pecuniary profit cannot guide their efforts with certainty toward their own ideals of public welfare.

3. Even from the point of view of business, prospective profit is an uncertain flickering light. Profits depend upon two variables, on margins between selling and buying prices, and on the volume of trade. These are related to each other in unstable fashion and each subject to perturbations from a multitude of unpredictable causes. That the system of prices has its own order is clear; but it is not less clear that the order fails to afford certainty of business success. Men of long experience and proved sagacity often find their calculations upset by conjunctures which they could not anticipate. Thus the money economy confuses the guidance of economic activity by interjecting a large element of chance into every business venture.

4. The hazards to be assumed grow greater with the extent of the market and with the time that elapses between the initiation and the fruition of an enterprise. But the progress of industrial technique is steadily widening markets, and requiring heavier investments of capital for future production. Hence the share in economic leadership that falls to lenders, that of receiving the various chances offered them for investment, presents increasing difficulties. And a large proportion of these investors, particularly the lenders on long time, lack the capacity and the training for the successful performance of such work.

These defects in the system of guiding economic activity and the bewildering complexity of the task itself allow the processes of economic life to fall into those recurrent disorders which constitute crises and depressions.

B. THE ECONOMIC CYCLE

100. The Periodicity of Commercial Crises

BY J. S. NICHOLSON

Attention has often been called to the periodicity of crisis. After the occurrence of a crisis, there is, in general, a period of depression with restricted confidence and want of enterprise. That the depression is real, in the sense of affecting the producing and consuming powers of the people, is shown by various kinds of statistics. There is, in general, a falling off in the employment of labor and an increase in pauperism; as regards capital, falling profits are shown by the income tax returns, and the contraction of enterprise

"Adapted from Principles of Political Economy, II, 211-214 (1893).

is evidenced by the reduction in the flotation of companies; the slackening of trade is revealed by the statistics of exports and imports, by the diminution of the returns of the clearing-houses and railway receipts; and the yield to taxes on commodities shows directly the decrease in consuming power. A low rate of interest, an abundance of "money," a fall in all the more speculative securities, especially compared with those of the first class, point to a contraction of enterprise and a check to the expansion of industry.

Gradually the period of depression gives place to a steady quiet improvement, which is shown by similar statistical evidence. As a rule, also, there is a slight upward, movement in the prices of commodities, and of the securities with dividends dependent on trade. An improved demand for "money" is shown by the gradual rise in the rate of discount and a corresponding fall in the price of firstclass securities with fixed interest. The period of steady prosperity, in its turn, gives way to a period of inflation culminating in a crisis.

It is hazardous to express an opinion on the causes of periodicity at a time when the periodicity itself seems questionable, but I venture to suggest that the causes should be sought for rather in mental than in physical phenomena. The most striking features in the well-marked cycles up to 1866 were the contraction, expansion, inflation and final explosion of credit. The cycles were especially credit cycles, and the effects on trade were apparently indirect. No one now will question the importance of the organization of credit. in production and consumption. But credit, although requiring for its full development certain material appliances, is essentially mental. Nothing, however, is more characteristic of mental phenomena than the oscillations between periods of depression, recovery and exaltation. This is shown in an exaggerated form in nervous disorders. It may well happen that the fear and distrust excited by a panic fade away in two or three years and give place to a sense of security, which in turn engenders over-confidence, and finally speculative mania. Of course some people will remain relatively cautious, and indeed the great mass of business may be conducted on sound principles, but it is sufficient to account for the phenomena if any considerable section of the financial world goes through these emotional stages. The sympathy of markets is well known, both in inflation and depression. The failure in recent years of the periodicity to assert itself in so marked a manner as before may be due to some great restraining influence, such as the continuous fall in prices, or the suppressed fear of the outbreak of a general war.

ΙΟΙ. The Rhythm of Business Activity®

BY WESLEY C. MITCHELL

With whatever phase of the business cycle analysis begins, it must take for granted the conditions brought about by the preceding phase, postponing explanation of these assumptions until it has worked around the cycle and come again to its starting-point.

A revival of activity, then, starts with a legacy from depression: a level of prices low in comparison with the prices of prosperity, drastic reductions in the costs of doing business, narrow margins of profit, liberal bank reserves, a conservative policy in capitalizing business enterprises and in granting credits, moderate stocks of goods, and cautious buying.

Such conditions are accompanied by an expansion in the physical volume of trade. Though slow at first, this expansion is cumulative. In time an increase in the amount of business which grows more rapid as it proceeds will turn dulness into activity. Left to itself this transformation is effected by slow degrees; but it is often hastened by some propitious event, such as exceptionally profitable harvests, or heavy purchases of supplies by the government.

etc.

A partial revival of industry soon spreads to all parts of the business field. For the active enterprises must buy materials and current supplies from other enterprises, the latter from still others, Meanwhile all enterprises which become busier employ more labor, use more borrowed money, and make higher profits. There results an increase in family incomes and an expansion of consumers' demands, which likewise spreads out in ever-widening circles. Shopkeepers pass on larger orders to wholesale merchants, manufacturers, importers, and producers of raw materials. All these enterprises increase the sums they pay to employees, lenders, and proprietors. In time the expansion of orders reaches back to the enterprises from which the initial impetus was received, and then the whole complicated series of reactions begins afresh at a higher pitch of intensity. All this while the revival of activity is instilling a feeling of optimism among business men.

The cumulative expansion of the physical volume of trade stops the fall in prices and starts a rise. For, when enterprises have in sight as much business as they can handle with existing facilities, they stand out for higher prices on additional orders. This policy prevails because additional orders can be executed only by breaking in new hands, starting new machinery, or buying new equipment.

"Adapted from Business Cycles, 571-579. Copyright by the author (1913). Published by the University of California Press.

The expectation of its coming hastens the advance. Buyers are anxious to secure large supplies while the quotations continue low, and the first signs of an upward trend bring out a rush of orders.

The rise of prices spreads rapidly; for every advance puts pressure on someone to recoup himself by advancing the prices of what he has to sell. The resulting changes in price are far from even: retail prices lag behind wholesale, and the price of finished products behind the price of their raw materials. Among the last-mentioned the prices of mineral products reflect changed business conditions more regularly than do the prices of forest and farm products. Wages rise more promptly, but in less degree than wholesale prices; interest rates on long loans always move sluggishly in the earlier stages of revival, while the prices of stocks both precede and exceed commodity prices on the rise.

In a great majority of enterprises larger profits result from these divergent fluctuations coupled with the greater physical volume of sales. For while the prices of raw materials and of bank loans often rise faster than selling prices, the prices of labor lag far behind, and the prices making up supplementary costs are mainly stereotyped by old agreements.

The increase of profits, under the spell of optimism, leads to a marked expansion of investments. The heavy orders for machinery, the large contracts for new construction, etc., which result, swell still further the physical volume of business, and render yet stronger the forces which are driving prices upward.

Indeed, the salient characteristic of this phase of the business cycle is the cumulative working of the various processes which are converting a revival of trade into intense prosperity. Not only does every increase in the volume of trade cause other increases, every convert to optimism make new converts, and every advance in price furnish an incentive for new advances; but the growth of trade also helps to spread optimism and to raise prices, while optimism and rising prices support each other. Finally the changes going forward swell profits and encourage investments, while high profits and heavy investments react by augmenting trade, justifying optimism, and raising prices.

While the processes just sketched work cumulatively for a time to enhance prosperity, they also cause a slow accumulation of stresses within the balanced system of business---stresses which ultimately undermine the conditions upon which prosperity rests.

Among these is the gradual increase in the cost of doing business. The decline in supplementary costs per unit ceases when enterprises have secured all the business they can handle with their standard equipment, and a slow increase in these costs begins when

the expiration of old contracts makes necessary renewals at higher rates. Meanwhile prime costs rise at a relatively rapid rate. The price of labor rises both because of an advance in nominal wages and because of higher rates for overtime. More serious is a decline. in the efficiency of labor, because of the employment of undesirables, and because crews cannot be driven at top speed when jobs are more numerous than men. The prices of raw material rise faster on the average than the selling prices of products. Finally numerous small wastes creep up when managers are hurried by the press of orders. A second stress is the accumulating tension of investment and money markets. The supply of funds available at the old rates. fails to keep pace with the swelling demand. It becomes difficult to negotiate new issues of securities except on onerous terms, and men of affairs complain of the "scarcity of capital." Nor does the supply of bank loans, limited by reserves, grow fast enough to keep up with the demand. Active trade keeps such an amount of money in circulation that the cash left in the banks increases rather slowly. On the other hand, the demand for loans grows,. not only with the physical volume of trade, but also with the rise of prices, and with the desire of men of affairs to use their own funds for controlling as many businesses as possible.

Tension in the bond and money markets is unfavorable to the continuance of prosperity, not only because high rates of interest reduce the prospective margins of profit, but also because they check the expansion of the volume of trade out of which prosperity develops. Many projected ventures are relinquished because borrowers conclude that interest would absorb too much of their profits.

The group producing industrial equipment suffers especially. In the earlier stages of prosperity this group enjoys exceptional activity. But when the market for bonds becomes stringent and the cost of construction high, business enterprises defer the execution of plans for extending old or erecting new plants. As a result contracts for this kind of work become less numerous as the climax of prosperity approaches. Then the steel mills, foundries, machine factories, lumber mills, construction companies, etc., find their orders for future delivery falling off.

The larger the structure of prosperity, the more severe become these internal stresses. The only effective means of preventing disaster while continuing to build is to raise selling prices time after time high enough to offset the encroachment of costs upon profits. and to keep investors willing to contract for fresh industrial equip

ment.