rather than in the light industries which produce consumers goods. The idle factories have been those that are engaged in normal times in making things for other industries to use. Such goods include machinery, power plants, railroad equipment, building materials, and things of similar sorts. The theory of pump priming has been that if consumer purchasing power could be increased, the producers of consumers goods would so enlarge their facilities as to force into activity the producers of durable goods.

The pump-priming policies based on the theories of consumer purchasing power have been used to justify vast expenditures of the most varied sorts. Included among them have been the great programs of public works, the bonus payments to veterans and to farmers, slum-clearance projects, and the subsidies to home builders and to shipbuilders. Some part of the increased expenditures for military and naval equipment belongs in that category, as well as the T. V. A., the irrigation, reclamation, and flood-control projects, and some of the activities for soil conservation.

THE GOVERNMENT AS BANKER

All this spending has been accompanied by lending, and as the Government has pushed forward its pump-priming efforts with increasing vigor it has at the same time been going more and more deeply into the banking business. It is now proposed as a part of the reorganization plans of the administration to bring together its new banking functions into one consolidated Federal lending agency. The new organization will come into existence in July, and it will probably have Jesse Jones at its head.

Some idea of the progress that the Government has already made in the banking business may be gained from the fact that the new agency will include the Reconstruction Finance Corporation, the Electric Home and Farm Authority, the R F C Mortgage Co., the Disaster Loan Corporation, the Federal National Mortgage Association, the Federal Home Loan Bank Board, the Federal Savings and Loan Insurance Corporation, the Home Owners' Loan Corporation, the Federal Housing Administration, and the Export-Import Bank.

The banking business of the United States Government is already the greatest banking business in the world. The loans and investments of its lending agencies now amount to more than 12 billion dollars. Most of this great total has come into existence in these recent depression years. It is worth noting that while the Federal lending agencies have been accumulating loans and investments of 12 billion dollars, the banks of the United States have lost loans and investments, and the total that they have lost also amounts to 12 billion dollars. The pump-priming activities of the Government have not succeeded in producing the recovery that was their aim. There are two principal reasons why they have failed. The first is that they have led the Government to intervene so deeply and in so many ways into the affairs of corporate business that men have become too doubtful about the prospects for future profits to be willing to make many risks in seeking them. Venturesome enterprise has come to believe that the risks involved in entering new undertakings outweigh the probable gains, and so money has been seeking security instead of assuming new risks.

The other reason is more concrete. It is that pump priming does not have the effects on industry that its advocates said it would. They assumed that when the demands of consumers were increased by the lavish distribution of public funds, the producers of consumers goods would build new factories and order new equipment in order to meet the enlarged demands. Experience shows that the results do not work out that way. The annual volume of output of consumers goods has never yet increased to levels as high as those of the prosperity period before the depression, and so there has been no need for many new factories or much new equipment in order to meet all demands.

It has become apparent that what happens during a period of pump priming is that the money spent by the Government is quickly used by its recipients for the purchase of consumers goods, and that as soon as it is spent it passes into business channels and most of it shortly comes to rest in the banks in the form of demand deposits. These deposits are largely those of businessmen and corporations. They have grown enormously during the years that pump priming has been under way. It is true that some part of them is the result of gold imports, but in large measure these demand deposits were originated by Govern

ment borrowing. Demand deposits are now about 50 percent greater than they were in 1929 at the peak of prosperity. They are largely idle funds, and their rate of turn-over is lower than ever before in our history.

Pump-priming does not operate successfully unless the pump itself is in good working order. In this case the pump is the great productive machine of American enterprise, and it is operating slowly despite the abundant funds that are available to speed it up. The reason why it works so slowly is that the only incentive which can accelerate it is the prospect for profits, and businessmen do not think those prospects are now attractive.

LENDING OUR WAY OUT OF DEPRESSION

A year from now the nominating conventions will be in session, and the political campaigns will be getting under way. Meanwhile measures must be taken not merely to increase business activity, but to convince the people that the administration has at last found a way to bring about recovery. There is increasing evidence that the new attempt will be to seek recovery through lending rather than through spending. The current hearings before the Temporary National Economic Committee, which is also known as the Monopoly Committee, indicate that the new plans for recovery by lending are now being formulated.

A month ago the case in defense of the new policy was brilliantly presented by an eminent economist, Prof. Alvin H. Hansen, of Harvard, and by the Assistant Secretary of State, Mr. Adolf A. Berle, Jr. Professor Hansen began his argument with the valid proposition that prosperity depends on a constant flow of investment into productive industry in order to supply it with improved equipment for taking care of its present output, in order to give it new facilities for making new products, and to provide greater capacity as population grows and demands increase.

This year, and during all the depression years, the flow of new investment capital into our productive industries has been abnormally small. Most economists believe that the reasons for that diminished flow are to be found in the barriers which the Government itself has erected against business enterprise, but Professor Hansen says that the reason is that this country has now reached such a stage of economic maturity that business no longer offers adequate opportunities for the profitable investment of our national savings. This creates unemployment in the capital-goods industries and slows down the entire economic machine.

His remedy for this is that the Government should take our savings by taxation and spend them itself for the development of new products and industries and for huge programs of public works. He blames our alarm about our continued unbalanced Budget on an obsolete system of public accounting, and says our accounting should list operating expenses separately from investments in public works, new industries, and the like. Then the Budget should not be considered to be out of balance as long as the income from taxes is sufficient to pay the operating expenses and the carrying charges on the public debt.

Mr. Berle agreed with Professor Hansen that private enterprise has failed. He advocated as a solution of the problem the creation of a public-works finance corporation. Such an organization would get its funds by issuing its own guaranteed bonds, or by rediscounting its notes at the Federal Reserve Bank, and by those means public works could be paid for without having to get Congress to appropriate money for them. He also advocated the organization of a Federal system of capital credit banks to provide money for new investments, and, as a temporary measure, Federal insurance of loans to small businesses.

Mr. Berle is perfectly well aware of what is inevitably going to happen if the Government continues to extend its activities in the field of banking. He said in his testimony, "Briefly, the Government will have to enter into the direct financing of activities now supposed to be private; and a continuance of that direct financing must mean inevitably that the Government will control and own those activities. * Over a period of years the Government gradually will come to own most of the productive plants of the United States."

* *

The Assistant Secretary of State appeared as the witness for the Securities and Exchange Commission, and he made it clear that he does not have a high opinion of our existing banking system. He said, "The theory that a bank must make a profit today has ceased to be valid, except in an extremely limited sense.

The

profit of the bank is interesting as showing that by financial standards its work has been well done. In the sense, however, that the bank is entitled to a profit, as a reward for something or other, there seems to be no reason for its existence." Attention is now being concentrated at Washington on the part of this program for lending our way to prosperity which proposes a system of Government insurance of bank loans for business purposes. The proposal now under active discussion is the Mead bill which is modeled after the F. H. A. program for insuring loans for home modernization. The bill would insure a bank against losses in excess of 10 percent on business loans up to $1,000,000 to any single borrower. The loans could run up to 10 years and bear interest of not over 4 percent, and there is no provision that they should appear to be sound loans or that they should be amortized.

This proposed legislation is regarded with much favor at Washington where Senators and Representatives are saying that the Government must find some way to use the idle money in the banks if private industry will not. Governor Eccles of the Federal Reserve System is advocating an alternative proposal for the establishment of an industrial loan corporation to insure bank loans to small business and to provide long-term capital for business firms. Careful observers in Washington are freely predicting that some form of Government insurance of business loans will be enacted.

THREE FALLACIES IN THE LENDING THEORY

There are at least three major economic fallacies embodied in these proposals for lending our way to prosperity. The first and greatest is Professor Hansen's proposition that our national economy has now reached such an advanced stage of maturity that business can no longer offer profitable opportunities for the investment of the national savings, and so the Government must take those savings away from us by taxation and spend them itself.

The best evidence that nations are not condemned to depression by the maturity of their economies is available in the data published by the League of Nations comparing the volumes of industrial production of leading countries in 1938 with those of the prosperity year of 1929. If we consider production as being 100 in 1929, the figures show that in 1938 it was only 72 in the United States, but it was 116 in England, 146 in Sweden, 124 in Mexico, 137 in Chile, 165 in Greece, 157 in Finland, and so on through a list of 20 countries, with the United States at the foot of the list.

Production in Canada in 1937 was as large as it was in 1929. Some of the countries are more mature than we are in an economic sense, and others are less mature. In some of them there is more governmental participation in business than we have here, and in others there is less. Clearly economic maturity is not the explanation of depression.

The second economic fallacy embodied in these plans for lending our way to prosperity is the idea that capital can be created by a banking mechanism. That theory is inherent in the Berle proposals, and it is present, although less obviously, in the projects of Governor Eccles and of Senator Mead. The fact is that capital consists of savings and it cannot be created by banks. If we are to insure loans and then rediscount them at the Federal Reserve bank, why should we not cut out all the intervening red tape of banking? Why not simply print the money and hand it out to the applicants who can persuade the spenders and experimenters at Washington that it is to be used for what Mr. Berle calls the plain needs of society, or still in his words, the obvious need, or the needs which every one recognizes?

The third great fallacy in the lending proposals is the idea that prosperity is created by bank loans. Our business history does not indicate that mere credit expansion is nearly as good an indicator of business prosperity as is commonly assumed. We have the records of the loans and investments of our national banks at four or five call dates each year for the past 75 years. Those records show that the loans and investments have always increased during every period of prosperity for three-quarters of a century, but they also show that they have increased during a majority of the periods of depression. The increase in the 16 periods of prosperity has averaged about 'six-tenths of 1 percent per month, while that in the periods of depression has averaged about five-tenths of 1 percent per month.

If one measures the changes in the loans and investments in each period of business expansion from the bottom of depression to the peak of prosperity, there was always credit expansion during recovery, but there was also credit expansion in a majority of the periods of business contraction from the peak of prosperity down to the bottom of depression. Periods of recovery are not notably periods

of great credit expansion. They are periods during which money is more actively used, checking transactions become much more numerous, and, as the economists would say, the velocity of circulation is greatly increased.

Rapid increases in borrowing have not often characterized periods of prosperity in this country. Bank loans have not as a rule increased much more rapidly during prosperity than during depression, and long-term borrowing through bonds and notes has not usually grown much more rapidly in prosperity years than it has in depression years. A healthy economy is one in which business can raise new money by floating issues of common stock, and that is what we have always done in this country in periods of business recovery.

BUSINESS LOANS MORE HAZARDOUS THAN BUILDING LOANS

There are two principal purposes behind the projects for changing our banking legislation in order to provide insured bank loans for small business. The first purpose is to help stimulate business recovery by making it possible for large numbers of small business undertakings to expand their operations, buy more materials, employ more people, and to increase their efficiency by making alterations and enlargements and purchasing improved equipment.

We have successfully tried the experiment of providing insured loans for the construction of new homes and the improvement of existing ones, and now it is proposed to apply similar methods of lending to help businessmen finance the activities by which they earn their livings and meet their pay rolls. The analogy between the existing insured loans for building and the proposed insured loans for business is an interesting and attractive one, but there is danger that it may be misleading.

The chief difference between the two classes of loans is that the safety of the building loan is secured by the value of the building itself so that the remaining part of the risk that is covered by the insurance does not create a dangerous credit hazard. There is no similar tangible security supporting the typical business loan. The prospects for the repayment of that sort of loan depend mainly on the quality of the management and its ability to earn continuing profits in the face of keen competition. Usually success depends on the continuing efficiency of a single individual, and it may be impaired by sickness, accident, or by any of a great variety of other unforeseen developments.

INSURED LOANS WOULD SUBSIDIZE FAILING FIRMS

The second principal purpose behind the projects for insured loans is that of aiding small businessmen. At first thought it would seem clear that businessmen as a class would be benefited if they could secure credit more easily, more plentifully, and at reduced expense, but that conclusion may be unwarranted. Proponents for insuring business loans contemplate that great numbers of loans will be made to people who are not able to borrow from banks under present conditions, and that the loans will be made for projects which bankers do not now consider safe risks.

Bankers are now seeking loans with a degree of eagerness and energy without precedent in the history of banking, and these proponents for insured loans propose to grant credit for projects which bankers do not consider safe risks even under the present pressure to find employment for idle funds. Unless the credit judgment of thousands of bankers has been wrong about these projects, it must be expected that a large proportion of the proposed insured loans will later on become part of the liabilities of insolvent business.

Here is one of the real dangers connected with insurance for business loans. If the granting of such loans on a large scale should in practice result in an important increase in the number of failures among small businesses, the results would prove harmful not only to the businesses that secured the insured loans and then failed, but also to all their competitors. There is no competition that is so hard to meet as that of the business that is on the way to insolvency and which is turning to desperate measures of price cutting and wage reductions in the hope of avoiding failure.

There appear to be three chief unfavorable economic implications that are inherent in the projects for insuring loans made to small businesses. The first is that these loans are far more hazardous than insured loans secured by new building construction. The second consideration is that insured loans will not be very helpful as a recovery measure because they will not bring much aid to the heavy industries where unemployment is most serious. The third unfavorable economic consideration is that insured loans for business ventures that cannot now secure

bank credit really constitute a form of Government subsidy which will create serious new competition for small businesses that are now in successful operation.

PUBLIC INTEREST UNAROUSED

This new movement for lending our way out of depression has gained great momentum without attracting much public attention. The newspapers have given it little space. The reports of the first hearings dropped into obscurity because they were eclipsed by the sinking of the first submarine. The subsequent hearings went almost unnoticed because our attention was completely distracted by the visit of royalty. Probably we have seldom had in our history so dangerous an instance of the failure of our people to pay attention to a development that gravely threatens our whole national future.

This project is sponsored by leading Senators; it is heartily endorsed by the Assistant Secretary of State; it is actively promoted by the Governor of the Federal Reserve System. Its major premise is that the American business system has failed, and that since it has failed the Government must progressively take over many of its functions and activities. The purpose is a vast increase in public spending, but it is to be spending disguised so that it will not appear to increase our national debt and will not be represented by figures in our unbalanced budgets. It is proposed to put huge additional sums of money into circulation by having private banks and public banks make great numbers cf loans which are to be guaranteed by the Government. It is planned to make loans for public projects as well as for private ones, and by doing the spending that way the need for having the money appropriated by Congress can be avoided. The voting public is becoming increasingly aware of the fact that public spending has got entirely out of control, and this new set of plans for guaranteed lending is a most ingenious political device designed to circumvent public opposition to spending.

The productive industry of America is like a great powerful truck that has won all the international competitions for carrying capacity, speed, economy, and endurance. Recently the truck was put in the charge of a new operating crew which changed all the adjustments and added a great number of new accessories. Among other changes they set the emergency brakes. The truck will still run, but it performs very badly. It keeps stalling, and it uses an appalling amount of fuel, and now it has to have ether mixed with the gasoline to make it run at all. The new crew is now making a report on its performance, and their recommendation is that it should be abandoned and that they should be commissioned to invent a different and superior type of vehicle. Our recommendation is that they

should try the experiment of releasing the brakes.

ESTIMATES OF THE AMOUNT OF LABOR CREATED BY FEDERAL LOANS OR EXPENDITURES FOR CONSTRUCTION PROJECTS

The construction of public works has long been a first line of defense against unemployment in periods of depression. In judging the effectiveness of any program of public works as a means of reemployment, several groups of workers must be considered. First, there are the men who work on the job itself. They are carpenters, bricklayers, stone masons, ditch diggers, cement finishers, and a host of other skilled, semiskilled and unskilled men who work with them. Second, there are the men in the factories who provide the brick, cement, lumber, and steel to be used on the job. Back of them are the miners, the loggers, and others who supply the raw materials for the factories; and last, there are the men on transportation systems which carry the materials to the factories and later to the job. Employment of these secondary groups of workers is just as important in any reemployment program as the employment of men at the site of construction. For a great many types of public works the materials, man-hours, and transportation men are numerically more important than the men working at the site of the construction projects.

The vast majority of contractors and subcontractors working on construction projects financed in whole or in part by Federal funds send monthly reports to the Bureau of Labor Statistics showing the number of employees, amounts of pay rolls, and man-hours worked at the site of each construction project. Each contractor also notifies the Bureau of the type and value of materials which he purchases for these projects as well as the source of his supplies. This provides a record of the total value of materials used in relation to the cost of the job and to the size of the site pay roll.