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BOARD
OF
GOVERNORS
OF THE
FEDERAL
RESERVE
SYSTEM
Mr. Ivan De Tarnowsky
Phone - Franklin 8751
Wants copy of or to see Dr. Curried report on
recession - 1937-B
(Mr. Tarnowsky says he had a discussion recently
with Currie and Currie told him he had worked
up quite a full report on the subject for the
Chairman — that it might be possible for Mr. T.
to get a copy of it or to come in and look it
over. Mr. T. says a similar situation is expected (by some) to develop and they are working up information and therefore would like to
read Currie1 s report on the last recession.)
Chairman says memo is Board property and confidential, and therefore Mr. T. should be checked into and information obtained as to who
is having him get information for report, to
what extent information from Currie report will
be used, etc. Mr. T. should have Currie write
a letter to the wh airman verifying his suggestion
to Mr. T., etc.
51
Confidential
April 1, 1938
Lauohlin Currie
CAUSES OF THE RECESSION
Introduction
A serious setback to the attainment of the national objective
of as full employment of our human and physical resources as can be
sustained under stable conditions was experienced in the last quarter
of 1937# Up to that time great progress had been made*
In the first
nine months of 1937 the index of production averaged 116 as contrasted
with an average of 64 for the year 1932 and 121 in the first nine
months of 1929* The national income was probably running at the annual
rate of #71 billion or $72 billion in the first nine months of 1937,
as contrasted with $40 billion in 1932, on a lower price level, and
$81 billion in 1929, on a higher price level# Assuming that three
million represents the more or less irreducible minimum of unemployment
compatible with conditions of general stability or "normal unemployment11,
wo had, by the summer of 1937, some four million people still to be
employed# This amounted to 9 per cent of the total working force*
The major part of this achievement was lost in a few months at
the close of 1937. After coming within striking distance of our goal
we havo fallen back to the 1934 levels of production and the prospects
of a quick recovery are not heartening*
In these circumstances it is urgent that a careful examination
bo mado of our recent experience in an attempt to ascertain the basic
oauses of the downturn* Only by proper diagnosis can we hope to
avoid a repetition of the mistakes of the past* This is particularly important in the present juncture, because of the extent to
which the Federal Government and its agencies participated in and
assumed responsibility for the recovery movement®
Background of the Recovery Movement
Transition Period, 1935-54
Some of the measures taken by the Administration when it
y
assumed office were, as the President recognized, deflationary in
their effect* They comprised the freezing of billions of dollars
of deposits in closed banks, and a reduction in the pay and, hence,
buying power of Government employees• The Administration apparently believed that some action was required both in the monetary
sphere and in a direct stimulation of consumer buying power to offset this deflationary effeot* For this and, doubtless, other
reasons, an embargo was placed on gold, and the National Recovory
Act, including the public works section, was passed* A sharp
inventory boom, based on anticipated price and cost advances, ensued*
This quickly collapsed* The Civil Works Administration was hastily
established as an emergency device to provide employment and purchasing power# This was followed by Federal Emergency Relief Admin*,
istration in 1934. After the short interlude of the gold buying
policy, the price of gold was stabilized in January 1934 at a price
which, for the next three years, yielded an approximate balance
l/ Soe ifew York Times, torch 14, 1938, p* 7*
in our international payments on other than capital account.
Period of Sustained Progress under Stable Pricesf 1934-1956
From 1934 to 1936 the largest single factor in the steady
recovery movement was the excess of Federal aotivity^creating expenditures over activity-decreasing receipts • An attempt has Tteen made
to measure this excess by adding together all federal expenditures
that appear to affect Tbusiness activity directly and subtracting
all taxes except estate and gift taxes® The chief -weakness of
the resulting figures lies in the assumption that all taxes represent a deduction from current spending, either on consumption or
capital account* To the extent that part of current savings would
not have been spent the estimates understate the magnitude of the
Government's contribution to community expenditures® Estimates of
total activity-creating expenditures, activity-decreasing receipts
and net activity-creating expenditures are charted on the following
page.
FEDERAL RECEIPTS AND EXPENDITURES
ASSUMED TO AFFECT BUSINESS ACTIVITY DIRECTLY
BLLIONS OF DOLLARS
'S?LLI0NS OF DOLLARS
900
900
i\
800
D
\
\
EI X P E N D I T U F !ES
:
ADJUSTEI
700
%
ji
600
800
t
4
I A n//W \\f A^
•V
?
V
1
11
600
A
A* I /
A
\*.
t
500
700
N A
500
{ADJUSTED
}
400
\fV
300
/
v V
200
A
1 /
j
/
1
1
/
IT^
j
A
M r
#
/
1
RECEIPTS
/1
400
\
300
\1 A /
j/y
/
Ajfr 1 I
200
V ^ V / N /
NET
100
EXf 3 E N D I T U R E S
o
n
ww
100
0
-100
-100
1932
1933
1934
1935
1936
1937
1938
1939
• f r -
it -will 'be observed that the estimated excess of activitycreating expenditures amounted to nearly $270 million a month throughout 1934 and 1935* The annual figures amounted to #3.2 billion in
1934 and |3*1 billion in 1935, or 41 per cent and 57 per cent of
the respective increases in the national income over the previous!
year*
That this factor was the motivating force in the recovery
movement is indicated in various ways* Studies in the changes of
the cash holdings of various economic groups from the end of 1933
to the end of 1935, in conjunction with other data, show that business collected from final consumers in the sale of products more
than it disbursed in the making of goods* The large increase in financial deposits indicated that a portion of the current interest
and dividend payments was not being returned to the monetary circulation* This evidence is confirmed by the lag in expenditures on durable goods such as houses, electric power and railroad and other
industrial plant and equipment*
The broad case for using fiscal policy as a recovery measure
rested on two main grounds* In the first place, it rested on the
belief that a substantial volume of new capital expenditures would
not be undertaken until the growth in consumer demand had resulted
in taking up much of the great excess of productive capacity, and
that, in lieu of a reduction in costs, it would not be profitable
to build now houses until the growth in consumer incomes had forced
up rents* In the second placo, in default of an increase in private
borrowing, deficit financing appeared the only way in which a restoration of the deposits sulject to check wiped out in the depression
could be accomplished*
By 1936 events appeared in a fair way to demonstrating the
soundness of the case for a compensatory fiscal policy in a severe
depression. By the middle of 1936 the volume of all adjusted deposits subject to oheck (except domestic interbank deposits) had increased
by over $10 billion over 1933 and was nearly $3 billion in excess
of the figure for 1929* Including currency outside banks, the total
was over $4 Mllion in excess of the combined figure for 1929. There
had also been a substantial follow-up of private expenditures on durable goodsv Mr* Terborgh estimates the total of such expenditures at
about $13 billion in 1936, as contrasted with $6 billion in 1933
and $23 billion in 1929* Expenditures on new housing finally got
under way and amounted to $1#2 billion in 1936#
This substantial growth in production, employment, and incomes,
and the follow-up in the durable goods industries, took place under
the relatively stable cost and price conditions that existed from
the beginning of 1934 to the fourth quarter of 1936*
Speculative or Boom Period, October 1936- March 1937*
The relatively stable cost and prico conditions, under which
such great progress had been made up to the fourth quarter of 1936,
wore lost in the five or six months' period beginning in November
1936* Tho monthly index of national income paid out increased at
>7the rate of 16 per cent per annum from September to March, as oon~
trasted with a rate of increase of 10 per cent per annum in the preceding six months# The Bureau of Labor Statistics index of wholesale
prices rose by
per cent from October to March, or at an annual
rate of 18 per cent and, perhaps of even greater significance, wholesale prices of durable goods, which had remained virtually unchanged
since the end of 1933, rose by 10 per cent from Octofter, 1936 to
March 1937, or at an annual rate of 24 per cent* The course of
wholesale prices of durable goods is shown in the accompanying chart*
Average hourly earnings in manufacturing rose 13#3 per cent from
October 1936 to May 1937#
The index of machine tool orders rose
from 118 in September 1936 to 202 in April, 1937*
The rise in these various indexes was symptomatic of a profound
change in the character of the recovery movement• From a condition
of orderly increase in production and productive facilities in
response to increases in consumer demands, under stable cost and
price conditions, there developed a condition in which both production and productive facilities were increasing in anticipation of
price and cost advances* In other words, a speculative element
of considerable dimensions entered the picture* Forward buying
and inventory stocking far in oxcess of current needs were widely
engaged upon* The speculative movement came to a close around
April 1937*
WHOLESALE PRICES OF DURABLE GOODS
1934 = 100
PER CENT
PER CENT
1934
1935
1936
1937
1938
—9—
Period of Unstable Equilibrium, April - August 1937
Various indexes of production, retail sales and incomcs
flattened out after March* The monthly indox of adjusted income
payments increased by only 1*1 por cent from March to August* The
adjusted index of compensation of employees reachcd its peak in
May. Industrial activity as a whole ceased to expand, the incroaso
in durablo goods production being offset by a steady decline in
non-durable goods production. Industry, in part, was operating
on the bank of unfilled orders accumulated in the previous poriod
and inventories continued to increase both absolutely and in relation to curront sales*
A recent survoy by Dun and Bradstrcot of 17,000 firms indicates a far larger increase in inventories than had previously
boon suspected* Assuming that this is a reliable sample, it appears
that the incroaso in inventories in manufacturing, wholesaling and
retailing amounted to over $2 billion in 1936 and to almost #3 billion
in 1937* Making the conservative assumptions that ono-third of
the incroaso in 1936 took place in the last quarter of the year and
that tho doclino in the last quarter of 1937 was about equal to the
average advance in tho first throo quarters, so that the total advance for the first throe quarters was about 50 per cent greater
than tho total incroaso for tho year, wo arrive at an estimated incroaso in inventories in manufacturing, wholesaling and retailing
in tho year ending September 30, 1937 of approximately $5 billion*
>10This is exclusive of any increase that may have occurred in agriculture, mining, service and other industries* This estimated increase
in inventories exceeded that of any post-war calendar year*
The combination of increasing inventories in the face of a
flattening out of production and sales created a highly unstable and
vulnerable condition* When new orders sufficient to maintain production failed to materialize in late August and early September, there
was a concerted rush to reduce inventories with the result that productive activity experienced one of the sharpest declines on record*
Factors in the Downturn
Two closely related developments require explanation* the speculative character of the movea^nt in the winter of 1936-37, and the
general cessation of growth that occurred in the spring and summer
of 1937*
Before recounting the specific and immediate developments that
contributed to the cost and price advances of the last quarter of
1936 it is first necessary to sketch in the background* Two essential
factors stand out* In the first place, recovery had proceeded uninterruptedly for nearly three years and much excess productive capacity held been absorbed and rents had risen sufficiently to moke the
building of houses profitable* By October steel operations were at
78 per cent of capacity, or close to the economic capacity of around
90 per cent* The index of industrial production in the stammer of
1936 was back practically to the level of the corresponding period of
1928* Our productive capacity had increased more largely in man
power than in capital equipment. We were, in other words, approaching a point where in many lines the employment of more people required the construction of more plant facilities, and this takes
time*
The second essential factor forming the background of the period under discussion was the speeding up of the rate of recovery
in 1936* Tho industrial production average for the year increased
17 per cent over 1935, as contrasted with a 14 per cent increase
of 1935 over 1934* Department store sales increased 11 per cent
over 1935, as contrasted with an increase of 5 per cent of 1935
over 1934. National income in 1936 increased 16 per cent over 1935,
as
contrasted with an increase in 1935 over 1934 of 11 per cent®
Hence, at a time when we wore approaching capacity in certain important lines, tho rate of recovery, instead of slowing down, was acceloratod.
This was attributable to various factors* Consumers1 incomes
wore increased through increased expenditures on consumers1 durable
goods purchased largely on credit, through increased expenditures
on durable capital goods, which have tho effect of increasing incomes
without increasing finished consumer goods^ and through increased
Government expenditures relative to roceipts* It is estimated
that expenditures on such durable goods as housing, automobiles,
household furnishings and miscellaneous, increased about $2 billion
over 1935, as contrasted with an increase in 1935 over 1934 of
$1#5 billion* Expenditures on durable producers' goods in 1936
increased ovor $X billion ovor 1935, as contrasted with an increase
in 1935 over 1934 of loss than $700 million* Including only 50 per
—12—
ocnt of the bonus bonds cashed in 1936, tho estimated excess of activityincrqasing federal expenditures over activity-do cro as ing rocoipts
amounted to $4 billion* Thus, in those three categories wo have nearly
$7 billion of a typo of expenditures that tond to increase activity
as contrasted wxtti a corresponding figure iri 193t> of $5 billion*
In addition, expenditures on inventories probably increased more
in 1936 than in 1935* For the time being such expenditures have
tho same effect as expenditures on plant, since they incroaso consumers1 incomes without increasing the amount of finished goods
offered for sale* Finally, expenditures for maintenance in manufacturing and railways increased more sharply in 1936 than in 1935#
As against these various increases of expenditures that stimulate activity must be offset the additional saving out of additional
income, including in such additions any increase in the current
payments of consumers for goods bought previously on credit* If
wo had sufficiently accurate figures for all these and some additional items, we could account fully for the increased national income and sales*
For present purposos the point that it is desired to bring
out is that if the rate of recovery was too rapid in 1936, and
there appears to be good roason to bolievo that it was, part of
tho responsibility rests on tho size of tho not federal contribution*
>13It.is interesting to note in passing that if the bonus had not
been passed over the President's veto our total figure for the year
would have been |3*3 billion, or very little larger than in 1935«
We now come to the fourth quarter of 1936 * Against the background of an accelerating rate of recovery as excess plant was
being absorbed, a series of incidents and developments contributed
to the rapid cost and price advances and speculative conditions discussed
cardie jr* Tho announcement o£ England**roarmcaontpragma* with
its accompanying speculation in certain international raw materials,
undoubtedly fanned inflationary sentiment here* Various political
and economic developments made it a favorable time for an attempt
to be made to unionize large industries on an industrial basis*
Substantial wage and hour concessions were made both in response to
pressure from the newly-formed unions and to checkmate the growth
of the unions* The strength of the organization of the employers,
the high rate of operations and the sellers1 market resulting from
anticipation of advancing prices and fear of delayed deliveries
from strikes and deficient capacity, all made it generally possible
for industry to pass along its higher costs in higher prices* The
practice of the steel industry, in particular, in announcing prico
increases to take effect on a future date, encouraged excessive forward buying*
>14The movement apparently culminated in March and April, 1937*
The vital steel and machine tool industries were then operating at
practicable capacity* The rise in the level of non-&gricultural
prices came to an end and various other important indexes flattened
outp
Although the wave of forward buying and inventory speculation
had to end sooner or later, various specific developments may have
played a part in the timing* Thus the rise inreserverequirements
xaay have taken some of the force out of the lfinflatlonfl talk* The
President* s statement of April 2nd, indicating that the rapid riso
in some prices was viewed with disfavor#may have contributed to the
same end* Atroad there lagan to appear a realization that the ixxminenoe
of a rearmament boom had been over-discounted* With the wage and
other agreements of TJ* S# Steel and General Motors with the C* I. 0*t
the lafcor situation became more stabilized and less uncertain* In
any case, tho extent of forward buying has its limitations, and sinco
tho movement had already proceeded for some time it may very well
have been due for a slackening up oven in the absence of those specific
developments*
The next question that requires answer is why incomes and consumer
buying flattened out after May, Why did we not resums steady progress
on tho basis of stabilizod higher oost and price and inventory levels?
The answer to this question requires information on the various factors
tending to increase and decrease national income and buying power, and
>15this information on a monthly basis is not as full as wo would wish®
As before, expenditures incurred in the making of durable consumers1
goods, durable producers1 goods and the net federal contribution
will be considered separately®
Residential building contracts awarded reached their peak in
April and declined thereafter®
The total for the year is estimated
at #1*3 billion as contrasted with #1*2 billion in 1936* Automobile
production throughout the late spring and summer ran higher than in
1936* The total for the year is estimated at #2*6 billion as contrasted with #8*6 billion in 1936* Expenditures on miscellaneous
consumers* durable goods probably continued to increase up until
the last quarter since the increase for the year as a whole over
1936 was #500 million* From all indications, expenditures on durable
producers1 goods continued to increase until August* The index of
production of durable goods in the third quarter of 1937 averaged
7 per cent over the first quarter* The estimate for the entire year
is #6®3 billion®
If commercial buildings are omitted, the total was
about #6 billion, which was not far short of the #6®6 billion in
this category in 1928* The increase over 1936 was #1*7 billion as
contrasted with an increase in 1936 of #1*1 billion over 1935* Inventories are ostimated to have increased nearly #4^ billion in the first
three quarters of the year, though at a diminishing rato*
It is in the net federal contribution to community expenditures
that the greatest decrease took place in the factors tending to increase business activity® For the crucial Seven-month period, March
>16to September, inclusive, this amounted to #400 million, or on average
of $60 million a month as contrasted with an average of #335
million a month throughout 1936*
The broad picture that emerges is as follows: In the spring
of 1937 the forces tending to bring about a further rise in income
became balanced by those tending to lower income* This, however,
was an unstable equilibrium sinco among the former forces was a largo
more or less ninvoluntary11 incroaso in expenditures for inventories
on the basis of prior commitments and a dangerous extension of installment credit in the automobile field* Expenditures for now residential
housing were declining and the net Government contribution was running
at a low figure and they probably together, in the second and third
quarters of tho year, did not amount to more than $1 billion* Durable
goods production continued to expand but this was in large part offsot by a doclino in the production of non-durable goods* The flattening out in retail sales and decline in new orders made unnecessary
any further incroaso in commitments for now plant and equipment than
those that had already been made* The volume of current saving out
of the income of corporations and individuals was apparently in excess
of tho expenditures on new plant and equipment, construction and the
net Government contribution by an amount roughly measured by tho
incroaso in inventories and consumer credit*
The answer to the question, then, as to why recovery did not
continue on the basis of tho new and higher level reached in the
spring appears to be that the drastic decline of some of the main
>17elements that had previously contributed toward increasing activity,
together with the increased saving that probably occurred along
v&th a higher level of money income, placed more of a load on durable
producers* goods expenditures than they could carry*
It is of interest to note that in 1925, when the national money
income closely approximated the rate at which it was running in the
summer of 1937, the total of consumers1 and producers* duraMe goods
expenditures approximated #21,5 billion, whereas in 1937 they approximated #17 billion* The main explanation of the difference lies in
expenditures for residential housing and commercial building, which
wero #4 billion larger in the former year* Expenditures for now
plant and equipment in mining and manufacturing were actually #400
million larger in 1937 than in 1925*
If housing expenditures and/or tho Government contribution combined had been some #4 billion greater annually ijfct Is
likely that the trend of consumers* incomes and retail sales would
have continued upward during the summer* If this had occurred it
is possible that inventories would havo become stabilized a t the
higher level and that now capital commitments would have, become necessary to moot growing consumer demands* The combination of those developments, in turn, might have boon sufficient to more than offset tho
aftormath of an oversold auto market*
Tho proximate causes of tho recession, thon, center around tho
factors giving riso to tho inventory and forward-buying boom, to the
failuro of a roal building revival to get under way, and to unfortunate
>18timing in the withdrawal of the Government' s contribution®
The petering out of the promising building revival that had gotten
under way in 1936 appears to be associated with the advance in the
price of new houses relative to the rise in rents® This advance in
price, in turn, was partly associated with the general advance in
prices and partly associated with developments in the building industry
itself*
The drastic nature of the decline in the Government's contribution was in large part associated with the payment of the bonus in
1936 and the excess of tax collections over disbursements under the
Social Security Act in 1937* Without the former our estimated net
figure would have boen $3*3 billion in 1936*- Without the latter our
estimated figure would have been $1*9 billion in 1937* A moderate decline in other expenditures and a substantial increase in other receipts
made up the difference*
Some Other Explanations Offered for the Recession
1* Monetary Policy* It has been said that the action of the
Board in raising reserve requirements and absorbing $1®5 billion of
excess reserves in the spring of 1937, together with the action of
the Treasury in sterilizing inflows of gold, were either responsible
for or contributing factors in the recession* This contention will
be examined in some detail*
In order to viow these actions in their proper perspective it
is necessary to review briefly monetary developments from the middle of
>191933 to tho end of 1936* The whole period was one of rapid expansion*
This was in accord with the policy of promoting monetary ease and
of meeting tho liquidity requirements of the community through restoring the volume of modia of payment wiped out in the depression* The
total volume of adjusted deposits subject to chock (exclusive of interbank deposits) of all banks plus currency outside of banks decreased
from $27 billion in 1929 to $20 billion in the middle of 1933* By
Juno 1936, a $11^ billion expansion had occurred, bringing the aggregate up to $31^ billion* Despite the increase in deposits and, honoo,
reserve requirements, tho volume of excess reserves had, by the
summer of 1936, increased to over $3 billion*
In the Banking Act of 1935 Congress placed upon the Board of Governors the responsibility of raising reserve requirements "in order to
prevent injurious crodit expansion** In view of the expansion that
had already occurred, and the magnitude of the excess reserves of
bonks, it appeared to bo a wise precautionary measure to reduce excess
reserves by increasing legal reserve requirements* Accordingly, the
Board took action to raise requirements by an amount sufficient to
absorb $1^ billion of the excess, leaving nearly $2 billion* This
action, taken in the summer of 1936, was generally commended and had
absolutely no offoot on interest rates or tho money markot generally»
Indeed, tho various inflationary developments mentioned earlier occurrod
subsequent to this action*
In January of 1937, the reserve position was oarofully roviowed*
Since the previous action had boon taken tho volume of deposits subject to chock had continued to expand rapidly* Despite the growth
in reserve requirements accompanying the incroaso in deposits, the
steady inflow of gold had swelled tho volume of excess reserves to
over #2 billion*
A body charged with tho responsibility of preventing an injurious
expansion of crodit was in duty bound to weigh the dangerous potentialities in tho situation* Tho volume of doposit currency and cash was
clearly not excessive for current requirements* Howovor, should tho
ratos of turnover prevailing throughout the Twenties bo rogained, the
volume of money would have supported a national income approaching
#100 billion, which could have boon achiovod in the near future only
by an excessive advanco in pricos* There was, as previously remarked,
inflationary sentiment in the air* In theso circumstancos it appoared
the course of prudence to reduce again the basis of potential expansion* Consequently, on January 30, it was announced that reserve ro«*
quiromonts would bo Increased by approximately #750 million on March 1st
and #750 million on May 1st, which would leave banks with be two on
one-half billion and one billion dollars of excess reserves on tho
latter date*
It was felt that if the step proved too drastic, proper adjustment
could bo made by using the flexible instruments of open xaarket purchases
of securities to increase excess rosorvos* If it proved inadequate in
.21itself to ohook excossivo expansion of credit it could be supplemented with open market sales of securities®
Purchases wore in fact
made in April and again in November which, along with the dosterilisation of $300 million of inactive gold, had the effect of increasing
bank reserves by a corresponding amount*
The rise in reserve requirements was regarded as a precautionary rather than a restrictive measure* In conjunction with the adoption of a policy on the part of the Treasury of sterilising new gold
inflows, it markod a fundamental readjustment of our banking system
to the now gold situation, and placed us in a position to rely henceforth on the customary instrument of open market operations as a means
of operating on bank roserves and, hence, on the volume of credit*
There are two possible ways in which the above monetary actions
might have had a depressing effect on business activity* The first
i8 psychological and the second, for lack of a better term, might
be called mechanical*
The action may have contributed to the removal of the fear or
expectation of monetary inflation and an indefinite rise in prices and
hence chocked a further expansion of forward buying and inventory
stocking* If so, its effect was salutary, as our present difficulties are tracoable in large part to the inflationary developments
in the winter of 1936-37* From this point of view, the criticism
should bo not that the action was taken, but rathor that it was unduly
delayed* Too much weight cannot be assigned the psychological argument, however, in view of the fact that price advances continued to
>22-
occur for some months after the announcement of the policy on
January 30th. Orders for machine tools reached their peak in
April, 1937*
Tho other, and more mechanical, way in which raised reserve
requirements and sterilizing new gold inflows might have contributed
to tbD recession deserves more consideration*
It has been argued
that the raised reserve requirements were responsible for bank
salos of bondsj bank sales of bonds resulted in weak bond prices*
weak bond prices discouraged new bond issuesf the difficulty of
issuing new bonds led to a decline in capital investment; tho
decline in capital investment resulted in the recession* It is
necessary to establish all these links in the chain connecting
monetary policy with tho recession, if the case for a causal
relationship is to be established, and this appears difficult to do#
It is, in the first place, a moot question as to what extent
the raised reserve requirements were responsible for bank sales of
bonds and tho decline in bond prices* Bond prices had risen steadily since 1934 and purchasers had accumulated substantial profits
on thoir holdings* It was to bo expected, as in the analogous
caso of stock pricos, that any dovolopmsnb which foreshadowed an
end of the rise would precipitate pro fit-taking* The various
factors that occurred in the winter constituted such a development*
Indeed, bond pricos reached their peak in England in October of
1936, and declined steadily thereafter* The average price of 87
English bonds fell by 6-| per oont from October to March, as contrasted
>23with a decline in the monthly average of Uf S. bond prices of 4-|
per cent from January to April* The decline in this country was
initiated by municipal and Federal bonds in January before action
with reference to excess reserves was announced*
It seems reason-
able to assume that the desire to take profits was as powerful a
motivating factor in bank sales of Government bonds as were raised
reserve requirements, particularly since sales were engaged in by
so many banks that possessed more than adequate reserves to meet
the now requirements. In a survey, made in January 1937, it was
ascertained that the excess reserves plus one-half of cash due
from banks were deficient to meet the new reserve requirements in
only 197 banks. The deficiency amounted only to #123 million* Hence,
raised reserve requirements probably acted more as a signal of an
end of a bull market in bonds than in forcing sales because of
inadequate reserves. Tho total sales of all securities by all
bonks amounted to less than $1 billion between December 1936 and
June 1937* In the same period bonk loans expanded by more than
$1 billion.
When wo turn to tho next link that could connect monetary
policy with the recession in business - the relation between decline
ing bond prices and capital expenditures - it is again difficult to
make out a valid ease. The volume of new corporate issues in the
first six months of 1937 was nearly double the volume in the corresponding period of 1936f the figures being $795 million and $455
million* Expenditures by railroads and utilities on new plant and
>24equipment for 193? as a whole increased 66 per cent over 1936, whereas
tte rate of increase for 1936 over 1935 was only 51 per cent* Expenditures by mining and manufacturing for new plant and equipment, despite
the bad last quarter, increased 36 per cent over 1936, which was the
rate of increase of 1936 over 1935* Doubtless most of the commitments for these expenditures were made in the first half of the year*
The flattening out in the rate of consumption, however, made additional
capital commitments in any large volume unnecessary in the summer*
There may have been individual cases where new capital expenditures
were postponed because of the difficulty of raising now money* National figures, however, indicate that the total volume of expenditures
on new capital goods were as large as could reasonably bo expected*
The increase of expenditures on additions to inventory from September
1936 to September 1937 was, as pointed out above, one of the largest
on record*
In conclusion it may be said that since the recession cannot be
attributed to a decline in producers* durable goods expenditures,
and since monetary policy can share none of the responsibility for
tho price and cost advances in the winter of 1936-1937, for tho enormous increase in inventories, for the failure of residential building
to expand in 1937, and the drastic decline in the Government1 s contribution to community expenditures, it cannot bo hold responsible either
as an initiating or contributory factor in the recession*
As events have turned out it would have been perfectly safe to
have postponed tho rise in reserve requirements that occurred in March
>25end May of 1937* This, however, was not evident in January of
1937 and is an entirely different matter*
2* The Undistributed Profits Tax, the Capital Gains Tax and
Stock Market Regulation*
Many writers appear to believe that
the basic cause for the recession was the difficulty industry experienced in securing capital for expansion* This difficulty
in turn was attributable to the action of the undistributed profits
tax in forcing out earnings, and the difficulty in securing new
money from the security markets*
The answer to this contention has already been given* There
is no evidence that the recession was attributable to a deficiency
of industrial plant and equipment expenditures and in the last
quarter of 1936 and the first two q uarters of 1937 industrial expenditures for inventories wore unquestionably too great from the point
of view of economic stability* If the money that went into excessive inventories had gone instead into plant and equipment, the
total of the latter type of expenditures would have been in excess
of 1929*
3* Lack of Confidence and a Recovery Based on Consumption*
The argument here runs that the profound political uncertainty
and general lack of confidence meant that the recove ly was supported
entirely by the excess of Government expend!tures over receipts*
There was no follow-up of private investment so that the recovery
movement promptly collapsed when Government support was withdrawn*
£ fr-
it is difficult to find any factual evidence in support of
this contention* The accompanying charts depicting the course of
expenditures for new plant and equipment of mining and manufacturing, railroads and utilities are pertinent in this connection* By
1937 expenditures for new plant and equipment in mining and manufacturing were back to the 1928 level* In railroads they were $138 million
short of the 1928 level, and in electric utilities |276 million*
The utilities are a particularly interesting case* The accompanying chart expresses rated kilowatt capacity, output and capital
expenditures as indexes with a common base year, 1929* This should
be borne in mind in order that the mistake should not be made in
interpreting the chart of believing that output was at capacity in
1929 or exceeded capacity in some other years* Actually, there was
a comfortable reserve capacity in 1929* The additions to plant capacity 1930i»32 and the decline in power output resulted in a large
excess capacity, relative to 1929, that was not taken up untij the
end of 1936 and beginning of 1937* Consequently, for the power industry as a whole, there was not much incentive to expand plant until
late in the recovery* The expansion in 1937 was in fact vigorous,
being 62 per cent above 1936* Total expenditures in 1937 were, how*
ever, about |300 million less than the total in 1923, when output
was as close to capacity as in 1937* It might be claimed with some
justice, therefore, that tho peculiar difficulties of the utilities
wore resulting in a one year1 s lag of expenditures behind what
might otherwise have been expected* The figure involved is negligible,
however, in relation to the total picture*
INDUSTRIAL PRODUCTION AND EXPENDITURES
FOR CAPITAL AND MAINTENANCE, 1919-1937
BILLIONS
OF DOLLARS
INDEX
120
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EXPE:NDIT URES
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1919
1921
1923
1925
1927
1929
1931
1933
1935
1937
FREIGHT-CAR LOADINGS AND RAILROAD EXPENDITURES
FOR CAPITAL AND MAINTENANCE, 1921-1937
INDEX
BILLIONS OF DOLLARS
2.2
140
AN
2.0
irMINT ENAN CE E XPEN DITUf AL—O
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CAPITAL 1EXPEtsi D ITURES
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0
1919
1921
1923
1925
1927
1929
1931
1933
1935
1937
INDEXES OF ELECTRIC POWER CAPACITY, OUTPUT AND CAPITAL EXPENDITURES
1929 =100
PER CENT
PER CENT
140
140
CAP,ACIP<
120
100
/
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80
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20
1921
1923
1925
1927
1929
1931
\
1933
20
1935
1937
4* Decline in Profit Margins Brought ATtout Through Higher Costs*
Apart from the automotive group and, in the late summer, the railroads, profit margins do not appear to have declined in the first
three quarters of 1937* On the basis of a sample study by Standard
Statistics of 176 large industrial corporations for the first six
months in 1937 it was found that the average ratio of net income
to sales was 8*5 per cent as compared with 8*4 per cent for the
corresponding 1936 period* Excluding the automobile companies* indicated margins for the two periods were 7*7 per oent and 5*6 per cent
respectively* In a special study made of the U. S. Steel Corporation it was determined that as a result of the advance in prices
relative to the advance in costs, the break-even point after preferred dividend requirements* was lowered from 50 per cent to 43
per cent of operations in relation to capacity* For the first six
months of 1937* profits of mining and manufacturing companies ran
some 30 per cent over profits in the first six months of 1936*
Apparently industry in general, in the conditions prevailing in
the first eight months of 1937, was able to pass along higher costs
in higher prices*
Roflections Prompted by a Consideration of the Factors
Causing the Recession
A survey of the underlying causes of the current recession
leads on to the questions, what measures at what times and in what
degrees would have been necessary
for the recovery to have pro-
ceoded uninterruptedly^ TJfhat economic and political conditions
would have made it possible for such measures to have been takenf
There we to, as we have seen, a series of developments that
culminated in ths rocossionf
-31~
The Timing of the Rate of Recovery
!• To go back no further than the summer of 1936 one lesson
that should be taken to heart is the importance of slowing down
the rate of increase of consumption as physical capacity is approached
in important Jines* This is because of what economists call wthe
principle of acceleration11 which is, that after capacity is attained,
a given increase in consumption necessitates a multifold increase
in expenditures on physical plant facilities, To produce
$1
million annually more of steel, for example, a plant costing many
times that amount must to erected* Hence a rate of recovery that
may be perfectly appropriate in a condition of widespread and large
excess capacity, may stimulate excessive price advances and forward
buying when capacity is approached in important lines*
We are prone to overlook this fact when there are millions of
people still unemployed and become impatient to secure their early
employment* Yet the conditions of a large any of unejqployed together with deficiency of plant capacity and requisite aanual skill
may easily arise in a recovery from a severe mnd.long-continued depression* In such periods the increase in the working force may far
outstrip the growth in physical plant capacity or in skilled workers *
The failure to add to productive capacity in a depression not only
results in increased unemployment at the time, but also results in
a later and longer continuance of unemployment, if it does not result in a boom and another recession*
.32Putting this in more specific terms, we may now say, with
the benefit of hindsight, that it would have been desirable had
the rate of increase in consumption slackened in the summer and
early fall of 19J56* This, theoretically, might have been achieved
through a reduction in the net federal contribution to community
expenditures.
If, however, we oast our minds back to the conditions in
the middle of 1936 we can readily see tho enormous difficulties
in such a course* In the first place, the Administration would
have had to have been absolutely convinced in the validity of a
forecast of price advances, etc., in the early winter* Secondly,
it would have had either to cut its expenditures suddenly and
drastically or increase its revenues. The only way in which revenues could have currently been increased would have been through
the immediate and hurried imposition of consumption taxes* Similarly, the only large non-reourring item of expenditures that
might have been cut, apart from the bonus, which was passed over
the President* s veto, was relief expenditures, and the relief load
at that time was still very heavy*
2* Organization and Price and Cost Advances
A substantial part of the Inventory and forward buying and
price and cost advances arose from tho anticipation of further
price and cost advances. Part arose from the fear of delayed
deliveries, either because of anticipated labor difficulties or
physical plant limitations* If, therefore, price advances could
•33.
have been avoided, the major part of the incentive for inventory
buying would have been removed. In the absence of excessive
inventory buying and advance ordering, deliveries could have kept
more in pace with orders and the fear of delayed deliveries because of plant and skilled labor shortages would have been in
large part removed®
If building materials, contractors1 margins,
and hourly skilled wage rates in the building field had not advanced*
it is probable that the building revival would have acquired momentum®
In other words, although we were approaching temporary capacity
in various important lines, we probably still had sufficient capacity to have handled orders promptly if they had not been swelled
by excessive inventory buying* Consequently, if price and cost
advances could havo been avoided it is possible that the recovery
movement could have proceeded on the firm foundation of increasing
producers1 goods expenditures and residential construction*
This is whore organization comes into the picture* Organized
labor asked for a greater increase in hourly earnings than could
be compensated for in a short time by increased efficiency* Consequently, its request meant an increase in the labor cost per unit
of production* Industry, by and large, was sufficiently wellorganized to be able to meet this demand and still maintain its
profit margin, and in some cases actually increase it, on the basis
of a given volume of business, by advancing prices*
.34The steel industry was an outstanding example of this* Price
leadership is so well-established that there was little incentive
to attempt to hold down per unit costs* In fact, the occasion
was seized to advance prices more than costs, as is indicated by
the lowering of the breakeven point (after preferred dividend
requirements) of the U* S# Steel Corporation from 50 per cent to
43 per cent of capacity operations*
In other cases, where the profit margin was more than adequate
to attract the necessary new capital into the industry, so that the
additional labor cost per unit could readily have been absorbed without an advance in price, prices were nevertheless advanced* This
appears to have been the case in the automobile industry*
In the building industry, individual strategically-located
unions, whose membership had greatly decreased since the period
of active building in the Twenties9 capitalized on the increasing
demand for their work, by asking and obtaining advances in the
hourly rate of earnings and by enforcing various trade practices
that increased cost,* Contractors sought to recoup themselves for
many lean years by upping their margins* The prices of Building
materials advanced for various reasons, many of them connected with
the fact of organization of employers and employees*
The broad lesson or moral that emerges is that, in tte solution
of the proMem of securing greater business stability, far more
attention must be paid to the proTMLem raised by Administered11
pricos on the one hand, and trade union policy on the other, than
>35has hitherto been considered necessary* There is absolutely no
assurance that another recovery will not be choked off by excessive
price and cost advances, nor that rovivals from future recessions
will not be seriously hampered by the maintenance of the peak levels
of prices and wage rates* There is no assurance that the building
industry will permit the present great physical shortage of housing
accommodations, in relation to the standards of 1929, to be made
up* In these circumstances, it appears imperative that a national
policy be developed in connection with organized industry and organized labor to ensure that their policies will not wrock tho possibility of scouring a greater measure of economic stability*
3* Problems of a Compensatory Fiscal Policy
A final opportunity to prevent the recession was presented in
the spring and summer of 1937* As was argued earlier, if consumption
had increasod steadily in this period, it is possible that tho recovery movement might have proceeded on tho basis of a new, higher and
stabilized level of costs, prices and inventories* A steady increase
in consumption and rise in rents would have necessitated more capital
expenditures and would again have made residential building profitable*
A steady riso
consumption under the conditions prevailing at
that time, however, would only have been achieved by a very substantial increase in the Government1 s contribution to national buying
power* It is not necessary to stress tho difficulties in such a
course# As in the previous but reverse case in the middle of 1936*
there are the difficulties of determining upon policy and of implementing policy*
>36Placing tte enormous difficulties of determining right policy
aside, it appears evident that if fiscal policy is to be truly
compensatory, a far greater degree of flexibility in expenditures
and receipts must be possible than is now tho case®
It may very
well bo that much flexibility cannot be achieved within the budget*
A large proportion of the taxes are levied on the previous yearfs
income and in accordance with prior enactments* The bulk of expenditures is determined by * appropriations made far in advance of the
period to which they apply* It may be that the solution lies in
securing flexibility in large part outside the regular budget* For
one thing, the possibilities of providing for executive discretion
in varying subsidies, and in maintaining, speeding up or retarding
various typos of expenditures, might be explored* Another avenue
of approach would be the exploration of the possibilities of securing
appropriate compensatory variations in receipts md/or expenditures
through tho use of automatic and non^discretionary devices linking
receipts and/or expenditures to changes in the rate of consumption
and production*
@FedFRASER