Irving Fisher

“ The strongest firms are left to build up a new credit structure. The continuous fall of prices has made it impossible for most borrowers to pay the old high rates of interest; the demand for loans diminishes, and interest falls to a point such that borrowers can at last pay it. Borrowers again become willing to take ventures; failures decrease in number; bank loans cease to decrease; prices cease to fall; borrowing and carrying on business become profitable; loans are again demanded; prices again begin to rise, and there occurs a repetition of the upward movement already described. ”

“ People are less hasty to spend money or checks when the dollars they represent are rising in purchasing power. The Q's (or quantities in trade) decline because (1) the initiators of trade—the enterpriser-borrowers—are discouraged; (2) the inertia of high prices can be overcome only by a falling off of expenditures; (3) trade against money which alone the Q's represent gives way somewhat to barter. For a time there is not enough money to do the business which has to be done at existing prices, for these prices are still high and will not immediately adjust themselves to the sudden contraction. ”

“ If banks are conservative in making loans during the periods of rising prices, and the expansion of credit currency is therefore limited, the rise of prices is likewise limited, and the succeeding fall is apt to be less and to take place more gradually. If there were a better appreciation of the meaning of changes in the price level and an endeavor to balance these changes by adjustment in the rate of interest, the oscillations might be very greatly mitigated. It is the lagging behind of the rate of interest which allows the oscillations to reach so great proportions. ”

“ He never dreams that he ought to lay by a sinking fund because the decrease in purchasing power of money is reducing the real value of his principal. Again, the stockholder and enterpriser generally are beguiled by a vain reliance on the stability of the rate of interest, and so they overinvest. ”

“ IV.13 The first cause of the unhealthy increase in trade lies in the fact that prices, like interest, lag behind their full adjustment and have to be pushed up, so to speak, by increased purchases. This is especially true in cases where the original impetus came from an increase in money. The surplus money is first expended at nearly the old price level, but its continued expenditure gradually raises prices. In the meantime the volume of purchases will be somewhat greater than it would have been had prices risen more promptly. ”

“ For when prices are likely to rise, people rush to borrow money and buy goods, and thus help prices to rise; business is inflated, and is managed recklessly and wastefully; those working on borrowed capital pay back less real value than they borrowed, and enrich themselves at the expense of the community. When afterwards credit is shaken and prices begin to fall, every one wants to get rid of commodities which are falling in value and to get hold of money which is rapidly rising ”

“ But the rise in interest, though belated, is progressive, and, as soon as it overtakes the rate of rise in prices, the whole situation is changed. If prices are rising at the rate of 2 per cent per annum, the boom will continue only until interest becomes 2 per cent higher. It then offsets the rate of rise in prices. The banks are forced in self-defense to raise interest because they cannot stand so abnormal an expansion of loans relatively to reserves. As soon as the interest rate becomes adjusted, borrowers can no longer hope to make great profits, and the demand for loans ceases to expand. ”

“ There will, in consequence, be little if any adjustment in lowering nominal interest. Because interest is hard to pay, failures continue to occur. There comes to be a greater hesitation in lending on any but the best security, and a hesitation to borrow save when the prospects of success are the greatest. Bank loans tend to be low, and consequently deposits (M') are reduced. The contraction of deposit currency makes prices fall still more. Those who have borrowed for the purpose of buying stocks of goods now find they cannot sell them for enough even to pay back what they have borrowed. ”

“ But, as a matter of fact, the business man's profits will rise more than this because the rate of interest he has to pay will not adjust itself immediately. Among his costs is interest, and this cost will not, at first, rise. Thus the profits will rise faster than prices. Consequently, he will find himself making greater profits than usual, and be encouraged to expand his business by increasing his borrowings. These borrowings are mostly in the form of short-time loans from banks; and, as we have seen, short-time loans engender deposits. ”

“ Trade (the Q's) will be stimulated by the easy terms for loans. This effect is always observed during rising prices, and people note approvingly that "business is good" and "times are booming." Such statements represent the point of view of the ordinary business man who is an "enterpriser-borrower." They do not represent the sentiments of the creditor, the salaried man, or the laborer, most of whom are silent but long-suffering,—paying higher prices, but not getting proportionally higher incomes. ”

“ When such a "money famine" exists, there is no way of doing all the business except by eking out money transactions with barter. But while recourse to barter eases the first fall of prices, the inconvenience of barter immediately begins to operate as an additional force tending to reduce prices by inducing sellers to sell at a sacrifice if only money can be secured and barter avoided ”

“ Failures result, constituting a commercial crisis. A reaction sets in; a reverse movement is initiated. A fall of prices, once begun, tends to be accelerated for reasons exactly corresponding to those which operate in the opposite situation. ”

“ Oscillations are set up which, though tending to be self-corrective, are continually perpetuated by fresh disturbances. Any cause which disturbs equilibrium will suffice to set up oscillations. One of the most common of such causes is an increase in the quantity of money.*51 Another is a shock to business confidence (affecting enterprise, loans, and deposits) . A third is short crops, affecting the Q's. A fourth is invention.
IV.30 The factors in the equation of exchange are therefore continually seeking normal adjustment. ”

“ So, although the gains of the enterpriser-borrower may exert a psychological stimulus on trade, though a few unemployed may be employed, and some others in a few lines induced to work overtime, and although there may be some additional buying and selling which is speculative, yet almost the entire effect of an increase of deposits must be seen in a change of prices. ”

“ In fact, from the point of view of those who are selling goods, it is the possibility of a greater volume of sales at the old prices which gives encouragement to an increase of prices. Seeing that they can find purchasers for more goods than before at the previously prevailing prices, or for as many goods as before at higher prices, they will charge these higher prices. ”

“ As the autumn periods of harvesting and crop moving approach, there is a tendency toward a lower level of prices, followed after the passing of this period and the approach of winter by a rise of prices.
§ 6 IV.33 In the present chapter we have analyzed the phenomena characteristic of periods of transition. We have found that one such "boom" period leads to a reaction, and that the action and reaction complete a cycle of "prosperity" and "depression." ”

“ IV.15 We next observe that the rise in prices—fall in the purchasing power of money—will accelerate the circulation of money. We all hasten to get rid of any commodity which, like ripe fruit, is spoiling on our hands.*46 Money is no exception ”

“ A ship in a calm sea will "pitch" only a few times before coming to rest, but in a high sea the pitching never ceases. While continually seeking equilibrium, the ship continually encounters causes which accentuate the oscillation. ”

“ This produces profits for the enterpriser-borrower, and his demand for loans further extends deposit currency. This extension still further raises prices, a result accentuated by a rise in velocities though somewhat mitigated by an increase in trade. When interest has become adjusted to rising prices, and loans and deposits have reached the limit set for them by the bank reserves and other conditions, the fact that prices no longer are rising necessitates a new adjustment. Those whose business has been unduly extended now find the high rates of interest oppressive. ”

“ IV.4 The transition periods may be characterized either by rising prices or by falling prices. Rising prices must be clearly distinguished from high prices, and falling from low. With stationary levels, high or low, we have in this chapter nothing to do. Our concern is with rising or falling prices. Rising prices mark the transition between a low and a high level of prices, just as a hill marks the transition between flat lowlands and flat highlands. ”

“ As is well known, the correspondence between loans and deposits is remarkably exact.*42 Therefore, deposit currency (M') will increase, but this extension of deposit currency tends further to raise the general level of prices, just as the increase of gold raised it in the first place.*43 Hence prices, which were already outstripping the rate of interest, tend to outstrip it still further, enabling borrowers, who were already increasing their profits, to increase them still further. ”

“ Even when interest begins to fall, it falls slowly, and failures continue to occur. Borrowers now find that interest, though nominally low, is still hard to meet. Especially do they find this true in the case of contracts made just before prices ceased rising or just before they began to fall. ”