Chapter I: Part II (1)

VI. Puts and Calls 89
VII. The Question of Dividends 101
Basing Railroad Values 104
Effects of Business Depression 105
Undigested Securities 108
How to Compute the Value of Rights 109
Barometer of Averages 110
Best Method of Trading 111
Indication of Crises 112
The Ordinary Swing of Prices 113
The Factor of Safety 114
Borrowing and Lending Stock 117
Scalping 120
Crop Damage 123
Selection of Securities 124
The Bank Statement 125
The Cycles of Stock Speculation 133
The Cycles of Grain Speculation 145
The Cycles of Cotton Speculation 155
Conclusion 163
Bibliography 176

The successful speculator requires four things:

1--A knowledge of values.
2--A knowledge of general conditions.
3--A knowledge of the machinery of speculation--and
4--Something besides.

I

Introduction

The first step in the education of the speculator should be to clear away the illusions which have grown rank through ignorance, and flourished through prejudice. We have heard, and continue to hear, a great deal of ethical talk on this subject, most of which emanates from people who are not authorities, and who have little real conception of the subject. It would be pretty safe to assume that a majority of these same instructors speculate themselves. They place an arbitrary construction on the word however, and draw a dividing line between stock or cereal operations, and other forms of speculation, although the basic principle is the same in all cases, i.e.: to buy what is cheap and re-sell at a profit. One of the most ridiculous forms which this pedantry assumes is the warning and preaching against speculation by very rich men who made their own money speculating and could not possibly have acquired it in any other way. Such expressions of opinion are born largely of an exaggerated ego.

The trouble with these critics and advisers is that they seldom approach the subject in the right way. With a full knowledge of the fact that speculation is an inherent part of human nature, and that a majority of human beings are bound to indulge in it in spite of everything, these sophists simply rail against the practice indiscriminately instead of attempting to point out what is foolish and fallacious. If we attack the practice in a general way little will be accomplished. If we say, “do not speculate,” our audience will perchance give us a respectful hearing,--and go on speculating. If, however, we point out what is dangerous and unreasonable, confine ourselves to attacking the evils and explaining the delusions, some good may be done in an educational way. We may, if we show by simple logic that the education and qualifications necessary to success are too difficult to acquire, actually deter many people from speculating in certain lines at all, a thing which could not possibly be accomplished by mere blanket warnings against the practice. One of the most serious blunders in the world is the common one of under-estimating other people’s intelligence. People are ready and willing to learn, and that they do learn is shown by the decreasing crop of lambs. It is not nearly so easy for the dishonest promoters and manipulators to market poor securities at high prices today as it was a few years ago. And in this regard it may be pointed out that the press has actually, although in many instances unconsciously, accomplished a great deal on exactly the lines suggested above. Magazines and newspapers have, in recent years, taken on an educational character. Periodicals once devoted to fiction or history now deal largely with business and social economics, and with the exposure of bad methods in high places, the ruthless uncovering of false or misleading statistics, and the simplification of questions hitherto involved; the public has been gaining rapidly in education and understanding. The fact that much space in leading periodicals is devoted to these subjects, is in itself _prima facie_ evidence that the people can and will learn, for with all due credit to the editors and publishers, it is certain that the contents of magazines and newspapers are selected in accordance with what the public demands and likes.

No one will attempt to deny that a majority of public speculators lose. In a former volume, the present writer undertook to establish by analysis of a large number of public accounts, the fact that 80% of the participators lost money. A number of critics commented on this statement as a body blow to speculation, asserting that the writer had shown that there was “80% against the player.” These writers proceeded to compare this percentage with that existing in games of pure chance, such as roulette, faro, etc., and wound up by pointing out the tremendous drawback to the speculator through percentage against the player. It seems incredible that any sane man should fall into such laughable confusion of ideas. The percentage of players who lose in any game has nothing to do with the percentage against the player. If these critics established anything at all, it was that speculation was not gambling; for it requires only a moment’s reflection to see that in any mechanical gambling game where there is _any_ percentage, no matter how small, in favor of the game, the percentage of players who eventually lose must be 100. This being the case, the gentlemen mentioned were at considerable pains to prove that, as 100 per cent. of the players did not lose, speculation was not a gambling game in the strict sense of the word. That is to say, it could not be correctly compared with any mechanical device where the element of skill was absent.

If we consider the matter in a gambling light, the percentage against the speculator can be determined by the proportions of commissions, interest, taxes, etc., to capital invested. Taking commission alone as our basis, we will find that he who purchases a stock at $100 a share and pays one-quarter of one per cent. commission, has a percentage against him of one-quarter of one per cent. If the speculator trades on limited margins the drawback increases accordingly. If we assume that 100 shares of stock are purchased in a bucket-shop on a one point margin, without intention or ability to “re-margin” the transaction, the mechanical percentage is large (25%); if 10 points margin is deposited, the mechanical percentage is reduced to 2½%, etc. In the first instance, $25 or 25% of the $100 involved was lost when the transaction was recorded, without any change in market price. In the second instance, $25 was again lost or 2½% of the $1,000 involved.

There is no doubt that fluctuations in prices of securities, cereals and staples are frequently used as a basis for mere gambling transactions. But the most remarkable feature of the whole problem is the fact that the percentage of loss in transactions is _greater_ than the mechanical percentage. In the work already mentioned, the writer undertook to establish this. In 500 accounts examined, there was a loss of $1,245,000, and profits of $288,000, leaving a deficit of $957,000. The commission charges and interest amounted to only $275,000. There thus appeared a loss of $682,000 which could not be attributed to a gambling percentage. It may be added that the period considered in the computations was from July, 1901, to March, 1903, and that the price of the stock considered (U. S. Steel Common) was the same at the beginning and the end of the period.

This tends to again refute the theory of mere gambling, with a ruinous percentage against the player, for no mechanical device could by any possibility operate against the player to a greater extent than the fixed percentage in favor of the machine. A gambling machine will stick to its knitting. If, for example, we take the simplest form of gambling device--two dice thrown from a cup,--we know that certain numbers formed by adding the total spots which appear uppermost will show more frequently than others. Thus the number two can be effected in but one way, the number three in two ways, the number four in three ways, and so on up to the number seven, which can be formed by six different combinations, thus:

4 and 3
5 and 2
6 and 1
3 and 4
2 and 5
1 and 6

from which point the chances decrease until the number 12 can be formed in only one way--two sixes. This proposition applies to all forms of mechanical gambling, and is so simple in principle, and so distinct in operation that if we make a fair number of casts, say 1,000, and do not make more sevens than any other one number, we may be positive that the dice are defective, or loaded.

Therefore, if percentages hold true, we must attribute the surplus loss in speculation to mental operations. In the total results mentioned, these mental operations were so erroneous as to cause a loss greater than the percentage itself; but, on the other hand, a certain number of accounts showed profits; that is to say, the percentage was overcome, which is again an obvious impossibility in true gambling.

The conclusion is offered, therefore, that not only can poor methods and imperfect understanding result in losses far in excess of a demonstrated drawback, but that this drawback may be overcome by other and more correct methods. It is difficult to understand why the opponents of speculation are continually harping on these points of gambling and percentage as bearing particularly on operations in stocks or commodities. If a man buys a certain security because it is cheap, or because he considers it cheap, and pays a certain commission to a broker for effecting the transaction, he is no more playing a percentage game than if he purchases a piece of real estate because it is cheap and pays the real estate broker a commission for his services.

Marginal trading is another abomination of the anti-speculative element, but here again the critics do not discriminate between use and abuse. Trading on insufficient margin is one of the greatest evils in the speculative world and when, as is frequently the case, this evil is combined with lack of knowledge as to values and conditions, the result is certain loss. But what is objected to here is the hazy view and comprehensive condemnation of _all_ marginal speculation. The line of demarcation is usually carelessly drawn. If an individual buys 100 shares of stock for cash, has it registered in his own name and later borrows funds from his banker with these shares as collateral, he escapes impeachment as a marginal speculator; but if he buys on margin, and borrows from his broker the unpaid balance, he is a gambler. And yet it would be hard to point out the difference in the two methods. If we wish to go a little further afield, we may reduce a very large percentage of the commercial structure to marginal trading. We may, in short, place in this category every merchant who buys goods on credit and every man who buys real estate on payments, if their object when buying is to sell at a profit.

It is highly probable that these contentions will be vigorously attacked, on the theory that more evil than good results from speculative ventures, and that therefore the whole structure should be razed on a “greatest good to the greatest number” basis; but aside from the intensely unphilosophical character of this view, it is not at all probable that any such thing can be effected unless human nature undergoes a radical change. Tear down every stock exchange in the United States tomorrow, and people will be speculating, a majority of them foolishly, in another week. The cure lies not in paternalism, but in evolution and understanding. As has been said, more has been accomplished in recent years by the educational crusade of the press than by all the rantings and warnings of a century. We have our periods of reckless over-indulgence, it is true, but the evil is dwindling. The South Sea bubble would deceive a much smaller number of people today than it did in the days of John Law.

It is the object of the present work to point out, so far as the abilities of the writer will permit, what essentials are required in any form of speculation, whether on margins, or masquerading in the guise of investment. As to this last distinction, it may be stated that the word “speculation” is herein taken to mean the purchase of any security or commodity because it is considered cheap, with the ultimate intention of disposing of the property so purchased at a profit. In the writer’s opinion this definition is correct. Speculation contemplates a rise in price, and an accretion in principal. Investment refers to interest returns on money.

One of the most flagrant errors in speculation is an entirely mistaken idea as to the _possibilities_ in this field. Nine men out of ten have a deep-rooted conviction that if any individual could be right in his main deductions for, say one or two years, he should make millions on a small capital. This is a great mistake, and leads to numerous minor errors which are productive of much loss in actual operations. The business of speculation never did, and never will result in abnormal profits. Large returns are sometimes made, it is true, but this fact is also true of every other line of business. Certain individuals grow very rich in Wall Street; this again is true of every commercial branch. We hear now and then of a million dollar coup by a Morgan or a Rockefeller, and do not stop to consider the great capital behind it. If an individual makes five thousand dollars in a year’s speculative ventures on a capital of twenty thousand, he is not considered a Napoleon of finance, but he has accomplished much more, in proportion to his capital, than Rockefeller would have accomplished if he had made five millions on similar operations.

In a recent conversation with a number of gentlemen who clung tenaciously to this idea of sudden riches, the writer undertook to establish his contention. Tapes were secured recording the fluctuations of sugar stock during a twenty point decline. The skeptics were given a hypothetical capital of $10,000 each, subjected to the ordinary rules of trading as to margins, etc., informed that sugar would decline twenty points before it again touched the first quotation established, and invited to “get rich quick.” The result was ridiculous in the extreme. Two of the experimenters lost their imaginary capital trying to double up and show large returns. The third took an unfair stand, by selling the maximum amount at the inception of the experiment and closing it after the 20 point decline had appeared. His operations, therefore, proved nothing. Here was a case where two traders, possessed of an absolute fore-knowledge of what was to occur, lost everything through the fault of over-speculation and the belief that abnormal returns could be made if the ultimate fate of a market could be correctly forecasted. Even if we assume that _every_ intermediate _movement_ were known in advance, that after a ten point decline there would be a five point advance, and that transactions were conducted to the full possibilities of both original margin and accrued profits, the result would not be the millions which dazzle the eyes and imagination of the unsophisticated. But to assume any such trading is foolish. The factor of safety would be wholly absent. No wise man will ever attempt pyramiding, and no foolish man who does, will succeed.

In order to clear the ground for discussion or study, the first thing to eliminate is this wholly unsupported and mistaken idea of sudden riches. No matter how correct the forecast of the future may be, safety disappears in inverse ratio to the increased possibilities of abnormal returns; and with the factor of safety continually ignored, the final results are bound to be disastrous.

It will also be necessary to dispel another illusion. If the speculator imagines that he can operate successfully without preliminary hard work to fit him for the business in hand he is grossly mistaken. It is necessary to qualify in this field as well as in any other. Knowledge of monetary conditions, values, interest rates, and in fact, of all influences bearing directly or indirectly on the future of prices must be acquired and thoroughly understood. Ignorance on any one point may mean defeat. On the other hand, a study of such conditions means a liberal education, valuable in every line of business life. It may be further stated that the man who attempts to evade necessary labor and research by placing his dependence on tips or charts, or the opinions of others, cannot hope to succeed. The gambling idea must be put out of the question entirely, and means sought whereby intelligent opinions may be formed by both inductive and deductive reasoning.

In preparing this work the temptation to enter more extensively into fundamental principles has been great. It would be impossible to do more than suggest a line of procedure in a single volume, and only the most elemental requisites are set forth. And not only do the prescribed limits of this volume forbid any exhaustive discussion, but such discussion is unnecessary. On every subject of importance we have books written by men of soberness and judgment, each a specialist in his field. A bibliography has been appended to this volume suggesting such works as are considered helpful. In this bibliography an attempt has been made to choose such books as are clear and simple, rather than those which are profound.

If the task as herein outlined, appears formidable, it may be said that it is absolutely necessary, and not so difficult as may appear. Before the student has entered far into the subject, he will find the matter interesting and will very quickly realize that the well grounded contentions and discussions of men who examine and diagnose economical questions correctly, are of more value than the combined tips, guesses and poorly based opinions of all the professional speculators and gamblers from one end of Wall Street to the other. This form of basic knowledge is just as important to the active trader as it is to the investor. If he can correctly judge of the general trend of future prices, he may operate safely _with_ that trend instead of floundering around helplessly in a slough of indecision, or possibly working directly against the current. If, for example, he has good solid reasons for expecting ultimately higher prices, he will not be disturbed by temporary reactions and, instead of being frightened out of his position through ignorance, he will take advantage of such reactions to make his purchases or cheapen his holdings. Knowledge, in this particular line as in all others, is the foundation of successful ventures.

II

The Cycles of Speculation

The great upward and downward swings of speculative prices, herein referred to as cycles, have invariably preceded or accompanied periods of business inflation or depression. This fact, apparently so elemental, is often disregarded by that very large class of speculators which is continually looking for artificial and unpregnant explanations of price changes. There can be no doubt as to the existence of manipulation, and, in rare cases, movements of considerable importance may be traced to this source alone; but manipulation consists, in its fullest sense, of the tactics resorted to for the purpose of liquidating shares in anticipation of a decline which the long-distance thinkers believe to be inevitable; or, per contra, for the accumulation of shares prior to a great recovery or readjustment. It is seldom employed as a positive means of enhancing or depressing values. In fact, to do either by mere manipulation would be an impossibility. Every observer of great speculative movements knows that at the highest point of a movement, and during the first half of a decline everything appears roseate, while at the lowest prices, and during the first half of an advance, the reverse is true.

There are several contributory causes which operate to produce these false appearances. The primary cause is the curtailed perspective and imperfect logic of the public investor or speculator. The most difficult thing to drill into the mind of the unsophisticated is the fact that speculation cannot possibly be successfully based on appearances which are open and obvious. Such a process is a flat contradiction of the word itself. It is unseen future developments or, in some cases, hidden and submerged present truths which must be consulted. Yet we find a great majority of the public element who seek riches in the speculative arena, constantly harping on the large business of certain corporations, and the excellent state of general trade as a reason for purchasing shares. These factors have, in all probability, been discounted in current prices. Generally speaking, the present is of no more use than the past in forming opinions of future price changes. It is a certainty that sales of stocks could not be made in great volume to good advantage unless everything _did_ look rosy, for who would purchase shares at high prices if the future appeared threatening or unpropitious, and who would sell holdings in the face of encouraging and inspiriting prospects.

This brings us to the second phase of the question--the _creation_ of false appearances, which is, in truth, the highest form of manipulation. When so-called inside selling is going on, great business is reported by railroad and producing corporations; dividends are increased, and public expressions of confidence emanate from men of high standing in the financial world. The effect of all this expressed optimism is, market-wise, of a negative character. When it is most prevalent and most decisive, prices halt or even decline. This period and action represents selling at the only time when advantageous selling is possible. In the main the truth only is told about existent conditions, possibly about the near future. Nothing else is necessary; but nevertheless the sellers are anticipating, not the events of the next week or the next month, but of a more remote period where they see probabilities in regard to which a discreet silence is maintained.

The constantly recurring cycles of prices, the alternate inflation and depression, must therefore be traced to something far more important than the grossly exaggerated potentiality of mere manipulation.

Principal Crises of the Last Century.

That crises in the financial world have occurred at more or less regular periods is a matter of history. Since the beginning of the nineteenth century ten of these readjustments have occurred. In 1812, after ten years of prosperous conditions preceding the war of that year, business fell off materially. The real panic, however, occurred in 1814. Washington was taken by the British on August 24th, 1814, and suspension of specie payments was general in the following two weeks.

In 1824, the protective tariff enactments were followed by general inflation in all lines of business. Two years later, in 1826, a general depression occurred with many failures. The depression at this period was even greater in England than in the United States, and many writers attribute the entire trouble to European business reverses, but it is probable that we had been living beyond our means and that this fact, to say the least, aggravated the disturbance.

In 1837, after six years of good times, another crisis occurred. This depression was attributed to various causes. The great New York fire of 1835, the loss of charter by the United States Bank in 1836, and the calling in of $37,500,000 of government deposits by President Jackson, are all given due consideration. The actual panic, however, did not appear until May 10, 1837. All the banks suspended specie payments, and securities,--in fact all properties of whatever kind--fell rapidly in value. The most plausible explanation of this crisis is over-speculation in land. The other evils mentioned might easily have been rectified by the recuperative powers of a growing country, had the more serious element of wild inflation been absent.

In 1848, after a long period of prosperity, broken only by the war with Mexico, business inflation and over-speculation again brought about the logical and inevitable result. Europe also had been over-speculating again and a crisis in England soon extended to the United States. Liquidation was drastic and the depression lasted until the discovery of gold in California began to bear fruit.

In 1857, one of the most serious, as well as the most short-lived, of our crises occurred. Again speculation was extreme; December, 1856, marked the high point in securities, and prices continued to sag for some months; but it was not until August, 1857, that a panic occurred.

In 1864, came a crash in speculative prices following tremendous inflation. Between April, 1864, and April, 1865, leading stocks declined from $50 to $100 per share. As the inflation of this period was caused largely by the high prices of commodities and greatly increased railroad earnings occasioned by the events of the Civil War, most writers on the subject do not consider it in their theoretical discussions of crises.

In 1872, another boom was on, particularly in Iron and Steel. The Chicago and Boston fires had not been as effective in breaking stock prices as might have been expected. Prices of stocks began going down materially in April, 1873, and in fact had been rather “toppy” during the preceding years. This panic, like most of the others, was preceded by enormous speculation and high prices. It is interesting to note that while stocks were declining, general business was booming. The trained minds of Wall Street were learning to discount the future at longer range and more accurately. The iron and steel business exceeded all former records in 1873, both in the matter of normal price and actual production.

In January, 1884, numerous failures and suspensions produced a panic which was in reality the culmination of a long decline. As in 1872, this panic was preceded by enormous general business. The steel and iron trade again broke all records in 1882, and other lines were equally prosperous.

In 1893, the period of prosperity which followed the enactment of the McKinley bill was rudely broken. Speculation had been rampant, as usual. On May 4th, 1893, the National Cordage Company went into the hands of a receiver. Only a year prior to that date, this corporation was paying 12% in dividends and the stock was selling well above par. There were many badly inflated stocks and many rotten spots in the speculative stock markets. The Distillers and Cattle Feeders shares fell from $70 to nothing, and were assessed $20 per share. The aggregate liabilities of business failures in 1893 were almost $350,000,000, over 20% greater than in 1892. Banks failed right and left, and several leading railroad companies went into the hands of receivers.

In 1903, another period of depression occurred. It is doubtful if this period can be rightly classed with the other crises already mentioned, for it was more in the nature of a drastic but orderly retrenchment than a panic, and the bull stock market of 1902 was again in full swing early in 1904.

In thus briefly detailing the crucial points of nineteenth century financial affairs, there is no intention of entering an economic discussion, and no pretence of giving anything like a comprehensive history of the events preceding or following their recurrence. The subject here discussed is speculation, and the object sought is to gain knowledge that may be of value in forming opinions as to future prices. We may gain some information of this character by analyzing the following points:

1--Did price declines in stocks precede, accompany, or follow
panics, crises, or general business depression?
2--What are the signs which usually precede such periods?
3--What are the salient causes?
4--Can any dependence be placed in the regularity
of these recurrences?

On the first head it will be found that in all cases the top of the stock market has been reached prior to the actual eruption in general business. Stock speculation in 1814 and 1826 was not of great volume nor importance, and cannot be given much consideration.

Beginning with the panic of 1837 we find that the highest prices for stocks were made in October, 1836, while panic conditions did not occur until May, 1837. Preceding the panic of August, 1857, highest prices were reached in the last months of 1856. Highest figures were recorded in April, 1872, just one year prior to the panic of 1873. The stock market anticipated the troubles of 1884 by 17 months of declining prices. In January, 1892, stocks began declining and continued their downward course until the panic of 1893 cleared the atmosphere. In our last period of depression (1903) stocks had reached their pinnacle in September, 1902, just one year before the market turned for the better.

We find therefore that in the majority of instances, highest prices for stocks were reached long before business troubles were openly apparent. This action represents to a certain extent the selling of stocks by men who were wise enough to foresee trouble.

Another interesting fact in regard to crises is that they are usually preceded by record-breaking business in all directions. As iron and steel may be considered the best barometer of business conditions, the following tables are instructive:

PIG IRON PRODUCTION IN THE UNITED STATES SINCE 1860.

Year Production
Tons
1860 919,770
1861 731,544
1862 787,662
1863 947,604
1864 (Depression) 1,135,996
1865 931,582
1866 1,350,344
1867 1,461,626
1868 1,603,000
1869 1,916,641
1870 1,865,000
1871 1,911,608
1872 2,854,558
1873 (Depression) 2,560,963
1874 2,401,262
1875 2,023,733
1876 1,868,961
1877 2,066,594
1878 2,301,215
1879 2,741,853
1880 3,835,151
1881 4,144,254
1882 4,623,323
1883 4,595,510
1884 (Depression) 4,097,868
1885 4,044,526
1886 5,683,329
1887 6,417,148
1888 6,489,738
1889 7,603,642
1890 9,202,703
1891 8,279,870
1892 9,157,000
1893 (Depression) 7,124,502
1894 6,657,088
1895 9,446,308
1896 8,623,127
1897 9,652,860
1898 11,773,934
1899 13,620,703
1900 13,789,243
1901 15,878,354
1902 17,821,307
1903 (Depression) 18,009,252
1904 16,497,033
1905 22,992,380
1906 25,307,191

It will be observed that the high record of production has been reached just prior to our greatest periods of depression, or during such periods.

The second phase of the question, “what signs usually precede such periods?” opens a wide field for the student of speculative changes. Some inspiration may be gained from an examination of the two points already considered, i.e.: priority of price movements and business inflation; but it would be extremely difficult to use them as guides unless many other factors were given consideration. If we eliminate the element of periodicity, any attempt to determine the turning point by examination of advances in prices of stocks or volume of production and consumption of commodities is futile. Using pig iron as a barometer we might, after production has gradually increased from 8,623,127 tons in 1896, to 15,878,354 in 1901, argue that a considerable reaction was due in this line, but we would be out in our calculations two years and two million tons. Neither can we accept the simple fact of a decline, or the beginning of a decline in iron or in any other single commodity as indicating lower prices for stocks; for however accurate iron may be as a barometer of general business, it is not at all a barometer of the stock market. It is practically certain that stock prices will move either to higher or lower prices long before any reasons for such movements are apparent to the ordinary observer. Future stock market movements are largely deductive, and are not founded upon ordinary industrial statistical evidence.

There is, however, one method by which some light may be thrown upon the subject of probable movements. A careful study of monetary conditions and expansion of credits will frequently reveal dangers not apparent in any other direction. It is scarcely necessary to say that such examination must not be confined to one quarter, such as New York City; or to one country, such as the United States. A comprehensive view of the world’s monetary conditions will be necessary. This subject is dealt with more fully in another chapter.

There is much difference of opinion among writers and students of economics as to the cause of depressions. Bagehot attributes it to the fact that, “at particular times a great many stupid people have a great deal of stupid money.” This writer contends that occasionally money accumulates abnormally and craves an investment outlet. To use his own words, “This blind capital seeks for some one to devour it, and there is plethora; it finds some one, and there is speculation; it is devoured, and there is a panic.” Horace White attributes panics to over-speculation. Bonamy Price says: “A vast outlay in new enterprises involving a large consumption of food and materials, whether in the way of pure waste or temporary unproductiveness, ought always to suggest a feeling of danger. This excess occurs in seasons of prosperity.” John B. Clark holds that it is due to an excess of production; or an excess of production in one line with a deficiency in others. Leone Levi: “The main cause for the occurrence of crises is the sudden realization of an insufficiency of capital to meet present demands.” Thorold Rogers says: “The cause exists in the function of exchange; in the expectation of unreasonable profits and in incorrect calculation.” It was the late Henry George’s theory that depressions are brought about by higher prices of land. He held that workers thrive as they have easy access to natural opportunities for production, and are impoverished as they are deprived of such opportunities. All periods of speculation and inflation end in higher land values. Landlords call for a larger percentage of the product than workers can afford to pay, and both labor and capital become idle until there is a readjustment. Prof. W. S. Jevons, and a host of others, attribute crises to sun spots and their effects on harvests. And so on through a long line of theories.

The consensus of opinion appears to favor the theory of over-speculation, whether in realty, commodities, or the shares of corporations, and this leads up to the question of periodicity. That there has been a recurrence of these troubles about once in ten years is not a debatable question. Nevertheless, many thinkers scout the idea of this repetition at marked periods being other than fortuitous. As prominent a student as Thorold Rogers, for example, ridicules the theory of periodicity. Many hopeful people believe that in time we will find means to avoid these bad spots; that the United States is a young and enthusiastic country, and that we will gradually sober down in both methods and effects. But against this theory lies the cold fact that these cycles have occurred with as charming regularity in France and England as they have in our own country, which would indicate that age and seasoning does not produce any appreciable improvement.

It is probable that the most acceptable theory as to the causes of periodicity is the psychological contention. Human nature is much the same throughout the civilized world. We suffer from a panic and a period of depression, and we grow wary and conservative. This course results in sound methods and accumulation. The business structure rests on a firmer foundation. Gradually the hard lessons of the past are forgotten by the older generation, and are entirely unlearned by the new business generation, all of whom are optimists. Again we expand our enterprises, again fortune favors us; the appetite for gold grows greater as wealth accumulates; men who were economical and satisfied on modest incomes now live extravagantly, and some of them dream of millions. Capital is spread out thinly. Story after story is erected on one foundation, and that foundation, sound enough at first, eventually gives way. Then we must begin our careful building once more. The ten year periods, therefore, may represent with more or less accuracy, the lapse of time between wisdom and folly,--the yard-stick of human intellect and experience.

Many of the writers on this subject seem to strive for tangible reasons for each depression. They dive into the subject for a cause and emerge with an effect, or a handful of effects. For example, the depression following 1893 was not caused by the failures of banks and other business institutions, but the failures were caused by the depression. It matters not that the failures ante-dated the bad conditions. Again, the depression itself was produced by prior inflation. It was the illness after over-stimulation. And so, in turn, we can ask what caused the inflation; and the answer is “Human greed and human folly.” This last analysis brings us around in a circle to the original theory of a psychological cause.

It is submitted that a dependence on periodicity of any kind, either in the ten year cycles or in year to year events is fraught with danger and cannot be adopted by the speculator. It is chart-playing pure and simple, and the man who disposes of his stocks for no better reason than that a depression appeared ten years ago, is liable to find himself in the position of the chart-enthusiast, who, after tracing a marked uniformity in movements for a period of years, runs into reverses and loses all.

It is not meant to say that a knowledge of the past is without value. Inductive reasoning is almost as important as deductive reasoning, when properly employed and applied. If we scrutinize the history of past crises and great movements with a view to determining the salient causes therefor, a great deal has been gained, for we may apply this knowledge to existent elements lying parallel to those which caused trouble in the past, and thus decide what is probable in the future. If, on the other hand, we place dependence on mere repetition, we gain nothing in education and stand in constant danger.

It may be contended that the active speculator has little to do with ten year cycles or their causes, but this is not the case. A correct understanding of the reasons for the great cycles will simplify the study of smaller intermediate movements. Much knowledge applicable to year to year movements will be gained. Monetary troubles, for example, occur almost annually, and their effects on market movements are usually, (not always), similar to those of more widely separated periods, but, of course, in a lesser degree.

III

The Gold Supply

It may be stated without hesitation that the effect of the increasing supply of gold upon prices of all bonds, shares, or commodities which may be classed as speculative, is more decided and certain in its operation than any other single factor. The process of readjustment due to this cause would be slow and regular if the principles at issue were universally and clearly understood. Not being generally recognized, however, the changes wrought by what is naturally an insidious factor are, at times, spasmodic and feverish. It is a remarkable fact that whenever a revolution occurs in any economic or financial process which is, by its nature, concealed or recondite, its existence and influence are discovered by a number of students simultaneously but independently. Important reversions or modifications may be submerged for a long period, and suddenly light is offered from all parts of the thinking world. It is probable that this intellectual phenomenon extends to, or is communicated to the financial world, and that marked and drastic changes in the affected quarters represent a belated recognition of forces hitherto unknown, and the readjustment of affairs by those who see first and furthest. That the operations of this minority will be important goes without saying. The faculty to grasp fully and quickly anything salient bearing on financial affairs is the ground-work of riches and consequently the trained minds of great holders of shares or commodities will respond most readily to sound basic arguments, and the greatest holders can often make of their knowledge a two-edged sword. For example, certain large holders of bonds, recognizing the fact that increasing gold production means higher interest rates, and consequently lower prices for bonds, would be able to dispose of bonds to advantage because of the apparent general prosperity growing out of this same production of gold. It may be assumed that in pointing out in interviews, etc., this reign of prosperity, the gentlemen in question would modestly omit to mention that the same influences which were causing high prices and much business in some quarters, were working damage in others.

Something of this kind has been going on in our bond and stock markets of late. The inevitable influence of gold on prices has made itself slowly felt for a long period, but it is only in the last year that a considerable number of individuals whose operations are of importance in the financial world have come to recognize how powerful this influence is. Price changes in divers securities and commodities hitherto unaccounted for, or attributed to wrong influences, have suddenly been explained to a number of important financiers, and a correct understanding of the problem has undoubtedly resulted in radical readjustments in some quarters. With that pertinacity in error which seems to distinguish the ordinary speculator, he has, however, gone on attributing these processes of equilibration to causes which have only a limited bearing on the case. The recent heavy decline in bonds and stocks, for example, was popularly ascribed to political and legislative action against railroads. Scarcity of money was given second place in these deductions, and gold production third place, or no place at all. If we reverse this order of importance and give gold production first place, monetary affairs second place, and political affairs third place, we are nearer the truth. It looks a little ridiculous that the scope of intelligent perspective should be blocked by three thousand miles of water, and that the unthinking majority who ascribe our decline in bonds to local politics should have failed to recognize so potent a fact as that the decline was world-wide; but such is the case. The readjustment in bonds was due to excessive over-production of gold, and it may be safely assumed that so long as this over-production continues to increase rapidly, bonds will continue low in price or, what amounts to the same thing, interest rates will remain high.

As to the importance of a correct understanding on this subject of gold supply and its influence on prices, I quote from Mr. Byron W. Holt’s book “The Gold Supply and Prosperity,” which, I may add, is used as the text book for this chapter. Mr. Holt says:

“This is the great problem that now confronts the
financial world and demands solution of every
investor. Not to solve it may mean great loss and
possible failure. To solve it means success and
greatly enhanced wealth for all who now have either a
fair share of this world’s goods or who have credit
and can intelligently go in debt for a large amount.”

As speculation or investment-speculation, as defined in the introduction to this book, are the subjects under discussion it is the intention to take up, in turn, such points as bear particularly upon price changes of speculative shares and commodities influenced by our increasing supply of gold. The main points to be considered are as follows:

1--The effect upon bonds and preferred stocks having a fixed
rate of income.
2--The effect upon common stocks of railroad corporations.
3--The effect upon stocks of industrial corporations.
4--The effect upon speculative commodities--wheat, corn,
oats, cotton, etc.

For the purpose of argument it will be assumed in this discussion that our supply of gold is rapidly increasing. We know that such has been the case in recent years, and it is the opinion of most students that this increase may be confidently expected to continue. To quote again from the work already mentioned:

“Both the output and supply of gold are likely to increase for many years.

“While the future output of gold is, of necessity, unknown and uncertain, there is great unanimity of opinion, among mining experts, on this point. It appears to be generally recognized that, during the last twenty years, the industry of gold mining, or rather of gold production, has been established on a very different and much more certain basis than any previously existing. No longer is the output of gold dependent mainly, or even largely, upon placer mining and the chance finds of ‘free’ gold. The supply of gold, in rock, sand, clay, and water, being inexhaustible, it is now possible, by machinery and metallurgical processes, to extract gold, in paying quantities, from many forms of these vast store-houses. To such an extent is this true that the future supply of gold is even more secure than is that of coal, iron, lumber, wheat or cotton.

“Even if prospecting were to stop and attention were to be devoted only to the gold mines and bodies already discovered, and geologically in sight, it is probable that the output of gold would continue to increase for many years. As Mr. Selwyn-Brown, a gold mining expert, tells us in his very interesting article, ‘as the rich surface deposits are being worked out, improvements in mining and metallurgical processes are enabling poorer and poorer deposits to be worked.’ That is, improvements in ‘stamp mills,’ cyanide mills, dredging machines and other gold extracting apparatus and processes are being made so rapidly that it is, every year, becoming profitable to work lower and lower grades of ore, sand and earth. As the grade declines the quantity in sight increases rapidly. In fact there are almost literally mountains of low grade gold ore that can even now be worked profitably. Some of the largest, most productive and most profitable mines of today contain ore averaging less than $3 and, in some instances, only $2 of gold per ton.

“The supply of such ore being inexhaustible the output depends upon the number and size of the mills employed to extract the gold. It is reasonably certain that, for years to come, the improvements in methods and processes of mining will more than keep pace with both the decline in the quality of the ore and the increase in the cost of mining due to rising prices and wages, occasioned by the depreciation of gold.

“In view of all the facts, Mr. Selwyn-Brown’s conclusion that ‘a progressive increase each year may confidently be expected’ is conservative. This conclusion, is almost a certainty. The uncertainty lies in the possibility, if not probability, either of discovering many important new mines in the practically unexplored parts of every continent, or of making improvements that will radically reduce the cost of extracting gold. In either case the increase in the output of gold might be not simply arithmetically but geometrically progressive.”

Admitting that the question of gold production is debatable, it remains for the future to develop any radical change, and it will be necessary for the student to decide this point for himself either by the light of facts as yet not established, or by accepting theories as yet not convincingly erected. If a change occurs, or may reasonably be expected, an understanding of the subject from the positive side of the question loses none of its value. The principles involved could be as successfully applied in reading the probable future by modifying or reversing effects, and reconciling them to a modification or reversal in the cause. If, for example, we accept the theory that increased gold production means advancing commodity prices, and find reason later to believe that gold production will cease to maintain its ratio of increase, we may alter our views accordingly so far as this single influence is concerned.

_1--The effect of the increasing gold production on bonds and preferred stocks having a fixed rate of income._

In this division of the question the crux of the whole matter is interest on money. The question might, in fact, be stated thus: “What is the effect of increasing gold supply on money interest rates?” and having solved that problem, the original inquiry is answered.

To reach a reasonable solution we must first examine the effect of an unduly increasing supply of gold on commodity prices. Over-production in any quarter inevitably leads to lower prices. Gold being a fixed standard cannot decline in figures, but it does so in fact. That is to say, the flexible prices of things which gold will buy rise to fill the gap. Thus, since 1896, prices of commodities have risen 50%. The man who loaned money ten years ago finds its purchasing power impaired 33⅓%, when it is returned to him today, for the reason that commodity prices having advanced 50% in the interim, his dollar will now buy only 66⅔% of what it would buy in 1897. This impairment of principal will be covered, in part at least, by interest rates. This effect, if not recognized and arbitrary would adjust itself automatically, regardless of whether or not investors recognize the influence of changing values of gold, for money, finding higher returns in other quarters, would speedily desert the long-term, fixed-interest investment field, and prices of such securities would decline through lack of demand.

On the subject of interest rates Mr. Holt says:

“But there is another reason why interest rates
should be high when prices are rising. When money
is shrinking in value interest rates should be high
to make up, or partly make up, the losses on the
principals of loans. To illustrate: Suppose that
prices are rising 10% a year. This means that the
purchasing power of money is declining about 10% a
year. Suppose, then, that $100 were loaned for one
year at 5%. At the end of the year the lender would
have $105; but with this $105 he could buy only about
as much as he could have bought with $95, at the
beginning of the year. In reality, he has received
no interest at all but has, instead, paid $5 to the
man for holding his $100. The man with money to
loan cannot afford to do business in this way. He
is usually as wise as are his neighbors, and fully
as able to protect his own interests and to get all
his money is worth, either by buying real property,
investing in bonds and stock or by loaning on notes
or on call.”

In submitting the above contentions it must be fairly stated that there is some diversity of opinion as to the effects of gold on interest rates. A few writers demur to the theory; others hold that the effect is nil, and one or two openly adopt the negative side of the discussion, and state that more money means lower rates of interest. The majority of recent investigators, however, appear to be accepting the theory as given herein, and it may be added that prices of the class of securities considered have borne out the hypothesis faithfully, and that the minority have failed to offer convincing explanations of this readjustment. It will not do to point to the fact that money has been fully employed in constructive rather than investment fields of late; for while this is true enough, it does not explain why gilt-edged bonds such as British Consols have declined in value, while stocks and shares which did not bear the onus of circumscribed returns have advanced. There are, of course, contributory causes: the Labor-Socialistic Government in England no doubt affects the prices of consols, but this influence is specific, and loses most of its force when we consider that not only these particular securities, but practically all others of their class the world over have suffered a radical decline. In other words, interest rates have grown comprehensively higher. The theory appears sound, is borne out by events, and mere denial does not weaken it. It may well be accepted until its opponents succeed in giving us something more convincing in its place.

In support of the theory, Mr. Holt reproduces the following table of British bonds from Moody’s Magazine for October, 1906.

PRICES OF BRITISH INVESTMENT BONDS.

% 1906 1905 1904 1896
British Consols 2½ 86½ 89⅛ 88½ 113⅞[1]
Met. Consols 3½ 102 104 104½ 128¾
London County 3 88½ 94½ 93 128¾
Leeds 4 108 109 111½ 130½
Liverpool 3½ 107 109 109 144¼
Manchester 4 123 128¾ 124¾ 159
New South Wales 3½ 100½ 100 96 112¼
Queensland 3½ 99½ 99 96 111½
Canada 3 98½ 100½ 97 107¼
Cape 3½ 97 98 95 120
Lon. & N. Western 3 93 96 95 124¾
Midland 2½ 76 79 78 124¾[2]
Great Western 4 123 127 123½ 164
----- ----- ----- ----- -----
Average 3.3 100.2 101.8 100.9 128.4

[1] Then 2¾%.

[2] Then 3%.

“Thus,” comments the writer, “these 13 British bonds,
supposedly the safest and least speculative of all
securities, have declined an average of over 28
points in ten years. Considering incomes and present
prices, the unfortunate investors in these bonds have
not only received less than 1% on their investments,
during the last ten years, but, should they sell
their bonds, they would find that the proceeds have
lost 30% of the purchasing power of a similar amount
ten years ago. Altogether, they have suffered a net
loss, over incomes, of more than 20%, or over 2% a
year.”

There are other economic influences affecting interest rates through gold supply, but the one given appears to the writer the most direct and forcible when applied to readjustment of prices to income.