20:33.700 --> 00:20:37.720 a country which has been accumulated during centuries is embodied. 190 00:20:37.720 --> 00:20:41.540 The amount of accumulated capital is a measure of the length of the stream. 191 00:20:41.540 --> 00:20:45.660 In a rich country the stream is very long, and goods have to pass through many stages 192 00:20:45.660 --> 00:20:50.540 before they reach the consumer. In a poor country, the stream is much shorter, and the 193 00:20:50.540 --> 00:20:55.700 volume of output correspondingly smaller. If during a time of economic progress capital 194 00:20:55.700 --> 00:21:01.500 is accumulated and invested, new stages of production are added, or in technical economic 195 00:21:01.500 --> 00:21:07.820 parlance, the process of production is lengthened, it becomes more roundabout. If you compare 196 00:21:07.820 --> 00:21:18.820 If we compare the way in which we produce today with the methods of our fathers, or the productive process of a rich country with the one of a poor country, innumerable examples can be found. 197 00:21:18.820 --> 00:21:21.820 But what has this to do with the business cycle? 198 00:21:21.820 --> 00:21:31.820 Now, when I spoke of the vertical structure of production, and the influence of monetary forces upon it, I thought of a lengthening and shortening of the productive process. 199 00:21:31.820 --> 00:21:38.820 Obviously, just as there must be a certain proportion between the different horizontal branches of industry, 200 00:21:38.820 --> 00:21:44.620 there must also be a certain relation of the productive resources, labor and capital, 201 00:21:44.620 --> 00:21:48.420 which are devoted to the upper and lower stages of production respectively, 202 00:21:48.420 --> 00:21:53.620 to the current production of consumers' goods by means of the existing productive apparatus, 203 00:21:53.620 --> 00:21:59.820 and to the increase of this apparatus for the increased future production of consumers' goods. 204 00:21:59.820 --> 00:22:07.720 If e.g. too much labor is used for lengthening the process, and too small an amount for current consumption, 205 00:22:07.720 --> 00:22:12.720 we shall get a maladjustment of the vertical structure of production. 206 00:22:12.720 --> 00:22:19.220 And it can be shown that certain monetary influences concretely, a credit expansion by the banks, 207 00:22:19.220 --> 00:22:26.220 which lowers the rate of interest below that rate, which would prevail if only those sums which are deliberately saved by the public, 208 00:22:26.220 --> 00:22:42.220 From their current income came on the capital market, it can be shown that such an artificial decrease of the rate of interest will induce the business leaders to indulge in an excessive lengthening of the process of production, in other words, in over-investments. 209 00:22:42.220 --> 00:22:53.220 As the finishing of a productive process takes a considerable period of time, it turns out only too late that these newly initiated processes are too long. 210 00:22:53.220 --> 00:22:59.100 A reaction is inevitably produced, how, we shall see at once, which raises the rate of 211 00:22:59.100 --> 00:23:03.380 interest again to its natural level or even higher. 212 00:23:03.380 --> 00:23:08.980 Then these new investments are no longer profitable, and it becomes impossible to finish the new 213 00:23:08.980 --> 00:23:11.000 roundabout ways of production. 214 00:23:11.000 --> 00:23:15.500 They have to be abandoned, and productive resources are returned to the older, shorter 215 00:23:15.500 --> 00:23:17.260 methods of production. 216 00:23:17.260 --> 00:23:21.360 This process of adjustment of the vertical structure of production, which necessarily 217 00:23:21.360 --> 00:23:25.760 only implies the loss of large amounts of fixed capital which is invested in those longer 218 00:23:25.760 --> 00:23:32.140 processes and cannot be shifted, takes place during, and constitutes the essence of, the 219 00:23:32.140 --> 00:23:37.480 period of depression. Unfortunately, it is impossible to discuss here all the steps of 220 00:23:37.480 --> 00:23:41.840 this process and to compare them with the corresponding phases of the business cycle 221 00:23:41.840 --> 00:23:45.080 of which they are the picture and explanation. 222 00:23:45.080 --> 00:23:49.840 I hope that it will be possible to give you a clear idea of what happens in our capitalistic 223 00:24:19.840 --> 00:24:22.840 to the indispensable minimum. 224 00:24:22.840 --> 00:24:25.840 Instead of shoes and houses, they produce power plants, steelworks, 225 00:24:25.840 --> 00:24:30.840 try to improve the transportation system, in a word, build up a productive apparatus, 226 00:24:30.840 --> 00:24:35.840 which will turn out consumption goods only after a considerable period of time. 227 00:24:35.840 --> 00:24:39.840 Now, suppose that it becomes impossible to carry through this ambitious plan. 228 00:24:39.840 --> 00:24:45.840 Assume the government comes to the conclusion that the population cannot stand the enormous strain, 229 00:24:45.840 --> 00:25:15.840 In any such case, if they are forced to give up the newly initiated roundabout ways of production, and to produce consumers' goods as quickly as possible, they will have to stop the building of their power plants and steelworks and tractor factories, and instead of that try to produce hurriedly simple implements and tools to increase the output of food and shoes and housing. 230 00:25:15.840 --> 00:25:45.840 Now, what in a communistic society is done upon a decision of the Supreme Economic Council is, in our individualistic society, brought about by the collective but independent action of the individuals and carried out by the price mechanism, if many people, individuals or corporations, decide to save, to restrict for some time their consumption, the demand for, and the demand for, and the demand for, and the demand for, and the demand for, and the demand for, and the demand for, 231 00:25:45.840 --> 00:25:54.840 When production of consumers goods declines, productive resources are shifted to the upper stages of production, and the process of production is being lengthened. 232 00:25:54.840 --> 00:26:06.840 If we rely on voluntary saving, we can assume that during every year, approximately the same proportion of the national income will be saved, although not always by the same individuals. 233 00:26:06.840 --> 00:26:22.340 Then we have a steady flow of savings, and the adjustment of production does not take place in terms of actual shifts of invested productive resources, but in terms of a lasting deflection of the flow of productive resources into other channels. 234 00:26:22.340 --> 00:26:26.640 There is no reason why this should not go on smoothly and continuously. 235 00:26:26.640 --> 00:26:31.740 Violent fluctuations are introduced by the influence of the banks in this process. 236 00:26:31.740 --> 00:26:35.240 The effect of the voluntary decision of the public to save, 237 00:26:35.240 --> 00:26:39.840 i.e. to divert productive resources from the current production of consumption goods 238 00:26:39.840 --> 00:26:44.640 to the lengthening of the process, can be produced also by the banking system. 239 00:26:44.640 --> 00:26:49.740 If the banks create credit and place it at the disposal of certain businessmen 240 00:26:49.740 --> 00:26:55.020 who wish to use it for productive purposes, that part of the money stream which is directed 241 00:26:55.020 --> 00:27:00.780 to the upper stages of production is increased. More productive resources will be diverted 242 00:27:00.780 --> 00:27:05.820 from the current production of consumers goods to the lengthening of the process than corresponds 243 00:27:05.820 --> 00:27:11.660 to the voluntary decision of the members of the economic community. This is what economists 244 00:27:11.660 --> 00:27:18.620 speak of as forced saving. First, everything goes all right, but very soon prices begin to rise 245 00:27:18.620 --> 00:27:37.620 Because those firms who have got the new money use it to bid away factors of production, labor, and working capital, from those concerns which were engaged in producing consumption goods, wages and prices go up, and a restriction of consumption is imposed on those who are not able to increase their money income. 246 00:27:37.620 --> 00:27:52.620 If, through previous investment of voluntary savings, there is already a tendency for the price level to fall, the new credit, instead of resulting in an absolute rise of prices, may simply offset the price fall which would otherwise take place. 247 00:27:52.620 --> 00:28:01.620 But after some time, a reaction sets in which tends to restore the old arrangement that has been distorted by the injection of money. 248 00:28:01.620 --> 00:28:09.320 The new money becomes income in the hands of the factors which have been hired away from the lower stages of production, 249 00:28:09.320 --> 00:28:16.520 and the receivers of this additional income will probably adhere to their habitual proportion of saving and spending, 250 00:28:16.520 --> 00:28:20.020 that is, they will try to increase their consumption again. 251 00:28:20.020 --> 00:28:28.320 If they do this, the previous proportion of the money streams directed to the purchase of consumers' goods and of producers' goods will be restored. 252 00:28:28.320 --> 00:28:50.720 For some time it might be possible to overcome this counter-tendency and to continue the policy of expansion by making new injections of credit, but this attempt would lead to a progressive rise of prices and must be given up sooner or later, then the old proportion of demand for consumers' goods and producers' goods will be definitely restored. 253 00:28:50.720 --> 00:29:07.520 The consequence is that those firms in the lower stages of production, which had been forced to curtail their production somewhat, because factors have been hired away, will in turn be able to draw away productive resources from the higher stages. 254 00:29:07.520 --> 00:29:18.720 The new roundabout ways of production, which have been undertaken under the artificial stimulus of a credit expansion, or at least a part of them, become unprofitable. 255 00:29:18.720 --> 00:29:24.320 They will be discounted, and the crisis and depression has its start. 256 00:29:24.320 --> 00:29:34.120 It could be otherwise, only if the new processes were already finished, when the additional money has become income, and comes onto the market for consumers' goods. 257 00:29:34.120 --> 00:29:38.600 In this case, the additional demand would find additional supply. 258 00:29:38.600 --> 00:29:43.640 To the increased flow of money would correspond an increased flow of goods. 259 00:29:43.640 --> 00:29:48.360 This is, however, almost impossible, because as Mr. Robertson has shown, 260 00:29:48.360 --> 00:29:53.400 the period of production is much longer than the period of circulation of money. 261 00:29:53.400 --> 00:29:58.680 The new money is bound to come on the market for consumption goods much earlier than the new 262 00:29:58.680 --> 00:30:03.000 processes are completed and turn out goods ready for consumption. 263 00:30:03.000 --> 00:30:11.500 Section 5. This explanation of the slump, of which I have been able to indicate here only the bare outline, 264 00:30:11.500 --> 00:30:15.000 could of course be elaborated and has been elaborated. 265 00:30:15.000 --> 00:30:21.500 If this interpretation of the crisis and of the breakdown of a large part of the structure of production is correct, 266 00:30:21.500 --> 00:30:26.300 it seems then comparatively easy to explain the further events in more familiar terms. 267 00:30:26.300 --> 00:30:30.000 Such an initial breakdown must have very serious repercussions. 268 00:30:30.000 --> 00:30:43.000 In our highly complicated credit economy, where every part of the system is connected with every other directly or indirectly, by contractual bonds, every disturbance, at one point, spreads at once to others. 269 00:30:43.000 --> 00:30:53.000 If some banks, those nerve centers where innumerable strands of credit relations come together, are involved and become bankrupt, a wave of pessimism is bound to come. 270 00:30:53.000 --> 00:31:00.500 As a secondary phenomenon, a credit deflation is likely to be the consequence of the general distrust and nervousness. 271 00:31:00.500 --> 00:31:08.500 All these things upon which the traditional monetary doctrine builds its entire explanation will make things even worse than they are, 272 00:31:08.500 --> 00:31:18.500 and it may very well be that the secondary wave of depression, which is induced by the more fundamental maladjustment, will grow to an overwhelming importance. 273 00:31:18.500 --> 00:31:35.500 This depends, however, largely upon the concrete circumstances of the case in hand, upon the peculiar features of the credit organization, on psychological factors, and need not bear a definite proportion of the magnitude of the real dislocation of the structure of production. 274 00:31:35.500 --> 00:31:44.500 This is the place to say a few words about an indirect connection between the alleged insufficient supply of gold and the present depression. 275 00:31:44.500 --> 00:31:52.100 It is undoubtedly true that since before the war, the quantity of gold has not increased so much as the volume of payments. 276 00:31:52.100 --> 00:32:02.900 To maintain a price level roughly 50% higher than before the war was possible only by building a comparatively much larger credit structure on the existing stock of gold. 277 00:32:02.900 --> 00:32:09.500 After the process of inflation has once been completed, this should not cause troubles in normal times. 278 00:32:09.500 --> 00:32:20.000 In times of acute financial crisis, one confidence vanishes, and when runs and panics make their appearance, such a system becomes, however, extremely dangerous. 279 00:32:20.000 --> 00:32:31.500 If the means of payment consist principally of gold and gold-covered notes and certificates, there is no danger that suddenly a large part of the circulating medium may be annihilated. 280 00:32:31.500 --> 00:32:45.000 A world system of payments, however, which relies to a large proportion on credit money, is subject to rapid deflation if this airy credit structure is once shaken and crushed down. 281 00:32:45.000 --> 00:32:55.000 For example, the adoption of a gold exchange standard by many countries amounts to erecting a daring credit superstructure on the existing gold stock of the world. 282 00:32:55.000 --> 00:33:00.360 The structure may easily break down if these countries abandon the gold exchange standard 283 00:33:00.360 --> 00:33:06.360 and re-adopt an old-fashioned gold standard. It would be, however, entirely wrong to conclude 284 00:33:06.360 --> 00:33:12.280 from this that we have to blame the niggardliness of nature, that the situation would necessarily 285 00:33:12.280 --> 00:33:17.320 be quite different if by chance gold production had been much larger during the last 20 years. 286 00:33:18.040 --> 00:33:23.320 Other factors are responsible, principally the inflation during and after the war. 287 00:33:23.320 --> 00:33:31.820 By means of such a monetary policy, it is always possible to drive any stock of gold however large it may be out of the country. 288 00:33:31.820 --> 00:33:38.420 The natural thing is then to substitute a later gold exchange standard for the abandoned gold standard, 289 00:33:38.420 --> 00:33:44.120 which means, as I have said already, the erection of a credit structure on the existing stock of gold. 290 00:33:44.120 --> 00:33:51.420 Therefore, if the annual output of gold had been larger than it actually was, the difference would have been only this. 291 00:33:51.420 --> 00:33:58.300 The credit structure too would have become larger, and we would have started in for the last boom from a higher price level. 292 00:33:58.300 --> 00:34:03.020 If this is a correct guess of what would have happened, and it seems to me very probable, 293 00:34:03.020 --> 00:34:14.060 the economic consequences of the last period of credit expansion, 1927 to 1929, and the present deflation, would have been exactly the same. 294 00:34:14.060 --> 00:34:20.220 It is of vital importance to distinguish between these additional secondary and accidental disturbances 295 00:34:20.220 --> 00:34:24.620 and the primary real maladjustment of the process of production. 296 00:34:25.260 --> 00:34:30.620 If it were only a wave of pessimism and absolute deflation which caused the trouble, 297 00:34:30.620 --> 00:34:36.300 it should be possible to get rid of it very quickly. After all, a deflation, however strong it may be, 298 00:34:36.300 --> 00:34:40.700 and by whatever circumstances it may have been made possible and aggravated, 299 00:34:40.700 --> 00:34:46.700 can be stopped by drastic inflationary methods within a comparatively short period of time. 300 00:34:46.700 --> 00:34:51.700 If we have, however, once realized that at the bottom of these surface phenomena 301 00:34:51.700 --> 00:34:55.700 lies a far-reaching dislocation of productive resources, 302 00:34:55.700 --> 00:34:59.700 we must lose confidence in all the economic and monetary quacks 303 00:34:59.700 --> 00:35:05.700 who are going around these days preaching inflationary measures which would bring almost instant relief. 304 00:35:05.700 --> 00:35:09.700 If we accept the proposition that the productive apparatus is out of gear 305 00:35:09.700 --> 00:35:13.860 that great shifts of labor and capital are necessary to restore equilibrium, 306 00:35:13.860 --> 00:35:19.300 then it is emphatically not true that the business cycle is a purely monetary phenomenon, 307 00:35:19.300 --> 00:35:25.860 as Mr. Hawtrey would have it. This is not true, although monetary forces have brought about the 308 00:35:25.860 --> 00:35:32.180 whole trouble. Such a dislocation of real physical capital, as distinguished from purely monetary 309 00:35:32.180 --> 00:35:39.620 changes, can in no case be cured in a very short time. I do not deny that we can and must combat 310 00:35:39.620 --> 00:36:07.620 I cannot go into this matter here. I only wish to say that we should not expect too much of a more or less symptomatic treatment and, on the other hand, we must be careful not to produce again that artificial disproportion of the money streams directed toward consumption and production goods, which led to overinvestment and produced the whole trouble. 311 00:36:07.620 --> 00:36:13.020 The worst thing we could do is a one-sided strengthening of the purchasing power of the consumer, 312 00:36:13.020 --> 00:36:20.120 because it was precisely this disproportional increase of demand for consumers' goods which precipitated the crisis. 313 00:36:20.120 --> 00:36:25.220 It is a great advantage of this more refined monetary explanation of the business cycle 314 00:36:25.220 --> 00:36:32.220 over the traditional one to have cleared up these non-monetary real changes due to monetary forces. 315 00:36:32.220 --> 00:36:38.940 In doing so, it has bridged the gap between the monetary and non-monetary explanation. 316 00:36:38.940 --> 00:36:45.740 It has taken out the elements of truth contained in each of them and combined them into one coherent system. 317 00:36:45.740 --> 00:36:53.980 It takes care of the well-established fact that every boom period is characterized by an extension of investments of fixed capital. 318 00:36:53.980 --> 00:37:00.700 It is primarily the construction of fixed capital and of the principal materials used for this, iron and steel, 319 00:37:00.700 --> 00:37:05.940 where the largest changes occur, the greatest expansion during the boom, and the most violent 320 00:37:05.940 --> 00:37:11.420 contractions in the depression. This fact, which has been stressed by all descriptive 321 00:37:11.420 --> 00:37:17.460 studies of the business cycle, has not been used by the traditional monetary explanations, 322 00:37:17.460 --> 00:37:23.140 which run in terms of changes in the price level, and look at real dislocations of the 323 00:37:23.140 --> 00:37:28.700 structure of production, if they regard it at all, as an unimportant accidental matter. 324 00:37:28.700 --> 00:37:33.780 The explanation which I have indicated not only describes this fact, as does the so-called 325 00:37:33.780 --> 00:37:39.140 non-monetary explanation of the cycle, but explains it. If the rate of interest is lowered, 326 00:37:39.140 --> 00:37:43.980 all kinds of investments come into the reach of practical consideration. May I be allowed 327 00:37:43.980 --> 00:37:49.620 to quote an example given by Mr. Keynes in a lecture before the Harris Foundation Institute 328 00:37:49.620 --> 00:37:55.380 last year? No one believes that it will pay to electrify the railway system of Great Britain 329 00:37:55.380 --> 00:38:06.020 on the basis of borrowing at 5%, at 3.5% it is impossible to dispute that it will be worthwhile, so it must be with endless other technical projects. 330 00:38:06.020 --> 00:38:17.620 It is clear that especially those branches of industry are favored by a reduction of the rate of interest, which employ a large amount of fixed capital, as for example railroads, power plants, etc. 331 00:38:17.620 --> 00:38:23.060 In their cost account, interest rate changes play an important role, but there is an indisputable 332 00:38:23.060 --> 00:38:28.740 general tendency to replace labor by machinery if capital becomes cheap. That is to say, 333 00:38:28.740 --> 00:38:33.780 more labor and working capital is used to produce machines, railroads, power plants, 334 00:38:33.780 --> 00:38:40.660 comparatively less for current production of consumption goods. In technical economic parlance, 335 00:38:40.660 --> 00:38:46.340 the roundaboutness of production is increased. The crucial point, and also the point of deviation 336 00:38:46.340 --> 00:38:51.700 from Mr. Keynes' analysis is to understand well that a reaction must inevitably set in 337 00:38:51.700 --> 00:38:57.860 if this productive expansion is not financed by real voluntary saving of individuals or corporations 338 00:38:57.860 --> 00:39:04.100 but by ad hoc created credit and it is practically very important the last boom should have brought 339 00:39:04.100 --> 00:39:09.140 this home to us that a stable commodity price level is not a sufficient safeguard against such 340 00:39:09.140 --> 00:39:14.820 an artificial stimulation of an expansion of production in other words that a relative credit 341 00:39:14.820 --> 00:39:19.780 inflation in the above-defined meaning of the term will induce the same counter movements 342 00:39:19.780 --> 00:39:25.240 as an absolute inflation. I hope that I have been able to give you a tolerably clear idea 343 00:39:25.240 --> 00:39:29.860 of this improved monetary explanation of the business cycle. Once more, I must ask you 344 00:39:29.860 --> 00:39:35.100 not to take as a complete exposition what can be only a brief indication. A sufficiently 345 00:39:35.100 --> 00:39:40.140 detailed discussion of the case could be only undertaken in a big volume. Therefore, I beg 346 00:39:40.140 --> 00:39:45.140 I beg you to suspend your final judgment until the case has been more fully presented to you. 347 00:39:45.140 --> 00:39:48.140 Only one objection I should like to anticipate. 348 00:39:48.140 --> 00:39:52.140 It is true this theory suffers from a serious disadvantage. 349 00:39:52.140 --> 00:39:57.140 It is so much more complicated than the traditional monetary explanation. 350 00:39:57.140 --> 00:40:02.140 But I venture to say that this is not the fault of this theory, but due to the malice of the object. 351 00:40:02.140 --> 00:40:07.140 Unfortunately, facts are not always so simple as many people would like to have them.