The Board's explanations of this rise in prices are pitifully weak. When first the price question was discussed in the Bulletin they apparently adhered to the explanation that the rise was due to changes on the monetary side of the equation of exchange. Gradually they changed their point of view until they began offering such reasons as a decline in production, an increase in demand and a growth in the inefficiency of labor. The inconsistency of their statements and their unwillingness to recognize the real reasons for the depreciation of the dollar reflect seriously upon the attitude of the members of the Board who should be motivated in their pronouncements by scientific considerations alone. Influenced perhaps by the attitude of the Board, the Secretary of the Treasury, in his annual report for 1919,169 offered as reason for the prevalent high prices the demand of the European belligerents as if that were explanation and justification. Demand, however, can not by itself alter the general price level which changes only in response to alterations in the volume of purchasing power. Through this period America was suffering from the curse of too much and too easy credit 170 just as Germany has been suffering since the armistice from a redundancy in her purchasing power media.

The year 1919 was mainly characterized by trading and speculation, speculation in securities, commodities and farm lands, and not by an increase in production or by any real prosperity. As Professor Mitchell puts it: "Such prosperity as we have had in 1919 has been business prosperity, not industrial prosperity. It represents high profits brought by active trading at rising prices, not by active production of useful goods. From the viewpoint of the national welfare it is an illusion produced by multiplying the values of most commodities by two and a fraction." 171

Even granting that it was not possible for the Board to have raised their rates through 1919, in January of 1920, when they were released from Treasury denomination, their rates should have been advanced immediately to levels equal to or slightly above market rates. During that month it will be remembered that the rate on ninety-day paper at the Federal Reserve Bank of New York was raised to only 6%, and the 7% rate did not become effective until the 1st of June. Perhaps the System, cling

170 See testimony of Professor Fisher, Stabilization of Purchasing Power of Money, p. 9.

171 Prices and Business in the Near Future, p. 4.

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ing to the idea that deflation might take place gradually, hesitated to raise rates suddenly fearing that this might precipitate a rapid and disastrous fall in prices. As we indicated before, a cyclic fall in prices once under way always proceeds rapidly. There can be no such thing as a gradual cyclic deflation. The Bank rate on ninety-day paper should have been raised in January to 7%. It is not unusual for central banks to raise their rates sharply. The rate at the Bank of England rose from 3% on July 29 to 10% on August 1, 1914. Furthermore, had Bank rates been raised sharply in America, had deflation set in at that time, the farmers could not have complained as they did later that the rise was deferred until they had planted their crops.

The System did well in abolishing preferential rates on trade acceptances. These should not be reëstablished until the quality of the trade acceptance in America has vastly improved. Abolishing the preferential rates on war paper on December 30, 1919, was an excellent step. Why they should have been reestablished on January 23, 1920, is beyond understanding. Not only did the System favor war paper by low rates but favored it in still another manner in that it extended loans to member banks on their notes collateralled by government obligations to the full par value of those securities even though Liberty bonds (1st 414's) fell in the post-armistice period as low as eighty-four dollars.172

In its vast purchases of bankers' acceptances through 1919 the System must be greatly censored. This action simply created more purchasing power and to that extent sent prices to higher levels. In the upward swing of the cycle the openmarket operations of central banks should be greatly curtailed if not entirely discontinued.

Not as yet can we say that the System has developed a clear cut discount policy. Obstacles in the form of Treasury policies, the vagueness of the Board's theory of prices, their doubts as to the efficacy of the Bank rate prevented this. They wavered in theory and practice. With indifferent success they relied on methods other than the Bank rate to achieve deflation. It was with this state of mind, with a vagueness as regards fundamentals, that the Board entered into the period of deflation.

172 The Financial Review, 1921, p. 226. This practice was given up by the Federal Reserve Bank of New York on July 1, 1921, after which date it loaned on government obligations up to only their market value. The Commercial and Financial Chronicle, June 4, 1921, p. 2366.

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CHAPTER VIII

DEFLATION

It was in May of 1920 that wholesale commodity prices reached their maximum in the United States at 147% above their average level for 1913.1 Prices had reached a maximum in England and Japan during March; in France and Italy, during April; in India and Canada, during May; in Sweden, during June, in the Netherlands, during July; and in Australia, during August.2 Within the short space of five months wholesale prices had turned downwards in the greater part of the world. Only in those countries where budgets were met by constant outpourings of paper money did prices continue upwards. The price declines affected oriental and occidental nations, the northern and southern Hemispheres, absolute monarchies and democracies alike. It respected no boundary of race or nationality. It was world wide. In America the general wholesale price index continued downwards, declining rapidly at first and then more slowly, until it reached a minimum of 138 in January of 1922.

The Japanese Crisis. The first forewarning of the general decline in prices was the collapse of the silk market in Japan in March of 1920. Except for a short crisis immediately following the outbreak of hostilities in Europe Japan prospered and buzzed with activity during the Great War. She profited enormously by the operation of her merchant marine and the growth of her export trade. Many new financial and trading corporations were formed. New capital flotations reached enormous

1 It will be remembered that it was during the latter part of April that the retail price cutting movement began in America. (The Financial Review, 1921, p. 31.) At the St. Louis fur auction held on May 11 prices dropped from 20-30% and at the wool auction held in Boston on the 20th of the month from 10-20%. The Bureau of Labor index number of wholesale prices recorded a decline of four points in the index number of June over that of May, the greatest declines taking place in cloths and clothing which fell from 328-314, in farm products which fell from 241-237 and in building materials which fell from 293-275.

2 Report of the Joint Commission of Agricultural Inquiry, Part I, p. 58.

figures.3 Prices rose in Japan during and after the war as they did throughout the rest of the world. The inpourings of gold, resulting from her increased export trade, caused notes and deposit currency to swell and prices to soar even higher than they did in the United States.

The tremendously high prices prevailing through the latter

3 For statistics see Federal Reserve Bulletin, 1920, p. 961.

4 Sources: Résumé Statistique de L'Empire du Japon, 1922, p. 67. Federal Reserve Bulletin, 1920, p. 1077; 1921, pp. 208, 1300.

part of 1919 reversed the flow of trade.5 Imports increased and grew to exceed the value of the goods shipped abroad. Foreseeing a loss of gold through this "adverse" trade balance the officials of the Bank of Japan became greatly concerned. They raised their discount rates and urged that private banks likewise conserve credit.

The contraction of credit coupled with a Chinese boycott was reflected in falling prices and in the collapse of the silk market in March. From January to May 1920, the index number of the price of raw silk in Yokohoma had fallen by more than 50% from 520 to 243. As a result of the confusion, uncertainty and lack of confidence prevailing everywhere, heavy sales of securities occurred with the result that on the 15th of March the Tokyo Stock Exchange was closed for two days. The failure of the Masuba Billbrokers' Bank on April 5 led to the closing of the Tokyo Exchange a second time and in addition the Osaka and Nagoya Exchanges were closed. After receiving as

6 Source: Report of the Joint Commission of Agricultural Inquiry, Part II, p. 36.