1933: The Government's Key to Economic Recovery

I

THE battle against business depression will be waged, during 1933, in the field of public finance. For three years now we have been asking ourselves whether the turn of the depression was at hand. The end of each year has found us in the midst of new difficulties and uncertainties. In 1930 we were overwhelmed by an avalanche of bank failures. During the last two months of the year, the number of suspensions and the amount of deposits involved were entirely unprecedented. At the close of 1931 we were in the midst of the fight to maintain the gold standard in America. We had won the first battle, and hoped that the contest was over: but it proved only a lull. In the late spring of 1932 the gold standard had to be defended all over again.

This second threat to the gold standard could have been avoided if the federal budget at Washington had been balanced promptly and resolutely in March of that year. But it was not balanced; and for some months there was growing doubt whether a satisfactory state of the public finances would be accomplished before Congress adjourned. In Europe the doubt about our budget was much more pronounced than with us. The people there had had experience of the bitterest sort with parliaments during times of financial stress. It had been their observation that parliaments never did balance budgets in times of great depression. The task could only be successfully carried through by someone who was granted, or who assumed, dictatorial powers. The antics of our Congress from March to May seemed, to the Frenchman, to run according to exactly the same pattern which French parliamentary history had followed during the spring of 1926, when the franc fell to two cents before its decline was finally arrested.

All this brought on a renewed withdrawal of gold on the part of France, Belgium, the Netherlands, and Switzerland. No nation which had withdrawable funds could be expected to leave them in a country whose parliament was conducting itself as our Congress was doing. It was of no avail to tell the Frenchman that the credit of the United States was good, and that its currency was sound. His reply was that that was exactly what he had heard about every country in Europe which had later been forced to abandon the gold standard, including his own. A renegade and irresponsible parliament could ruin any currency, and the credit of any country.

Before the most dangerous proposals for spending money had been defeated, and new tax measures had been passed which would bring the budget nearer balancing, the country had slipped into a phase of the depression which was lower than any which it had reached before. Industrial production, according to the index of the Federal Reserve Board, had still stood at 69 per cent of the 1923-25 level in February. It fell off to 58 by midsummer. Factory pay rolls declined from 54 to 40. At that point they were only a little more than one third of what they had been in 1929. The security market, for both stocks and bonds, suffered declines which it is not necessary to describe here. The American business community has only too vivid a recollection of that debacle.

There can be no doubt that this worst and final phase of the depression was directly occasioned by the legislative action of these months. One thing was saved out of the wreck: that was the gold standard. When Europe had taken home all her balances, we still had almost one billion dollars of gold which would have been free and available for export if it had been necessary to send it out. The predictions of the European speculators and of some of our own people that we should be off the gold standard before autumn were proved groundless. Never, during all this period, had we come anywhere near being driven off the gold basis, all statements of officials to the contrary notwithstanding. The only things that could have driven us off the gold standard would have been an actual hoarding of the yellow metal by our own people, or an export of capital in large volume, such as Germany and France experienced in recent years. There was some hoarding of gold; and this would doubtless have gone further if the conditions which prevailed in May had continued several months longer. But tax legislation and the adjournment of Congress came in time to forestall this calamity.

The reaction from the hysteria of those months, and the constructive steps taken to settle the reparations question at Lausanne, brought a reversal — first in the security markets, and then, during September and October, in industrial production and trade. But as the year ends we have not yet gotten back to the levels of last February.

II

The decline in prices, wages, dividends, and business activity which accompanied the events of last spring has created a new situation which is inimical to the continuance of business revival, unless it is swiftly remedied. It has thrown the public finances, especially of state and local governments, into serious disorder. Even the federal budget has been affected by the economic consequences of the events of those months. The new taxes are yielding far less than was expected. Unless something is done to remedy this situation, the credit of the United States Government will suffer in coming months.

In the state and local governments these developments have resulted in a serious increase in tax delinquencies. The backbone of their tax system is still the general property tax. As the situation continued to grow worse, people simply refused to pay their taxes. In some states these delinquencies amount to one third of all the taxes levied upon property. The tax rate on property had been growing steadily during the last two decades. With the decline in values and assessments, which has come during the last two years, the rate shot up rapidly. The result is a breakdown of the property tax. It has broken down because it can no longer be made to yield the revenues needed to cover current expenditures.

The result of these developments has been an impairment of confidence in the credit of all governmental units, from the federal down to the school district. No business revival can be sustained as long as such a condition of affairs exists. In every time of recovery, there must be some safe point of anchorage in the financial world where the private investor and financial institutions can employ their funds. It is only in this manner that savings become purchasing power in the hands of those who will use them to buy goods and commodities. Only once in the history of this country has there been a business revival which did not start with an upturn in the bond market. This exception was in 1915, when European war orders speeded up the wheels of industry. It is the use of bank credit and of personal savings that furnishes the starter for business when it is stalled on the dead centre of depression.

To-day, there is an abundance of funds in the country available for investment. It consists of potential bank credit which the banks themselves would normally use for the purchase of bonds; and of hoarded money which is earning its owners nothing. The sums involved in both categories are large.

The member banks of the Federal Reserve system alone have excess deposits lying idle at the twelve reserve banks amounting to five hundred million dollars. This money pays them no interest and earns them nothing. Now bankers operate for profit, and they naturally want to employ these funds in the purchase of sound bonds. The technique of the credit operation involved in the purchase of securities by banks is such that these excess reserves would sustain at least four billion dollars of such purchases. This would put funds at the disposal of the previous owner of the bonds, or of the government which issued them, if they were new.

But banks will not buy municipal bonds of cities whose budgets show deficits, and 30 per cent of whose taxes on property are delinquent. They are even hesitant about buying longterm bonds of the United States Government. Instead, they purchase notes which have only a few months to run, even though these yield them rates as low as one per cent or less. These institutions have no doubt of the ultimate soundness of the credit of the United States, but the action of Congress in the spring of 1932 is still fresh in their minds. They are still in doubt whether Congress will take definite and firm action in enacting the taxes needed to balance the budget, in eschewing bonus legislation, and in cutting governmental expenditures. As long as the financial community is in doubt on these matters, the future of bond prices will be uncertain enough to prevent the banks from buying. This situation will continue until Congress manifests a firm determination to reform the budget in drastic fashion.

The individual investor is in exactly the same frame of mind. The amount of hoarded currency tucked away in safety deposit boxes and in other less secure hiding places still amounts to a billion and a half dollars. The money in circulation, as that term is used by the Treasury, is two billion dollars more than one would expect it to be in this time of depressed trade. It is practically a billion dollars more than it was at the peak of business activity in 1929. The difficulty is that a great part of this currency is not being used as a medium of exchange for the purchase of goods and securities. It lies in hiding. If even half of the hoarded money were brought forth and used for the purchase of federal, state, and municipal bonds, it would stimulate an active bond market with rising prices. Such an investment market will never come to life as long as the present state of our public finances persists. The anti-hoarding campaign, inaugurated in the spring of 1932, made a fair start. But it came to an abrupt end the moment Congress staged its revolt against the tax programme of its leaders.

So the purchasing power of our people and of our banks lies idle. This money is barren, both for its owner and for the social structure in which it might be functioning as effective demand. Our bank credit has shrunk by thirteen billion dollars during the last three years, and by ten billions within the last year and a half. It is capable of an expansion which could revive both investment and industrial activity. The gold imports which have flowed back into this country in the last six months have created a great hoard of excess reserves, but they lie inert and useless.

III

The bonds of governments have for the foundation of their credit the taxing power. When it is exercised intelligently and honestly, it makes of these securities investments of the first rank. But taxing power is of no avail for the support of credit unless it is used, and unless expenditures are kept within the limits of taxes which it is possible to collect. The restoration of confidence in government credit on the part of investors, both individual and institutional, is the fulcrum of the situation. If the coming months bring about the establishment of a sound budget, we shall find ourselves advanced a long distance on the way toward normal business by the end of 1933.

This revision of taxes and expenditures will not be accomplished without a great deal of noise and fury. The taxes, if they are to be productive, cannot be levied merely on large incomes. These have shrunk too seriously to yield the revenue needed. They operate wonderfully well in times of prosperity, but they dry up in times of dividend reductions and falling security prices. The new taxes must have a broad base, resting upon the expenditures of the great mass of the people. They must be taxes, too, which we shall pay as we go, so that they cannot become delinquent. There will be bitter complaints, on grounds of social injustice, against any tax which hits everyone. But these are emergency taxes. If they restore prosperity, they will be a cheap price to pay.

The cuts in appropriations will bring even more vociferous complaints, for they must be deep and drastic. When once our state and local governments face the question of reducing outlays sufficiently to enable the system of property taxes to function once more, they will be staggered by the reductions which must be made. In the abstract, people believe in economy. But a cut in salaries of 25 to 35 per cent from the levels of 1929 for all public officials, including public-school teachers and Civil Service employees at Washington, will be considered harsh and inhuman. Yet cuts which must be made to restore public credit are of this order of magnitude.

To many it will seem that such a cut in expenditures, especially for personal services, will destroy the purchasing power of these employees and thereby still further decrease the demand for the products of industry. But it will not reduce general purchasing power. It will only leave it in the hands of the taxpayer instead of transferring it to the government employee. The important thing which it will do for purchasing power is to release the money now being hoarded, and to call into being and make active the potential credit which is locked up in the excess reserves of our banks.

The tax situation has become so serious in our local communities that they will make these readjustments, drastic though they may be. Many of them have already made a large part of these reductions, and are rapidly on the way to placing their financial houses in order. The new Congress which will come to Washington during 1933 brings with it a fresh memory of the sacrifices which people have been making back home. If the present Congress does not revise the finances and bring them into order in its short session, the next one certainly will.

IV

Fortunately, those general economic readjustments which are the necessary conditions of business revival have, for the most part, already been made. These are, first of all, a downward revision of prices. First raw materials fall; then finished products at wholesale; and finally, commodities at retail. All this has been accomplished with a vengeance. Raw materials as a group have fallen by almost one half. Those which enjoyed the protection of pricemaintenance pools — such as copper, rubber, sugar, silk, and others — are down even more. In the fields of finished products, at wholesale and at retail, commodities are cheap. Wages have been reduced; and overhead expenses have been curtailed in a manner that would have been considered utterly impossible even two years ago. The efficiency of both labor and management has been increased.

As a result of these adjustments, the cost of production per unit of output has been cut so greatly that producers can make a profit even at low prices, if only they can increase their volume. If confidence is restored in public credit, the volume of output should increase by 30 per cent during the year. This would still leave it a good distance below the peak of 1929,—or even below normal, — but, with the reduced cost and the improvement in management, it would give respectable profits to a large number of businesses which are not able to earn anything to-day.

One of the unqualifiedly favorable elements in the situation at the beginning of 1933 is a marked change in the gold situation. For years now we have heard constant complaint over the scarcity of gold. It has been commonly said, by those who were conversant with the gold situation, that the world produced about four hundred million dollars’ worth of gold annually. Of this, roughly one half was absorbed by the demand of the arts and by imports into India for purposes of hoarding. This left two hundred million available for monetary uses. This amount was considered insufficient to sustain prices and the necessary volume of credit.

But the last two years present quite a different picture. Gold production has been steadily rising, until in 1932 it exceeded $460,000,000. This is almost equal to the highest production ever reached. The employment of new gold in the arts has fallen to practically nothing during the past year. Even in 1931 it was small as compared with any previous year. In consequence, the last two years have made available for monetary uses about $850,000,000. In addition, India has not been a buyer of gold during these years. By the autumn of 1932 she had exported over $250,000,000 from private gold holdings, and the yellow metal is still coming out of that country. When this is added to the new production which was not absorbed in the arts, it gives a total for the two years of $1,100,000,000, or more than half a billion annually, available for monetary uses. Some of this is for the moment being hoarded by private banks and individuals, so that it does not yet appear in the reserves of central banks. But it is beginning to flow out of these hoards, and will, during the course of 1933, be added to these central reserves.

There is every prospect now of a record-breaking production of new gold during 1933. What confronts us, then, is an abundance of gold and not a scarcity. This is certain to make credit easy and interest rates low in any country where confidence is maintained. Such a condition will stimulate business revival. The year 1933 should lay the foundations for a great refunding of the short-time government loans which have been issued during this business depression, into long-term government bonds at low interest rates. It should also witness the initiation of an active and rising bond market.

This new situation with respect to gold will have an important bearing on the future of commodity prices. Gold has been made scarce during the last three years by the abnormal demand of those governments which accumulated it because it was the one commodity whose value was stable in a highly uncertain world. This has served to press down commodity prices. Much of that gold will be released again when it is no longer needed as a ‘storer of value.’ Together with the new gold which is coming into monetary uses, it will make gold abundant; and will raise commodity prices. We may not see much increase in 1933, but we shall certainly see the beginning of that development, if we conduct our affairs with wisdom.

There are a horde of other less important problems which will occupy our attention during the year. Foremost of these is the question of interallied debts. No one yet knows what ingenious scheme will be devised for the final solution of that problem, but that some plan will be evolved before the end of 1933 which will put this question at rest seems more than likely. In fact, it is probably of much less importance for American prosperity than we are prone to think at this moment when the question is so prominently before us. One thing is certain. We enjoyed great prosperity during a long period of years when we received nothing whatever by way of debt payments, and we can enjoy prosperity again, no matter how small may be the payments ultimately agreed upon.