Prosperity and Depression.pdf

Nature and Callses 0./ the CyclePart IIindirect investment through the banks may be mentioned as afactor which tends to accentuate the deflationary possibilities ofthe economic system. The public, instead of holding securitiesdirectly, holds bank deposits (savings deposits or time-deposits)and the banks in turn hold securities, or loans backed by securities. 1If and when-possibly as a result of a fall in security values whichweakens the position of the banks-the public loses confidencein the bank deposits and desires to turn them into cash, the banksare forced to sell securities in order to find the money. Thisprecipitates a further he~dlong fall in security values, which ofcourse raises the real rate of interest at which business can raiselong-term capital. It may be objected that, if the public whichconverts its deposits into cash does not use the money to buy upsecurities as fast as the banks unload them on the market, thisshows that it prefers holding money to holding securities at thecurrent price, the effect of which-even in the absence of indirectinvestment through banks-must be to force the price of securitiesdown to the same extent. This objection probably assumestoo much "rationality" on the part of investors. It is likely thatpeople who have bought securities at a high price will hold on tothem when the market is low, even where they would no longer bewilling to buy the same securities at the same price. Moreover, thevery fact that the banks hold securities may lead-as a result ofthedoubts which it engenders as to their ability to meet their obligationsand the "runs" which it provokes-to a contraction ofcommercial credit which will be even more deflationary than theeffect on security prices.Even though an active policy of credit contraction on the partof the commercial banks is in practice-though not of log~calnecessity-an almost invariable feature in one phase or anotherof every depression, it does not follow that it always continues tothe very end of the depression ·as the sole or principal deflationary1 For an indication of the importance of the movement tQwardsindirect investment through the holding of bank deposits, especially inCentral-European countries since the inflation and in the United Statesof America since the war, and for a discussion of the consequencesinvolved, see Commercial Banks 1925-1933, League of Nations, Geneva,1934. Ct. also Ropke : Crises and Cycles, pages 126 and 127.