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 accompanined 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 dullness 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.

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, etc. 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. 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 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 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 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 equipment.

But it is impossible to keep selling prices rising for an indefinite time. In default of other checks, the inadequacy of cash reserves

would ultimately compel the banks to refuse a further expansion of loans on any terms. But before this stage has been reached the rise of prices is stopped by the consequences of its own inevitable inequalities. These become more glaring the higher the general level is forced; after a time they threaten serious reductions of profits to certain business enterprises, and the troubles of these victims dissolve that confidence in the security of credits with which the whole towering structure of prosperity has been cemented.

In certain lines in which selling prices are stereotyped by law, by contracts for long terms, by custom, or by business policy, selling prices cannot be raised to prevent a reduction of profits. In other lines prices are always subject to the incalculable chances of the harvests. In some lines the recent construction of new equipment has increased the capacity for production faster than the demand for wares has expanded under the repressing influence of high prices. The unwillingness of investors to let fresh contracts threatens loss not only to the contracting firms but to the enterprises from which they buy materials. Finally, the success of some enterprises in raising prices fast enough to defend their profits aggravates the difficulties of the men who are in trouble.

As prosperity approaches its height, then, a sharp contrast develops between the business prospects of different enterprises. Many are making more money than at any previous stage in the business cycle. But an important minority faces the prospect of declining profits. The more intense prosperity becomes the larger grows this threatened group. In time these conditions bred by prosperity will force radical readjustment.

Such a decline of profits threatens consequences worse than the failure to realize expected dividends. For it arouses doubt about the future of outstanding credits. Business credit is based primarily upon the capitalized value of present and prospective profits, and the volume of credits outstanding at the zenith of prosperity is adjusted to the great expectations which prevail when affairs are optimistic. The rise of interest rates has already narrowed the margins of security behind credits by reducing the capitalized value of given profits. When profits begin to waver, creditors begin to fear lest the shrinkage in the market rating of business enterprises which owe them money will leave no adequate security for repayment. Hence they refuse renewals of old loans to enterprises which cannot stave off a decline in profits and press for settlement of outstanding

accounts.

which start

And in the Once begun,

Thus prosperity ultimately brings on conditions a liquidation of the huge credits which it has piled up. course of this liquidation prosperity merges into crisis. the process of liquidation extends rapidly, partly because most enterprises called upon to settle put similar pressure on their own debtors, and partly because news presently leaks out and other creditors take alarm.

While this financial readjustment is under way the problem of making profits is subordinated to the more vital problem of maintaining solvency. Business managers nurse their financial resources rather than push their sales. In consequence the volume of new orders falls off rapidly. The prospect of profits is dimmed. Expansion gives place to contraction. Discount rates rise higher than usual, securities and commodities fall in price, and working forces are reduced. But there is no epidemic of bankruptcy, no run upon banks, and no spasmodic interruption of ordinary business processes.

Crises, however, may degenerate into panics. When the process of liquidation reaches a weak link in the chain of interlocking credits and the bankruptcy of some conspicuous enterprise spreads unreasoning alarm, the banks are suddenly forced to meet a doubled strain— a sharp increase in the demand for loans and the demand for repayment of deposits. If the banks meet both demands, the alarm quickly subsides. But if many solvent business men are refused accommodation at any price and depositors are refused payment in full, the alarm turns into a panic. A restriction of payments by banks gives rise to a premium on currency, to hoarding of cash, and to the use of various unlawful substitutes for money. Interest rates may go to three or four times their usual figures, causing forced suspensions and bankruptcies. There follow appeals to the government for extraordinary aid, frantic efforts to import gold, the issue of clearing-house loan certificates, and an increase in bank-note circulation as rapidly as the existing system permits. Collections fall into arrears, workmen are discharged, stocks fall to extremely low levels, commodity prices are disorganized by sacrifice sales, and the volume of business is violently contracted.

There follows a period during which depression spreads over the whole field of business and grows more severe. Consumer's demand declines in consequence of wholesale discharge of wage-earners. With it falls the business demand for raw materials, current supplies, and equipment. Still more severe is the shrinkage in the investor's