Article by Irving Fisher published anonymously in The Yale Review on the financial panic of 1907

The Yale Review.


Fundamental Cause of the Panic; New Problem of Internal Waterways; Scientific Legislation in Wisconsin.

The recent sensational events in Wall Street have been the occasion of a great deal of discussion as to the present soundness or unsoundness of the industrial and commercial world, and as to the causes which have precipitated so sharp and sudden a panic. Among the causes assigned have been the character of the speeches of President Roosevelt and of Gov. Hughes, the evils of “frenzied finance” the organization and promotion of trusts with their “undigested securities” and their arbitrary effect on prices, and the particular characteristics of the individuals and firms who have failed.

While undoubtedly some of these factors have had an influence on the result, they have been merely precipitating causes and are of far less importance than the causes which have for years been making ready for present conditions. We refer to the progressive rise in prices due undoubtedly to the increasing supplies of gold.

If we turn back to the records of the early [18] fifties and sixties, we shall find the same phenomena of rapidly rising prices, enormous stimulation of trade, gradually rising rate of interest, strikes by working men the purchasing power of whose wages was falling, expansion of credit, and a crisis which in 1857 interrupted the otherwise steady movement of prices. Then, as now, few if any business men realized that a rise in prices not only makes an important disturbance for those with fixed salaries and receipts, and affects profoundly the relation between debtors and creditors, but that it gradually affects the rate of interest.

It has been generally believed that an increased supply of money would tend to lower the rate of interest. Although it is true that an increased supply of money to lend will tend to reduce the rate of interest, it is not true that a mere general increase in the supply of money in circulation will have that effect. The truth is that as money becomes more plentiful and its purchasing power decreases, it becomes necessary for the lender to recoup himself for the gradually sinking principal by increasing the rate of interest.

It would be better for the business world if the readjustment of the rate of interest could take place more promptly, and it is probable that such an adjustment might be brought about if those who make up commercial circles were aware that such an adjustment must sooner or later come about. Owing to their conservatism, rates of interest like all other terms of commerce are only slowly changed.

The common notion that the rates of interest were down to stay has operated to prevent borrowers from being willing to accept, or lenders to require any considerable rise in the rate of interest. In many cases banking institutions maintain a fixed rate from year to year, with almost scornful disregard of market conditions.

It is clear that if, as is now the case, the purchasing power of money is depreciating to the extent of something like four per cent, per annum, this amount would need to be added to the rate of interest in order fully to compensate for the change. The effect would be to bring the rate of interest up to something like seven or eight per cent. And yet, in spite of the gradual rise in the rate of interest during the last year, there are few contracts that have been put on so high a basis.

As usually happens in such cases, those who find themselves in difficulties lay the blame on the wrong factor. Those who have been financing large enterprises find themselves unable to repay, and complain of the high rates of interest which they now encounter in renewing their loans. The trouble, however, is not that the rate of interest is high, but that it had not already been high enough to prevent men from embarking on unprofitable ventures. While it is true that deposits of loanable funds from the government and individuals are at the present moment a benefit, generally speaking, the situation would have been improved during the last few years had the rate of interest been higher than it was. The fact that it was not higher led to speculative enterprises and put off the evil day of reckoning, which must always come when men wake from their dream and realize that they have left out of their calculations a general rise in prices.

We believe therefore that the fundamental factor in the situation is that the business world has not forecast the general rise in prices. As this general rise goes on steadily, it necessarily confounds all predictions which have been based upon the belief in relatively steady prices. Many who have plunged into speculative ventures find that their expenses, especially for interest, have unexpectedly risen and have begun to withdraw from their ill-fated enterprises. The result has necessarily been to involve many firms in financial difficulties. We are entering upon a commercial crisis, and if our analysis is correct the effect will not be confined to New York City nor this country.

A few years ago there was much complaint that the value of money was rising, and Mr, Bryan and his party were clamouring for a change in the standard which would produce a rise in prices. In a sense their wishes have been fulfilled, for gold unexpectedly turned from appreciation to depreciation. As a consequence we have had experience with the stimulation of business and the glittering appearance of prosperity which a rise in prices at first produces.

The time must come when the business world will take up in earnest the subject of a stable standard for debts, and seek to prevent the ebb and flow in the value of money which is able to produce the far-reaching evils alternately of contraction and inflation. There is perhaps no problem in the commercial and industrial world which can compare in importance with this problem of a stable standard of value. But as yet only an insignificant minority of those affected by fluctuations in the value of money are aware that such a problem exists.

The subject of improving our inland waterways seems destined to receive renewed attention in the immediate future, and to be viewed in a light quite different from that under which it has hitherto been regarded. For a generation and more, waterways in this country have been looked upon as the natural competitors of the railroads. The strongest argument for their improvement has been rather the effect they would have in regulating and reducing railway rates, than in actually diverting traffic from the railways. Now, however, there appears to be a disposition to regard them as a means of supplementing and assisting the railroads instead of competing with them. Not the least significant feature of this remarkable change in public opinion is the fact that the man whose words have done most to produce it is perhaps the leading railroad manager in the country. The cause of this change of attitude toward the waterways, both on the part of railroad men and the general public, is of course the enormous increase of traffic which has outrun the capacity of the railroads to handle. While these conditions continue, this new relation of railways and waterways will continue, but it can hardly be considered permanent. Sooner or later capital enough will be found to enlarge the capacity of the railroads to meet the volume of traffic, and when that time comes, competition between railways and waterways will begin again. The question of most importance to consider, therefore, in connection with this subject, is not whether waterways can be profitably developed as a means of helping the railroads out of their present difficulty, but whether the conditions of competition in the future are likely to be different from those in the past, so that the investment of labor and capital in waterways will prove as economical and profitable as in railroads. In other words, will the waterways stand any better chance during the next generation of sharing in our vast internal commerce than they have in the last?

In one respect the conditions of competition are likely to be much more favorable to the waterways in the future. The rapid building of railroads in this country between 1850 and the end of the [18] eighties resulted in the creation of a railway net, whose capacity for carrying traffic was vastly in excess of what the country had to furnish. Almost every railroad was in the position of being able to increase its traffic without increasing its fixed charges. The only considerable expense which additional traffic involved was in operating expenses, and of course any additional traffic which could be called into existence or attracted from other railroads or waterways by rates that would cover these expenses and anything more was eagerly sought. The result was more severe competition in the transportation industry here in America than in any other industry anywhere in the world. Against this competition the waterways of the country have been powerless to make any headway; and it is easy to see why. With numerous railroads either running parallel with them or to competitive markets, willing and able to carry traffic at rates that represented only a portion of the cost of the service, they could not hold the few kinds of traffic which they were fitted to carry. In the future all this is likely to be changed. The railroads have now no great investment of capital in roadbed, and terminal facilities, which are not fully utilized. To take on additional traffic they must secure a rate for carrying it, not only sufficient to cover operating expenses, but also to pay interest on the enormous capital necessary to rebuild and reequip their roadbed and enlarge their terminal facilities. The railroads in the future are never likely to be in a position to offer such low rates for the additional traffic they can attract from the waterways as they have been in the past. This circumstance rather than the great volume of tonnage on the German rivers or through the “Soo” Canal, so often cited, affords reasonable ground for thinking that waterways may play an important part in the transportation system of the country in the future.

An article appears below on the work of the Wisconsin Legislative Reference Library by one of its staff. This new movement is in many ways the most interesting experiment that has been made in the field of practical politics in recent years and deserves an additional word of comment.

An observing visitor to Madison, especially if himself an Easterner, is at once struck with an interesting and novel spectacle.

In the central square stands the State House and at the edge of the city looms the University “on the hill,” but instead of these two institutions representing two conflicting ideals, gazing at each other with mutual aloofness or scorn, we find the intervening avenue a highway of sympathetic intercourse between them. The legislator, perplexed with the intricacies of legal and economic problems which confront him, turns naturally to the university as a storehouse of available knowledge of past experiments and present needs. The academic scholar, so far as the subjects of his study permit, looks toward the State House as the field wherein his labors will bear the fruit of increased social welfare and higher social standards.

To a certain extent this may be the result of the university’s position as a State institution. As a salaried official of the government the scholar may feel a more direct call to apply his knowledge to the public service; as the voter of handsome appropriations from the public revenues the legislature may feel a keener anxiety to see that the state receives a more immediate and tangible return for its money than the general education of its young men and women. But deeper than any such quid pro quo motives lies a common motive to public service and the recognition of common rather than diverse aims, bringing about a genuine approach to that cooperation of the men who do and the men who think, which is of such great importance for the proper solution of any social problem. It is an admirable spectacle and one full of promise.

The chief connecting link between the two is found in the Legislative Reference Library. Under this modest name and starting from modest beginnings Mr. Charles McCarthy has built up a department of unique interest. His conviction was that the great majority of legislators are honest and mean to serve honestly the interests of the people whom they represent; but that on the other hand they are ignorant of the problems with which they have to deal, and inexperienced in legislative procedure, since it is the American practice to change the personnel of the legislature at each election. This double ignorance either leads the legislator into bungling law-making which proves useless or harmful], or makes him the prey of the crafty lobbyist, whose power lies less in the size of his cash-roll than in his superior knowledge and skill. The solution seemed to lie in providing a source of accurate and unbiased information for the legislator both as to the kind of law he wanted and as to the way in which to get his real purposes into statute form, A small appropriation, — too small to tempt the ordinary politician, — was available. The idea was active in the mind of an enthusiast who combined conviction and tact in unusual degree. The experiment was started, proved itself under the test, and grew to its present dimensions.

The object of this department is to secure from all sources any information that will throw light on a prospective piece of legislation, including especially facts regarding similar legislation in all other states and countries. This information must be so digested and arranged as to be both clearly intelligible and sufficiently condensed for the use of the busy legislator. Here the university serves two purposes. In the first place its professors are constantly at the service of the legislator whether the knowledge sought is in the field of law, history, economics, chemistry, mechanics, hygiene, or agriculture. In the next place its graduate students are drilled in the very work of research and tabulation of material which is essential to the reference library, constantly cooperate with it and furnish many experts to its staff. The work of this body is three- fold: (i) the “comparative,” which includes the gathering of laws and cases from all outside jurisdictions regarding any proposed piece of legislation; (2) the critical, which consists of securing critical information regarding the working of such laws including in addition to printed material a great collection of personal letters from those who have been able to watch their operation; (3) the constructive, which consists of scientific drafting of bills by expert and impartial lawyers, aiming to secure the real results desired and to avoid the errors or loopholes of similar legislation elsewhere.

The scheme must appeal to sensible men everywhere as a most interesting solution of many legislative problems. To many it will seem too good to be practical. If anything so good will work, why isn’t it universally adopted ? Now the important thing about the whole matter is that in Wisconsin it does work, and, to understand its working, it is necessary to appreciate the importance of the personal element of the problem. Probably the Wisconsin legislature is more open to such movements, and less suspicious of sinister motives, than some legislatures farther east, but more important has been the personality of the father of the movement. Mr. McCarthy combines with a native integrity and energy the technical training of a scholar (he is himself a member of the university faculty), and what is more important, an instinct for practical politics which is apparently a natural part of the Hibernian birthright. What the legislators came to trust first was not the institution but the man, and what the lobbyist who tried to conceal the negro in the woodpile came to fear was not so much an array of filing cases and a corps of cataloguers, as the growing tendency to go upstairs and “see what Mac has to say about it.” A sufficient appropriation will provide a well of pure information in any statehouse; the problem is to induce the average law-maker to drink of it. This was accomplished through tact and good-sense including a complete absence of officiousness, advertisement, or any attempt to pour the good water down unwilling throats.

It often happens, however, that a new method which depends in its experimental stage on some one person’s individuality, achieves a stability through its inherent efficiency. This seems to be the case in Wisconsin, where the institution has come to stay, and this is the feature that is particularly encouraging for its adoption elsewhere. Already many states have sent to the Wisconsin Legislative Library for men trained there to inaugurate similar systems. Much still depends on the character of the men who undertake such new enterprises, but with a successful example now firmly established, it is not too much to hope that the efficiency of the new device will make its own appeal, and that a radical and general change for the better will make itself felt throughout the field of State legislation.

Excerpted from PDF pg. 271 of The Yale Review Volume Sixteenth



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