CREDIT CYCLES.
#87. Industry is Periodic#. Everybody ought to understand that trade
varies in activity, from time to time, in a periodic manner. #A thing is
said to vary periodically, when it comes and goes at nearly equal
intervals# like the sun, or rises and falls like the tides. Now, in
industry, as Mr. William Langton pointed out twenty years ago, there are
tides almost as regular as those of the sea. Shakespeare says truly--
"There is a tide in the affairs of men,
Which, taken at the flood, leads on to fortune."
Some of these tides depend upon the seasons of the year; business is
more active in the spring and summer, and falls off in winter. It is
comparatively easy to borrow money in January, February, March, June,
July, August, and September; October and November are particularly bad
months; the rate of interest then often runs up rapidly, and the
bankruptcies in these months are more numerous than at any other time of
year. April and May are also dangerous months, but in a less degree. Men
of business should always bear these facts in mind, and, by being
prepared beforehand, they may escape disaster.
There is also a much longer kind of tide in business, which usually
takes somewhere about ten years to rise and fall. The cause of this tide
is not well understood, but there can be no doubt that in some years
men become confident and hopeful. They think that the country is going
to be very prosperous, and that if they invest their capital in new
factories, banks, railways, ships, or other enterprises, they will make
much profit. When some people are thus hopeful, others readily become so
too, just as a few cheerful people in a party make everybody cheerful.
Thus the hopefulness gradually spreads itself through all the trades of
the country. Clever men then propose schemes for new inventions and
novel undertakings, and they find that they can readily get capitalists
to subscribe for shares. This encourages other speculators to put forth
proposals, and when the shares of some companies have risen in value, it
is supposed that other shares will do so likewise. The most absurd
schemes find supporters in a time of great hopefulness, and there thus
arises what is called a bubble or mania.
#88. Commercial Bubbles or Manias.# When the schemes started during a
bubble begin to be carried out, great quantities of materials are
required for building, and the prices of these materials rise rapidly.
The workpeople who produce these materials then earn high wages, and
they spend these wages in better living, in pleasure, or in buying an
unusual quantity of new clothes, furniture, &c. Thus the demand for
commodities increases, and tradespeople make large profits. Even when
there is no sufficient reason, the prices of the remaining commodities
usually rise, as it is called, #by sympathy#, because those who deal in
them think their goods will probably rise like other goods, and they buy
up stocks in the hope of making profits. Every trader now wants to buy,
because he believes that prices will rise higher and higher, and that,
by selling at the right time, the loss of any subsequent fall of prices
will be thrown upon other people.
This state of things, however, cannot go on very long. Those who have
subscribed for shares in new companies have to pay up the calls, that
is, find the capital which they promised. They are obliged to draw out
the money which they had formerly deposited in banks, and then the
bankers have less to lend. Manufacturers, merchants, and speculators,
who are making or buying large stocks of goods, wish to borrow more and
more money, in order that they may have a larger business, the profit
seeming likely to be so great. Then according to the laws of supply and
demand, the price of money rises, which means that the rate of interest
for short loans, from a week to three or six months in duration, is
increased. The bubble goes on growing, until the more venturesome and
unscrupulous speculators have borrowed many times as much money as they
themselves really possess. #Credit is said to be greatly extended#, and
a firm, which perhaps owns a capital worth ten thousand pounds, will
have undertaken to pay two or three hundred thousand pounds, for the
goods which they have bought on speculation.
But the sudden rise which, sooner or later, occurs in the rate of
interest, is very disastrous to such speculators; when they began to
speculate interest was, perhaps, only two or three per cent.; but when
it becomes seven or eight per cent., there is fear that much of the
profit will go in interest paid to the lenders of capital. Moreover,
those who lent the money, by discounting the speculators' bills, or
making advances on the security of goods, become anxious to have it paid
back. Thus the speculators are forced at last to begin selling their
stocks, at the best prices they can get. As soon as some people begin to
sell in this way, others who hold goods think they had better sell
before the prices fall seriously; then there arises a sudden rush to
sell, and buyers being alarmed, refuse to buy except at much reduced
rates. The bad speculators now find themselves unable to maintain their
credit, because, if they sell their large stocks at a considerable
loss, their own real capital will be quite insufficient to cover this
loss. They are thus unable to pay what they have engaged to pay, and
#stop payment#, or, in other words, become bankrupt. This is very
awkward for other people, manufacturers, for instance, who had sold
goods to the bankrupts on credit; they do not receive the money they
expected, and as they also perhaps have borrowed money while making the
goods, they become bankrupt likewise. Thus the #discredit# spreads, and
firms even which had borrowed only moderate sums of money, in proportion
to their capital, are in danger of failing.
#89. Commercial Crisis or Collapse.# The state of things described in
the last section is called a commercial collapse, because there is #a
sudden falling in of prices, credit, and enterprise#. It is also called
#a Crisis, that is, a dangerous and decisive moment# (Greek, krino,
_to decide_), when it will soon be seen who is to become
bankrupt, and who not. No sooner has such a crisis arrived, than
everything changes. No one ventures to propose a new scheme, or a new
company, because he knows that people in general have great difficulty
in paying up what they promised to the schemes started during the
bubble. #This bubble is now burst#, and it is found that many of the new
works and undertakings from which people expected so much profit, are
absurd and hopeless mistakes. It was proposed to make railways where
there was nothing to carry; to sink mines where there was no coal nor
metal; to build ships which would not sail; all kinds of impracticable
schemes have to be given up, and the capital spent upon them is lost.
Not only does this collapse ruin many of the subscribers to these
schemes, but it presently causes workpeople to be thrown out of
employment. The more successful schemes indeed are carried out, and, for
a year or two, give employment to builders, iron-manufacturers, and
others, who furnish the materials. But as these schemes are completed
by degrees, no one ventures to propose new ones; people have been
frightened by the losses and bankruptcies and frauds brought to light in
the collapse, and when some people are afraid, others readily become
frightened likewise by sympathy. In matters of this kind men of business
are much like a flock of sheep which follow each other without any clear
idea why they do so. In a year or two the prices of iron, coal, timber,
&c., are reduced to the lowest point; great losses are suffered by those
who make or deal in such materials, and many workmen are out of
employment. The working classes then have less to spend on luxuries, and
the demand for other goods decreases; trade in general becomes
depressed; many people find themselves paupers, or spend their savings
accumulated during previous years. Such a #state of depression# may
continue for two or three years, until speculators have begun to forget
their failures, or a new set of younger men, unacquainted with disaster,
think they see a way to make profits. During such a period of
depression, too, the richer people who have more income than they spend,
save it up in the banks. Business men as they sell off their stocks of
goods leave the money received in the banks; thus by degrees capital
becomes abundant, and the rate of interest falls. After a time bankers,
who were so very cautious at the time of the collapse, find it necessary
to lend their increasing funds, and credit is improved. Then begins a
new credit cycle, which probably goes through much the same course as
the previous one.
#90. Commercial Crises are Periodic.# It would be a very useful thing if
we were able to foretell when a bubble or a crisis was coming, but it is
evidently impossible to predict such matters with certainty. All kinds
of events--wars, revolutions, new discoveries, treaties of commerce, bad
or good harvests, &c.--may occur to decrease or increase the activity of
trade. Nevertheless, #it is wonderful how often a great commercial
crisis has happened about ten years after the previous one#. During the
last century, when trade was so different from what it now is, there
were crises in or near the years 1753, 1763, 1772 or '3, 1783, and 1793.
In this century there have been crises in the years 1815, 1825, 1836-9,
1847, 1857, 1866, and there would probably have been a crisis in 1876 or
1877 had it not been for an exceptional collapse in America in 1873.
There is at present (February, 1878) the great depression of trade which
marks the completion of one cycle and the commencement of a new one.
Good vintage years on the continent of Europe, and droughts in India,
recur every ten or eleven years, and it seems probable that commercial
crises are connected with a periodic variation of weather, affecting all
parts of the earth, and probably arising from increased waves of heat
received from the sun at average intervals of ten years and a fraction.
A greater supply of heat increases the harvests, makes capital more
abundant and trade more successful, and thus helps to create the
hopefulness out of which a bubble arises. A falling off in the sun's
heat makes bad harvests and deranges many enterprises in different parts
of the world. This is likely to break the bubble and bring on a
commercial collapse.
Generally, #a credit cycle#, as Mr. John Mills of Manchester has called
it, will last #about ten years#. The first three years will witness
depressed trade, with want of employment, falling prices, low rate of
interest, and much poverty; then there will be perhaps three years of
active, healthy trade, with moderately-rising prices, a reasonable rate
of interest, fair employment, and improving credit; then come some years
of unduly-excited trade, turning into a bubble or mania, and ending in a
collapse, as already described. This collapse will occupy the last of
the ten years, so that the whole credit cycle will, on the average, be
as follows:--
|---------------------------------------------------------------|
| YEARS. |
|---------------------------------------------------------------|
| 1 2 3 | 4 5 6 | 7 8 | 9 | 10 |
|----------- |----------- |--------- |-----------|--------------|
| DEPRESSED | HEALTHY | EXCITED | _Bubble._ | _Collapse._ |
| | | | | |
| TRADE. | TRADE. | TRADE. | | |
|----------- |----------- |--------- |-----------|--------------|
#It is not to be supposed that things go as regularly as is here
stated;# sometimes the cycle lasts only nine, or even eight years,
instead of ten; minor bubbles and crises sometimes happen in the course
of the cycle, and disturb its regularity. Nevertheless, it is wonderful
how often the great collapse comes at the end of the cycle, in spite of
war or peace or other interfering causes.
91. #How to avoid Loss by Crises.# Now, these bubbles and crises are
very disastrous things; they lead to the ruin of many people, and there
are few old families who have not lost money at one collapse or another.
The working-classes are often much injured; many are thrown out of
employment, and others, not seeing why their wages should be reduced,
make things worse by strikes, which, after a collapse, cannot possibly
succeed. It is most important, therefore, that all people--working-people,
capitalists, speculators, and all connected with any kind of
business--should remember that #very prosperous trade is sure to be
followed by a collapse and by bad trade#. When, therefore, things look
particularly promising, investors should be unusually careful into what
undertakings they put their money. #As a general rule, it is foolish to
do just what other people are doing, because there are almost sure to be
too many people doing the same thing.# If, for instance, the price of coal
rises high, and coal-owners make large profits, there are certain to be
many people sinking new mines. Such a time is just the worst one for
buying shares in a coal-mine, because, in the course of a few years, there
will be a multitude of new mines opened, the next collapse of trade will
decrease the demand for coal, and then there will be great losses in the
coal business. This is what has happened in the last few years in England,
and the same thing has happened over and over again in other trades. As a
general rule, #the best time to begin a new factory, mine, or business of
any kind, is when the trade is depressed, and when wages and interest are
low#. Mining, building, or other work can then be done more cheaply than
at other times, and the new works will be ready to start just when
business is becoming active and there are few other new works opening.
This rule, indeed, does not apply to the schemers, speculators, or
#promoters#, as they are called, who start so many companies. These
people make it their business to have new schemes and shares to offer
just when people are in a mind to buy, that is, during a bubble or time
of excited trade. They take care to sell their own shares before the
collapse comes, and it is their dupes who bear all the loss. A prudent
man, therefore, would never invest in any new thing during a mania or
bubble; on the contrary, he would sell all property of a doubtful or
speculative value, when its price is high, and invest it in the very
best shares or government funds, of which the value cannot fall much
during the coming collapse. The wisest men have been deluded during
manias; and in the Library of the Royal Society is shown a letter from
Sir Isaac Newton requesting a friend to buy shares for him in the South
Sea Company, just at the moment when the South Sea Bubble was at its
worst. Let people take warning by Sir Isaac Newton, and never speculate
in a thing because other people are doing the same; then these bubbles
and collapses will be prevented, or will become much less disastrous.
Credit cycles will go on until the public learn to look out for them,
and act accordingly. Business men must become bold during depressed
trade, careful during excited trade, instead of acting exactly in the
opposite way. It is only a knowledge of these credit cycles which can
prevent them, and this is the reason why I have said so much about them
in this Primer.