2. Anatomy of the Bubble

Who, then, is he who provides it all? Go and find him and you will have once more before you The Forgotten Man. . . . The Forgotten Man is delving away in patient industry, supporting his family, paying his taxes, casting his vote, supporting the church and the school, reading his newspaper, and cheering for the politician of his admiration, but he is the only one for whom there is no provision in the great scramble and the big divide.

—WILLIAM GRAHAM SUMNER

Command of labor and materials built the pyramids. The economic world was then very simple. Some private usury, of course, but no banking system, no science of credit, no engraved securities issued on the pyramids for investors to worry about. Merely, the whim of Pharaoh, his idea of a pyramid, his power to move labor, and the fact of a surplus of food enough to sustain those who were diverted from agriculture to monumental masonry.

It is believed that on Cheops alone 100,000 men were employed for twenty years. And when it was finished all that Egypt had to show for 600,000,000 days of human labor was a frozen asset. Otherwise and usefully employed, as, for example, upon habitations and hearthstones, works of common utility, means of national defense, that amount of labor might have raised the standard of common living in Egypt to a much higher plane, besides insuring Egyptian civilization a longer competitive life. But once it had been spent on a pyramid to immortalize the name of Pharaoh it was spent forever. People could not consume what their own labor had produced. That is to say, they could not eat a pyramid, or wear it, or live in it, or make any use of it whatever. Not even Pharaoh could sell it, rent it, or liquidate it.

History does not say what happened to the 100,000 when Cheops was finished. Were they unemployed? Were they returned to agriculture whence they came? If so, that would be like now sending suddenly four or five million people from industry back to the farms in this country.

You may take it, at any rate, that when Cheops was finished, there occurred in Egypt what we should call an economic crisis, with no frightful statistics, no collapsing index numbers in the daily papers, no stock-exchange panic, no bank failures, but with unemployment, blind social turmoil, Egyptian bread lines perhaps. And this crisis, like every crisis since, down to the very last, was absorbed by people who could not consume what they had produced, whose labor had been devoured by a pile of stones, and who understood it dimly if at all. The forgotten people.

This story of a pyramid has the continuing verity of a parable. For all the worlds that have passed since that Egyptian civilization departed, for all the new wonders of form, method and power that seem to make this one of ours original, nevertheless, what happened to the forgotten people of Egypt happens still in our scheme; it happens to The Forgotten Man of William G. Sumner’s classic essay, and for the same reasons.

There is here no solitary Pharaoh with the power to move labor by word alone. In this world labor is free, receiving wages. Yet you have to see that the passion among us for individual and collective aggrandizement by command of labor and materials is what it always was and that the consequences of pursuing it far in selfish and uneconomic ways are what they are bound to be and anciently were.

In place of one responsible Pharaoh at a time, we have a multitude of irresponsible Pharaohs; and beyond these we have the Pharaoh passion acting in governments big and little, in States and cities, in great private and public organizations, all seeking their own exaggeration and all seeking it by the one means. The motive may be avarice, it may be good or bad, it may derive from a sense of rivalry between nations or from an idea of public happiness. In the nature of economic consequences, strange to say, the motive does not matter. A pyramid is a pyramid still. When too much labor has been spent upon pyramids, or things that are unproductive and dead in the economic meaning of pyramids, there will be a crisis in daily well-being, and free labor in that case will be as helpless as slave labor was. It cannot consume what it has produced; it is without all those human satisfactions that might have been produced with the same labor in place of the pyramid, and it is without them forever. The labor that is lost cannot be recovered by unbuilding the pyramid.

But in this world where labor is free and no one has the apparent power to move it beyond its own volition, how is it moved or procured to waste itself too far upon works of public and private aggrandizement? How now do we build pyramids? There is a new way. It is a way the ancients, the Pharaohs, with no science of banking, could not have imagined. The name of it is credit. In our world, a world of money economy, command of credit is the command of labor and materials. There may be intervening complexities, the obvious may be obscured, yet in every case that is what it comes to at last; and, in fact, people have no other use for credit.

Borrowing and lending are as old as the sense of mine and thine; therefore, so is credit in the simple term. But modern credit as we know it, or think we know it, is a new and amazing power, still evolving, still untamed. Men have been much more anxious to release the power of credit, to employ and exploit it, than to control it or even to understand it. That would be only human. As formerly there was no aggrandizement, private or public, without a Pharaoh-like command of labor and materials, so now there is none without command of credit.

This holds for aggrandizement in any dimension. The very magnitude of human life in the present earth is owing to the power of credit. The whole of our industrial phenomena is founded on it. By means of credit the machine is created in the first place; by means of credit the machine is manned and moved and fed with raw materials. By means of credit the product of machines is distributed. By means of credit more and more this product is consumed, as when credit is loaned at home to the instalment buyer or loaned abroad to the foreign customer. Thus the power of credit is employed dynamically in the aggrandizement of trade, wherein are many dangers yet to be explored, such as those of wild inflation and deflation, followed by sudden crisis. The greed of individuals and groups, the extravagances of civic ego, the ambition of nations, ideas creative and destructive both, great social ends and great fallacies at the same time, even war—credit for all of these is the fabulous agent. And then, besides, with any motive, it builds pyramids, which is the singular point and the one we are after.

That is the one thing credit is supposed not to do. The restraining principles are interest and amortization. To amortize a debt is to redeem it, to extinguish it finally, or, literally, put it to death. Debt we have not mentioned. Most of the follies we commit with the power of credit are from forgetting that debt is the other face of credit. There is no credit but with an exact equivalent of debt. That is to say, when by means of credit you command labor and materials, you borrow them and become a debtor. As a debtor you must pay interest, so much per annum, on what you have borrowed, and sometime later return the principal, which puts the debt to death. We suppose commonly that interest and amortization concern only the borrower and lender. Who lends money will demand something for the use of it while he himself is doing without it, and surety for its return after a certain time. That is so; but that is not all of it.

From the point of view of the total social organism, interest and amortization have a kind of functional significance. They are the only two checks we have upon the universal passion to abuse the power of credit, or to waste in reckless and uneconomic ways the labor that is by credit commanded.

The borrower is expected to say: “This thing I propose to create with credit will be in turn creative. I mean it will be productive and give increase. Out of the increase I will pay interest for use of the credit; out of the increase I will extinguish the debt. The remainder I will keep for my own as profit.”

He may say that of a steel works, a textile factory, a railroad, an electric-power plant, of ten thousand and one things you may not think of; he cannot say it of a pyramid.

Precisely, therefore, the function of interest and amortization, beyond any private concern of either borrower or lender, is to restrain pyramid building. Nevertheless, it will be perceived that the modern world is magnificent with pyramids. Where Pharaoh built one by tyrannical command of labor and materials, credit now builds thousands. You are not to look for them in the exact shape of Pharaoh’s. Ours are in shapes of endless variety, many of them apparent, some not so apparent because they present a specious aspect of usefulness, and some invisible. The invisible kind are of all the most devouring.

Taking them by kinds, what are they—our pyramids? The most obvious to perception are those in the category of public works, such as monumental buildings, erections to civic grandeur, ornate boulevards, stadiums, recreation centers, communal baths, and so on. Here, to begin with, the restraining function of interest and amortization is relaxed. It is not said that works in this character will be productive. It is said that they will contribute to the happiness and comfort of people, which is their justification, and it is generally true. And it is said, moreover: “Why should people wait until they can have saved the money for this extension of their happiness and comfort when they may have it immediately on credit? They will tax themselves to pay interest on the debt and to pay the principal of the debt as it comes due.”

But so even with pyramids in this very desirable meaning, let the impatience for them become extravagant and reckless, as it will and does, and let too much labor be moved by credit to the making of them all at once, and you may be sure of what will happen. To pay interest on the debt and then to pay the debt itself taxes will rise until people cannot afford to pay them. That is what they will say. But the reason they cannot afford to pay taxes is that they could not afford those very desirable unproductive things to begin with. Either they did not know this in time or they did not care. They may repudiate the debt, yet as you may consider society in the whole that will make no difference whatever, since it remains true that society in the whole is wanting all those other exchangeable human satisfactions, more important than sights and diversions, that might have been produced with the same labor in place of those well-intentioned and premature pyramids.

In another category are things that afterward turn into pyramids. This will happen when those by whom the credit was commanded have used it with bad judgment, or too much of it for a given result, or dishonestly, or to create a thing for which after all there is no demand, so that what they were pursuing was not a reality within reason of probability but a delusion of profit—and pursuing it with other people’s labor, other people’s money. Yet the thing itself may be magnificent, like the tallest skyscraper in a great city, so marvellous in its architectural and engineering features that people will come from great distances away for the thrill of looking at it. Whether or not in such a case given, the entire motive was profit, free of any will to aggrandizement, it is profit or loss that will determine the economic status of each new piece of wonder. If there is profit, if it can pay interest and put the debt to death out of its earnings, or, that is to say, if it can return to the common reservoir the credit that was borrowed, then it is not a pyramid. It is a thing productive, giving increase. But if there is loss, so that interest and amortization cannot be met out of the increase, out of the earnings, out of the rents, then and exactly in the measure to which this is true, the thing is a pyramid. We say in that case the capital is lost. But what the loss of capital means is that the labor is lost, and again, no matter who specifically takes the loss, society as a whole is wanting all the imaginable other satisfactions that might have been produced in place of this pyramid.

By the same definition, the overbuilding of industry beyond any probable demand for the product represents devoured credit. Here the spirit of aggrandizement acts as if it were a biological law, each separate organization trying to outgrow all the others of its own kind in the industry of one country, and then that industry as a whole in one country trying to outgrow the competitive industry of another country, and this going on with benefit of more and more credit, until at last—what is the problem? The problem is that so much credit, that is to say labor, is trapped, frozen, locked up in the world’s industrial machine, that people cannot afford to buy the whole of its product at prices which will enable industry to pay interest on its debt. This is perhaps the most involved form of pyramid that human ingenuity has yet devised.

To see it clearly, you may have to push it to the focus of extreme absurdity. Suppose, for example, that half of all the capital in the world were invested in shoe-making machinery. You have there the capacity to make in one day many more shoes than there are feet in the world, and yet the necessity to pay interest on half the capital in the world and charge it to the price of shoes will make shoes so dear that nobody can afford to buy them. The answer is that all the capital invested in excess shoe-making machinery is lost. Nearly half the capital in the world! Half less the relatively small amount that may be properly so invested. Exactly. It is really lost. The labor it represents is lost. All the wanted things that this labor might have produced in place of that excess of shoe-making machinery—they are lost, and forever lost. You cannot recover the labor by unbuilding the machinery any more than Pharaoh could have recovered his wasted Egyptian labor by unbuilding the pyramid.

Then the invisible pyramids—what are they?

A delirious stock-exchange speculation such as the one that went crash in 1929 is a pyramid of that character. Its stones are avarice, mass-delusion and mania; its tokens are bits of printed paper representing fragments and fictions of title to things both real and unreal, including title to profits that have not yet been earned and never will be. All imponderable. An ephemeral, whirling, upside-down pyramid, doomed in its own velocity. Yet it devours credit in an uncontrollable manner, more and more to the very end; credit feeds its velocity.

In two years brokers’ loans on the New York Stock Exchange alone increased five billions of dollars. That was credit borrowed by brokers on behalf of speculators, and it was used to inflate the daily Stock Exchange quotations for those bits of printed paper representing fragments and fictions of title to things both real and unreal. It was credit that might have been used for productive purposes. The command of labor and materials represented by that amount of credit would have built an express highway one hundred feet wide from New York to San Francisco and then one from Chicago to Mexico City, with something over. Or taking wages at six dollars a day, it represents more than the six hundred million days of man power wasted by Pharaoh on his Cheops. But the use of it to inflate Stock Exchange prices added not one dollar of real wealth to the country.

You may think that since it was all a delusion on the profit side, the loss also must have been imaginary; that if nothing was added to the wealth of the country, neither was anything taken away. But that is not the way of it. First there was the direct loss of diverting that credit from all the possible uses of production to the unproductive use of speculation. Secondly, a great deal of it was consumed by two or three million speculators, large and small, who, with that rich feeling upon them, borrowed money on their paper profits and spent it. In this refinement of procedure what happens is that imaginary wealth is exchanged for real wealth; and the real wealth is consumed by those who have produced nothing in place of it. Thirdly—and this was the terrific loss—the shock from the headlong fall of this pyramid caused all the sensitive sources and streams and waters of credit to contract in fear. The more they contracted the more fear there was, the more fear the more contraction, effect acting upon cause. The sequel was abominable panic.

This is only the most operatic example of the pyramid invisible. Such a thing must be any artificial or inflated price structure, requiring credit to support it. The Federal Farm Board built two great pyramids in agriculture, one in wheat and one in cotton, and named them stabilization. It was using government credit, borrowed from the people, to support wheat and cotton prices. Nevertheless, wheat and cotton prices were bound to fall, and that credit was lost. There has been a vogue for pyramids by the name of stabilization. Scores of them have been built, private and public, all using credit in a more or less desperate effort to support prices that were bound for natural reasons to fall.

Foreign trade inflated by the credit we loaned to our foreign customers—that was a grand pyramid of a special kind, half visible and half invisible, partly real and partly unreal. The trade was visible; the idea of profit in it was largely a delusion. Almost we forgot that we were buying this trade with our own credit.

Moreover, of total loans out of the American credit reservoir to foreign countries, amounting grossly to fifteen billions of dollars, a great deal of it has been used not to inflate foreign trade but by the foreign borrowers to build pyramids of their own at our expense. This magnificent oddity, here only to be mentioned, will return in its due place.

A certain confusion may now be beginning to rise. Credit, again, regarded simply as a command of labor and materials. In that definition the mind makes no difficulty about relating it to ponderable things, such as pyramids in the form of public works or excess industrial capacity, for these are only certain physical objects in place of others that might have been wrought with the instrumentality of that same credit; it may, however, find some difficulty in relating it to imponderable things also called pyramids, such as a Wall Street ecstasy. For how does credit originate? Whose is it to begin with? How is command of it acquired? How does it get from where it originates to where it is found producing its prodigious effects?

All of this may be seen, and will be easier to do than you would think. To see credit rising at its source, to see whose it is to begin with, to see how it moves from the spring to the stream and then anywhere, even to the maelstrom, and to see at the same time Sumner’s Forgotten Man, you have only to go to the nearest bank and sit there for half an hour in an attitude of attention. Any bank will do. The first one you come to.

Observe first the physical arrangements. There will be along the counter a series of little windows, each with a legend over it. Above one window it will be “Savings.” Over the next two or three it will be “Teller.” Then one, “Discounts and Collections.” And at one side, where the counter ends, you will see behind a railing several desks with little metal plates on them, one saying “President,” another “Vice President,” and another “Cashier,” unless it is a very small bank, in which case the cashier will be behind one of the windows.

Then observe the people and what they come to do. Some go straight to the window marked “Savings.” These all bring money to leave with the bank at interest. One is a man in overalls. That is wage money to be saved. Another is a farmer’s wife, and that may be milk or butter money. Next the poultry man with some profit to be put aside. Then two or three housewives, evidently, such as regularly include in their budgets a sum to be saved. After these a foreman from the railroad and a garage mechanic, and so on. Each one puts money between the leaves of a little book and pushes it through the window; the man there counts it, writes the amount in the little book and pushes the book back to the depositor. That goes on all day. At the day’s end all the money received at this window is counted, bundled and tossed into the safe, and then written down in the big book of the bank as “Time Deposits.”

Those who go to the windows marked “Teller” are somewhat different. They represent local trade, commerce and industry. Their accounts are current, called checking accounts or credit balances. They bring both cash and checks to deposit; and besides making deposits they may tender their own checks to be cashed, often at the same time. For example, the man who owns the sash and blind factory brings nothing but checks to deposit; everybody owing him money has paid him by check. But he hires ten men and this is pay day. Therefore, needing cash to pay wages, he writes his own check for the amount of his pay roll and receives that sum in cash. But this money he takes away presently comes back to the bank through other hands. The employees of the sash and blind factory spend it with the grocer and butcher and department-store keeper who immediately bring it to the bank and deposit it at the “Teller” windows where it came from. What the employees of the sash and blind factory do not spend they themselves bring back to the bank and leave at the window marked “Savings.” Such is the phenomenon called the circulation of money. The same dollar may go out of the bank and return again two or three times in one week. The speed with which a dollar performs its work and returns to the bank is called the velocity of money.

At the end of the day the men at the “Teller” windows count up in one column what they have received and in another what they have paid out, and the difference is written down in the bank’s books as an increase or decrease of “Demand Deposits.” The rule is that more will have been received than was paid out, so there is normally each day an increase of deposits. It is normal that all these people representing local business should bring to the “Teller” windows more than they take away, because their activities are severally productive, giving always some increase, more or less according to the state of the times.

Well, then, this daily increase of “Demand Deposits” from the “Teller” windows is tossed into the safe, along with those “Time Deposits” from the window marked “Savings.” Thus the bank accumulates deposits—that is to say, money. What does it do with the money? A bank pays interest; therefore, a bank must earn interest. It must earn more interest than it pays out, else it cannot make a profit for itself. So the bank must lend its deposits. To receive money on which it pays interest and to lend money on which it receives interest—that is a bank’s whole business.

Now, what proportion of its total deposits do you suppose a bank lends? How much would you think it was safe to lend? The half? Three quarters? All? The fact is—and even those who know it well and take it for granted are astonished in those moments when they stop to reflect on it—the fabulous fact is that a bank may lend ten times its deposits. That is to say, for each actual dollar of other people’s money it has received and locked up in its safe, it may lend or sell ten dollars of credit money.

Not every bank does lend ten to one—ten dollars of credit to one of cash in the vault; but if you take the banking system entire it has the potential power to erect credit in that ratio to cash. Ten to one was the formula adopted by the United States Treasury and other Federal Government agencies in their campaign against hoarding. In official messages broadcast over the country people were exhorted to stop hoarding and bring their money back to the banks on the ground that each dollar of actual money in hiding represented a loss of ten in the credit resources of the country, and that each dollar of money brought back to the banks represented an increase of ten dollars in credit for the common benefit of trade, commerce and industry.

The beginning of all modern credit phenomena is in this act of multiplication, performed by the banker. How can a bank lend credit to the amount of ten times its cash deposits?

Perhaps the easiest way to explain it will be to tell the story of the old goldsmiths who received gold for safe keeping and issued receipts for it. These receipts, representing the gold, began to pass from hand to hand as money. Seeing this, and that people seldom touched the gold itself or wanted it back, so long as they thought it was safe, the goldsmiths began to issue paper redeemable in gold, without having the gold in hand to redeem it with. A very audacious idea. And yet it was sound, or at least it worked, and if a goldsmith was honest he was solvent because in exchange for that paper, which he promised to redeem in gold on demand, he took things of value, called collateral, in pledge, so that against his outstanding paper he had good assets in hand, and if people did come with his paper, wanting the gold on it, he had only to sell those assets, buy the gold, then redeem the paper according to his promise—always provided the assets were liquid and easily sold and that too many people never came at once, all demanding gold on the instant. Fewer and fewer people ever did want the actual gold. So long as they believed in the goldsmith they preferred to use his paper for all purposes of exchange—paper which no longer represented the actual gold and yet was as good as gold and was counted as gold because whenever anybody did want the gold it was forthcoming. From this evolved modern banking. That circulating paper itself became legal money against which the banks were obliged by law and custom to keep a certain amount of gold in hand, called the gold reserve. The next step was to discover that upon this structure of legal paper money with a gold reserve behind it you could impose another strata of paper—a new free kind, redeemable either in gold or legal paper money. That new free kind of paper was the bank check we all know; and the use of bank checks in place of actual money has increased by habit and necessity until now we transact more than nine tenths of all our business by check, no actual money passing at all, or almost none. In the year 1929, for example, the total amount of actual money of all kinds in the country was nine billions; but the total exchange of bank checks was 713 billions, or nearly eighty times all the actual money in existence.

What a bank now lends is credit in the form of a blank check book. You use the credit by writing checks against it. You may write a check for cash and draw out actual money in the form of gold or legal paper money, but if you do and spend the money it will go straight back to the bank. When you borrow at the bank, what happens? The banker does not hand you the money. He writes down in the bank’s own book a certain credit to your account and gives you a book of blank checks. Then you go out and begin to write checks against that credit. The people to whom you give the checks deposit them in the bank. As they deposit your checks the sums are charged to your account, deducted from your credit on the books. No actual money is involved.

If these last few passages have been difficult, take the fact lightly and without blame. Of all the discoveries and inventions by which we live and die this totally improbable helix of credit is the most cunning, the most liable, the least comprehended and, next to high explosives, the most dangerous. All that bankers themselves really know about it is how it works from day to day. Beyond that it is a gift from Pandora.

But you are still sitting in the local bank. Take it, if necessary, as an arbitrary fact that for each dollar of actual money that passes inward through those windows and stops in the safe the bank will have six, eight, maybe ten dollars of credit to lend. To whom does it lend this credit? And how?

There is a window yet to be observed, the one marked “Discounts and Collections.” The transactions at this window take more time. Papers are signed and exchanged. These people are borrowers; they are attending to their loans, paying them off, or paying something on account, or arranging to have their promissory notes extended. One is the local contractor who has had to have credit on his note to pay for materials and labor while building a house; the house is finished, he has been paid by the owner, and now he returns the credit by paying off his note—with a check. Another is the local automobile dealer who has just received from Detroit a carload of automobiles with draft attached, and the draft reads, “Pay at once.” To pay the draft he must borrow credit at the bank; as he sells the automobiles one by one in the community he will return the credit—by check. Another is the radio dealer who sells radios on the instalment plan. He is borrowing credit against which he will write a check to pay the radio manufacturer for ten sets; as security for the loan he gives his own promissory note, together with the ten purchase contracts of the ten local people to whom he has sold the radio sets. As they pay him he will pay the bank—by check. Another is a farmer who has sold his crop and now is paying back—by check—the credit he borrowed six months ago to buy fertilizer and some new farm machinery.

Lending of this character, to local people, the bank knowing all of them personally, is not only the safest kind of lending for the bank; it is the ideal use of credit. Unfortunately, the local demand for credit is not enough to absorb the bank’s whole lending power. From the savings of the community, always accumulating in the safe as cash deposits, the bank acquires a surplus lending power. Having satisfied its own customers with credit at the window marked “Discounts and Collections”, what will the bank do with the surplus credit? Well, now you will see how credit, so rising at the obscure local source, overflows the source and begins to seek outlets to the lakes and gulfs and seas beyond—how its adventures begin.

The first thing the bank thinks to do with a part of its surplus credit is to lend it to a big New York City bank.

What will the New York bank do with it? The New York bank may lend it to a merchant in domestic trade or to one in the foreign trade; it may lend it to a broker on the Stock Exchange who lends it to a speculator; it may lend it in Europe to the Bank of England or it may lend it to a German bank where the interest rate is very high. Fancy local American credit, originating as you have seen, finding its way from this naive source to a Berlin bank! Well, several hundreds of millions of just that kind of American credit did find its way to the banks of Germany and got trapped there in 1931. The German banks said they could not pay it back. That was what the moratorium was all about. Germany said if we insisted on having our credit back, her banks would simply shut up; she advised us to “freeze” it and leave it there on deposit in the German banks, in the hope that they might be able later to pay, and since there was nothing else to do we did that.

What else will the local bank do with its surplus credit? It will buy a United States government bond; it is simply lending this local credit to the Federal Government.

What will the Federal Government do with it? The Federal Government may give it to the Federal Farm Board to support those wheat and cotton pyramids; the Federal Government may give it to the Reconstruction Finance Corporation, which will lend it to the railroads; the Federal Government may give it to the Veterans’ Bureau, which will lend it to war veterans, or the Federal Government may spend it either to finish the memorial bridge across the Potomac River at Washington or for paper and lead pencils to be distributed on the desks of the Senate and House.

But the local bank has still a surplus of credit to lend. So far, by all the rules, it has been very conservative. The credit it has loaned to the big New York City bank is returnable on call. No worry about that. To get back the credit it has loaned to the United States Government it has only to sell the bond, and there is always an instant market for government bonds. So now the bank thinks it may take some risk, for the sake of obtaining a higher rate of interest.

You may notice a man talking very earnestly to the president at the desk behind the railing, and from something you read in his gestures you may take him to be a salesman. That is what he is—a bond salesman from Wall Street, and his merchandise this time is foreign bonds. He has some South American government bonds that pay seven per cent, and some German municipal bonds that pay eight per cent., and these are very attractive rates of interest, seeing that the bank pays its depositors only three and one half.

“You may think,” the salesman is saying to the president, “that such rates of interest as seven and eight per cent. imply some risk in these bonds. Really there is no risk. The bonds are absolutely good. Foreign borrowers have to pay high rates of interest in this country, not because they are anything but good and solvent borrowers, but because our people are strange to foreign investments. That being temporarily so, this is a rare opportunity for a little bank like yours to make some very profitable investments.”

So persuaded, the local bank with the remainder of its surplus credit buys foreign bonds. When it buys the bond of a South American Government, it is lending credit to that government, knowing no more about it than the salesman says. What will the South American Government do with that credit? Anything it likes, because it is a sovereign government; it may use it to build a gilded dome. Many new gilt domes have been built in foreign countries with just this kind of local American credit.

In buying the German bonds the bank is lending credit to the Free City of Bremen, perhaps, or to Cologne. What does the Free City of Bremen do with it? She may use it to widen the fairway of her harbor and build some new piers. The same credit might have been used to make ship channels and piers in the Hackensack Meadows of New Jersey. And what does Cologne do with it? She may use it to build a stadium or a great bathing pavilion for the happiness and comfort of her people. How strange! The local American community out of which this credit rises to perform such works in Germany has neither stadium nor swimming pool of its own. Or Cologne may use it to help build the largest new bridge in Europe across the Rhine, a bridge she really does not need, except to provide employment for her people. The same credit might be used to build a bridge across the Golden Gate at San Francisco.

One last observation before you leave the bank. How remote these people are from what is doing with the credit that rises from the dollars they leave at the windows! How little they know about it! Fancy telling that woman at the “Savings” window, who gets her money up in small bills from the deeps of an old satchel, that her dollars, multiplied ten times by the bank, will go to build ornaments for a grand boulevard in a little Latin-American country she never heard of, or to build workmen’s houses in a German city better than the house she lives in. Fancy telling the man in overalls who comes next that his money, multiplied ten times by the bank, will go to a speculator on the New York Stock Exchange, or to mend a cathedral in Bavaria, or to a foreign bank that may lose it unless the matter of reparations is somehow settled in Europe, or that it may be loaned to Germany in order that Germany may pay reparations to the Allies in order that they may be willing to pay something on account of what they owe to the United States Treasury.

Remember as you leave the bank that it was one of 25,000, big and little, all performing the same act of multiplication, all in the same general ways lending the product of multiplication, which is credit. You have seen only one spring in the woods. Think of 25,000 such springs in the land, all continually overflowing with credit, and how this surplus local credit, seeking interest, by a law as unerring as the force of gravity finds its way to the streams that lead away to the lakes, gulfs and seas beyond. If you will keep this picture in suspense, you will better understand what else happens, if and when it does—and it is bound to happen from a reckless or deluded use of the power of credit.

There is a change in the economic heavens. Some stars fall out. On the ground some pyramids collapse. For two or three weeks what the Wall Street reporters call a debacle on the Stock Exchange holds first-page news position. Then one day a New York City bank with 400,000 depositors must paste a piece of paper in its plate-glass window, saying: “Closed by order of the State Bank Examiner.” Of the surplus credit rising from the cash deposits of its forgotten 400,000 that bank has loaned too much on things such as afterward turn out to be pyramids—for example, skyscrapers.

Do you remember the old lady with the satchel at the window marked “Savings” in the small local bank? She has a friend in New York City who was one of the 400,000. She gets a letter from this friend, saying a bank these days is no place for one’s money. It will be safer, even though without interest, in many places a woman can think of. It may be the bottom of the flour can. So this old lady appears again at the window marked “Savings.” She wants all her money out. Then the man in overalls comes; he has heard something to the same effect and he wants all of his money out. These two would not matter to the great American banking system as a whole. But remember, this is one of 25,000 banks, in each one of which a few depositors are asking for their money back, all at one time. This, then, is the beginning of that contraction in all the springs and streams and waters of credit that was spoken of before.

What now takes place is the reverse of multiplication. It is deflation. The banker cannot control it. If he has multiplied credit in the ratio of ten for one, so, as his depositors take away their money, he must reduce credit in the same ratio. That is to say, for each dollar of cash that is taken out of his hands, he must call back from somewhere ten dollars of credit. Thus the vast and sensitive mechanism of credit, running at high speed, is put suddenly in reverse motion, with a frightful clashing of gears.

Return to the case of the little local bank, where you were sitting. As its depositors continue to withdraw cash, it must call in credit. First it sends word by telephone or telegraph to the big New York City bank, saying: “Please return our credit. We need it.”

But since the New York bank, remember, has loaned that credit out, it must in turn call it back from some one else. If it has loaned it on the Stock Exchange to brokers, who have loaned it to speculators, these must give it back. But suppose the New York City banks that supply the Stock Exchange with credit are all calling at the same time for it to be returned, because thousands of local banks all over the country, where the credit came from, are calling upon them to return it.

In that case the Stock Exchange brokers are sunk. They cannot replace the credit they are called upon to give up, because the sources of credit are now contracting. This being the fact, the brokers say to their customers, namely, the speculators: “We are sorry and this is awful, but there is no more credit. The banks are calling our loans. We cannot carry your securities any longer on credit. If you cannot pay for them in cash in the next fifteen minutes, we shall have to sell them for what they will bring, to save ourselves.”

From this cause there is a new day of panic on the Stock Exchange, a further debacle, with hideous wide headlines in the papers. Panic is advertised. The whirling Stock Exchange pyramid is falling, for want of credit to sustain it. This is an effect that becomes in turn a cause. Because of the headlong decline in prices on the Stock Exchange, in which the loss of imaginary wealth is measured, and for other reasons not exactly given, more banks fail. Each day the lines of anxious depositors grow longer. Thus the waters of credit continue to contract, and the rate is accelerated.

But suppose the New York bank has loaned the credit to a bank in Berlin and cannot get it back at all. What will it do in that case? For it is obliged either to return the credit to the small local bank that is demanding it back or confess itself insolvent. Well, in that case the New York bank must sell some securities out of its own reserve investments. But if all the New York banks are doing the same thing at the same time, as more or less they will be, the effect on the Stock Exchange is even worse. The banks will be selling bonds where speculators would be selling only stocks, and the effect upon the mind of the country from a fall in bonds is much more disturbing.

Now what you are looking at is liquidation. Credit is contracting because these thousands of forgotten bank depositors are calling for their money; and because credit is contracting everybody is calling at once for the return of it to its source, and there is no way for the person who last borrowed to return it but to sell something.

Suppose, however, that the local bank gets its credit back from the New York bank. It is not enough. Its depositors continue to take their money out; more credit must be called in—always, remember, ten for one. Somebody, somewhere, must give up ten dollars of credit for each dollar of actual money the depositors withdraw. The local bank next thinks of selling its South American bonds. That is another way of calling credit back. Somebody will have to buy the bonds, of course, but that simply means that whoever buys them from the bank will be taking the bank’s place as creditor of the South American Government that issued the bonds. The bank need not worry about who that buyer is; the transaction will take place in the open bond market, where the law of caveat emptor holds. Buyer, beware.

But when the local bank goes to sell its South American bonds it finds them quoted at thirty—the same bonds it paid ninety for. The South American Government is in financial trouble, and all the buyers standing in the bond market know it; that is why they will offer only thirty for the bonds. If the bank sells them at thirty it will have lost forever two thirds of the credit it loaned to the South American Government. Besides, if that is all it can get for the bonds, it will not greatly help to sell them. So it puts these bonds aside and looks at its German bonds. But German bonds also have collapsed. Their condition may be as bad, or worse, because Germany is in trouble. What else can the bank sell? It can sell its United States government bonds; yet even in these there is a considerable loss. They have declined in price under the selling of hundreds, thousands, of other banks all in the same dilemma, all tempted to sell their United States government bonds instead of worse bonds on which they cannot afford to take the loss.

Having got back the credit it loaned to the United States Government, by selling its United States government bonds, the local bank goes on for a while, paying off its depositors, exhorting them to desist, telling them everything will be all right, hoping for the best. Then one day the Bank Examiner from the Comptroller’s office at Washington comes unexpectedly to look at the books and decide if the bank is solvent. Having looked at the books he says: “See here! You have sold all of your best assets. Now to make your books balance with bad assets you still value them at what you paid for them. These foreign bonds, for example—still valued on your books at ninety and ninety-five when you know very well they are worth in the market to-day only thirty or thirty-five. You are not a solvent bank. You will have to close.”

Then the fatal piece of white paper is pasted on the plate glass, and all the depositors then at the windows asking for their money are put out.

That—almost exactly that—happened to 3,635 banks of all kinds in the two years 1930 and 1931. The deposits of these 3,635 ruined banks were more than 2½ billions of dollars.

It is easily forgotten that the depositor who stands outside to read the Bank Examiner’s verdict through the glass was the original lender.

Consider what it is a depositor does. It is clear enough that when he makes a deposit he is lending money to the bank. But what does the money represent? If it is earned money the depositor brings, it represents something of equal value produced by his own exertions, something he would sooner save than consume. It may be a cord of wood. Suppose it.

There are only a few things to do with a surplus cord of wood. If you store it for your own future use it represents earned leisure. If you exchange it with a neighbor for something else you want that is conversion by crude barter. In neither case is there any increase. It is all the time one cord of wood. You may sell it for money. If you hoard the money you have the equivalent of one cord of wood and yet no increase. But suppose you take the money to the bank and leave it there at interest. In that case you have loaned the bank your surplus labor to the value of a cord of wood, and there is the beginning of increase. Another industrious man, who is without tools, borrows money from the bank to buy an ax, a maul and some wedges. These tools represent your cord of wood. With these tools that man chops three cords of wood. One he wants for himself and two he sells. With the proceeds of one he returns to the bank the money he borrowed to buy the tools. He has still in his hand the proceeds of the third cord, which is profit or increase. Let him resolve, instead of spending the increase, to save it. He puts it in the bank. Now the bank has two cords of wood where there was but one before—not the cordwood itself, not the labor itself, but the money agent of labor; besides which are the tools still in the man’s hand. All this from one surplus cord of wood to begin with.

Thus we accumulate wealth, and there is no limit to it, provided the labor is not lost.

Now suppose a third man comes and borrows all of that money to build a toy in the meaning of a pyramid that has no economic value, or to make an unlucky speculation, or to buy something he is impatient to enjoy before he has produced anything of equivalent value and then afterward fails to produce the equivalent, so that it turns out that he is unable to pay interest or return the principal. We say in that case the money is lost. Really it is not. It still exists. But what the money represented is lost, and that was the amount of labor necessary to produce two cords of wood.

There is neither value nor power in money itself, only in what it represents. Every dollar of actual money should betoken that a dollar’s worth of wealth has been somewhere in some form produced; every dollar of credit multiplied upon that money by the banker should signify that somewhere in some form a dollar’s worth of wealth is in process of creation.

Anything that happens to money to debase it, to degrade its relation to the total sum of wealth, so as to impair its buying power, is something that happens to people who have loaned their labor to the banks.

Why do we confine the function of money issue to the government, and have very rigid laws concerning the exercise of that function by the government, and make counterfeiting a crime? All that is with the idea of keeping the value of money constant, for if money is permitted to increase faster than the wealth of things which we price in money, then the value of labor saved in the form of money will deteriorate like a cord of wood in the weather. When for any reason a government is moved to embrace legal counterfeiting, when it begins to issue spurious money—money that has no definite relation to any form of wealth in being or in process—the sequel is well known. There is progressive inflation, which, once it begins, there is no stopping or controlling, short of the final disaster. At the end, the savings of a lifetime, reconverted into money, may not be enough to buy a hat.

This we have learned about money itself, dimly. We have yet to learn it about credit, even dimly.

To any suggestion that the government shall set its printing presses free and flood the country with fiat money, all our economic intelligence reacts with no. Only those will say yes who are mentally or politically unsound. And if a government is obliged by vote of the unsound to do it, then everybody, including the unsound, will begin to hoard gold because gold is the one kind of money no government can make or dilute. Or if it were proposed that every bank should have the privilege to issue money as it might think fit, entirely in its own discretion, we should all know better. Even banks would say no to that. It is not only that people cannot trust private bankers with that privilege; private bankers would be unwilling to trust one another with it.

Yet on this jealously guarded base of money itself, banks are free to inflate and multiply credit, each in its own discretion, notwithstanding the fact that the inflation of money and the inflation of credit are similar evils, producing similar miseries. Inflation of credit—ecstasy, delusion, fantastic enrichment. Deflation of credit—depression, crisis, remorse. One state succeeds the other and there is no escape, for one is cause and one is effect.