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 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 ensuring 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 pursing it far in selfish and uneconomic ways are what they are bound to be and anciently were.
In place of one responsible Pharoah 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 Pharoahs, 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 installment 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 on 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 marvelous in its architecture 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 increase, out of 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 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 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. 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.
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 may 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.
A certain confusion may now be beginning to rise. Credit, again, is 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?
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 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.
--selected from Garet Garrett, A Bubble that Broke the World, 1932
Categories: Education, Monetary Policy
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