Chapter II: Part II (2)

In weighing the influence of increasing gold production and its effect upon interest rates through the advancing prices of commodities, the student is liable to fall into one grave error. He may perhaps jump to the conclusion that gradually advancing prices of commodities mean gradually advancing rates of interest. This is not at all the case. A sustained ratio of advance means sustained high rates of interest--nothing more. In order to make this clear let us go back to the original principle.

Increasing prices for commodities mean an impairment of the purchasing power of money. If the purchasing power of money is impaired 2% per annum through increasing prices of commodities, and the normal rate of interest is 4%, we can cover the deficiency by making the interest rate 6% _and leaving it there as long as this ratio of impairment is maintained_. In other words the man who loans $1,000 at 6% loses $20.00 per annum in the impairment of capital and receives normal interest of $40.00 per annum and $20 extra to cover his loss in capital. Strictly speaking the extra 2% is not interest at all, but an amortization payment. It matters not how high prices ultimately go, he receives each year a bonus sufficient to cover his loss in capital, and the interest rate remains 6%.

Therefore, if prices of commodities advanced for ten years and then ceased to advance, but were maintained at the highest figures reached, interest rates would fall because there would be no further impairment of capital, and what was formerly amortization, would become usury. On the other hand, if a new ratio of increase should occur in commodity prices and they should advance 4% per annum, interest rates would, if fully adjusted, reach 8%-4% for normal interest, and 4% for impairment of capital.

_2--The effect upon Common Stocks of Railroad Corporations._

Here the effect of high interest rates is, or in time may be, offset by returns in the form of dividends, undivided profits, improvement of property, or the fact that income is not limited. But there is another trouble, and a serious one, for which the gold supply is responsible.

If the increasing supply of gold is responsible for higher commodity prices it must be at once apparent that the building, equipment and maintenance of railway properties costs more and more as all commodities, including labor, advance in price. This would be all right if the selling commodity, i.e.: transportation, also advanced proportionately in price; but it is so difficult to override popular prejudice and widespread misunderstanding on this point, that we find continued agitation and legislation not only against advancing rates, but with a view to reducing those which already obtain. There must, of course, be a limit to this thing, and if the cost of production continues to increase, the railroads must be permitted to demand higher prices for transportation. Otherwise a point would finally be reached where every railroad in the country would be forced into bankruptcy. The great danger lies in a belated assimilation of this truth by the masses, and too much demagoguery on the part of politicians who do understand, but, being politicians, prefer to reflect the views of a majority of constituents, rather than to enter a campaign of proselyting. That evils have been fostered and wrongs committed by eminent railroad financiers is certain; but there is considerable confusion of ideas on this head. Over-capitalization, illegal combinations, manipulation of funds for private gain, and the swelling of dividends for stock-jobbing purposes, when the funds so distributed should have gone into improvements or surplus, have all played their part in arousing the wrath and indignation of the great majority, and they are, as a class, prone to jump to the conclusion that any and every railroad corporation is charging unduly high rates for its services, and making exorbitant returns on invested capital. This has, no doubt, been more or less true in the past in certain cases where extremely high rates were made, and the apparent returns on money attenuated by over-capitalization; but this evil is gradually decreasing, and the real fight is, or should be, against these abuses. The railroads are suffering for the sins of the past, and may suffer still further; but the time is not far distant when, unless conditions change radically, the railroads must be allowed more latitude in the adjustment of rates.

The prevalent opinion, that needed reforms which strike at the root of the evils mentioned above is a bear argument, is another popular fallacy. Such reforms intelligently conceived, and unswervingly carried out, are all in favor of the small shareholder. If laws can be enacted which will prevent individual interests from plundering or misusing the funds of corporations, and which will compel these corporations to issue reports and statements which are not so involved and complex as to be beyond the ordinary comprehension, the small holder or investor will have a better show. But, having cured these evils, no laws can possibly endure which contemplate curtailing fair returns on money, and fair profits through natural enhancement in values.

But, however fair or cheering this view may appear, the fact remains that it will be slow in its acceptance and slower in its operation. We may therefore summarize the situation thus. Increasing production of gold brings about increasing cost of operation, and so long as cost of operation is advanced with no corresponding advance in selling price of transportation, the ratio of profits will gradually decrease until a vanishing point is reached.

In the last analysis, a probable tardy and reluctant recognition of the true status of the case warrants the belief that for the near future, the railroads have a hard time ahead of them, and that so far as this single important influence is concerned, it is decidedly a bearish factor.

_3--The effect upon stocks of industrial corporations._

Here we have a different proposition. Rising prices for commodities do not interfere with the earning power of corporations which produce and sell commodities, the prices of which are not limited by law. In fact these corporations are, in many cases, gainers by this influence which tends to advance prices, not only of what they buy, but of what they sell. It may be added, parenthetically, that railroad companies which own valuable coal lands, etc., find the bad influences already discussed partially offset by the gain from such holdings. The railroad company, however, may be considered as pre-eminently a seller of transportation and has been so regarded herein.

The industrial corporations whose products are subject to regulation by law, such as gas and electric lighting companies, are subject to practically the same influences as those which operate against the prices of railroad stocks. Their cost of production advances easily and inevitably, and the selling price remains fixed, or advances with difficulty and under protest.

_4--The effect on speculative commodities--Wheat, Corn, Oats, Cotton, etc._

This phase of the subject will be dismissed with a few words. If the contentions already made are accepted, it is apparent that all such commodities will gradually seek a higher level. A brief examination of statistics will show that this readjustment has been going on for years. The gradually ascending pivotal point, or average price, is particularly marked in the cheaper cereals,--corn and oats, and also in cotton. This is probably due to the fact that wages have not advanced as rapidly as have prices of living. It is found that in periods of hard times consumption of cheaper foodstuffs and textile fabrics is increased, while the consumption of higher priced commodities and luxuries are curtailed. The wage-earner, therefore, has been in reality living in a regime of hard times, although this fact is easily submerged by steadier employment, by a fictitious appearance of general prosperity, and the ability to spend a larger number of dollars, without realizing fully the loss of purchasing power in the dollars.

It would be out of the question to attempt to enter anything like a comprehensive study of the question of gold production and its effects in a single chapter, or even in a single volume; neither is it necessary to the purposes of this work, for the student who desires a comprehensive education in this regard will find ample means and material ready to his hand. From the standpoint of investment and speculation alone, it is submitted that increasing production of gold is, to use the phraseology of the street, bearish on long time bonds and other securities yielding a limited rate of interest or income, temporarily bearish on railroad stocks, bullish on industrial shares, except as noted, and bullish on speculative commodities.

At the risk of indulging in undue reiteration, attention will again be called to the fallacy of considering such subjects as the one of gold production too remote in concrete effects, or too sluggish in operation to be of importance to the speculator. A thorough understanding of cause and effect bears upon the operations of today, in that it anticipates the results of tomorrow. Through knowledge of influences of this character, serious error may be avoided. For example, one of the profound axioms of the speculative world is that bonds advance first and stocks afterwards. If we understand _why_ bonds have been, and are at present, declining we may be justified in modifying this view and considering the axiom more or less obsolete. He who operates an engine without a clear understanding of its motive power is likely to get into trouble, or perhaps be blown up.

It may be pointed out also, that a too literal acceptance of the suggested effects of this or any other great price influence is highly dangerous. Even while gold production continues to increase rapidly, prices, not only of shares, but of all things, will overleap themselves and will also swing backwards to the other extreme. The cycles are not completed, until both zenith and nadir have been touched. Changes in gold production will not prevent declines in prices; they will, however, interfere with the regularity of the cycles.

This chapter may be fittingly closed with the following list of conclusions reached by Mr. Holt, in the work already mentioned. These conclusions cover all the points herein presented, and others which are of interest and value:

“1--That both the output and supply of gold are
likely to increase rapidly for many years.

“2--That, therefore, the value of gold will
depreciate as the quantity increases.

“3--That this depreciation will be measured by the
rise in the average price level.

“4--That a rising price level, if long continued, is
accompanied by rising or high interest rates.

“5--That high interest rates mean lower prices for
bonds and all other long-time obligations drawing
fixed rates of interest, dividends, or income.

“6--Rising prices increase the cost of materials and
of operation and tend to decrease the net profits
of all concerns, the prices of whose products or
services either cannot be advanced at all, or are not
free to advance rapidly.

“7--Rising prices tend to increase the net profits of
all concerns that own their own sources of materials
and supplies.

“8--Rising prices of commodities tend to cause
the prices of all tangible property to rise. This
includes lands, mines, forests, buildings and
improvements.

“9--Rising prices of commodities and property tend to
increase the value of the securities of corporations
holding commodities or property.

“10--Rising prices and cost of living necessitate
higher money wages, though the rise of wages will
follow, at some distance, behind the rise of prices.

“11--As rising prices do not mean increased profits
to all concerns, many employers will not concede
higher wages without strikes.

“12--Rising prices and wages, therefore, mean
dwindling profits and troublous times in many
industries, with complete ruin as the final goal.

“13--Because wages will not rise as fast or as much
as prices and the cost of living, there will be
dissatisfaction and unrest among wage and salary
earners.

“14--Rising prices of commodities and property
encourage speculation in commodities, stocks and real
estate and discourage honest industry.

“15--Thus, rising prices, by diminishing the
incomes of ‘safe’ investments in ‘gilt-edged’
bonds and stocks and by increasing the profits of
speculators encourage extravagance, recklessness and
thriftlessness.

“16--As rising prices decrease the purchasing power
of debts, and thus aid debtors at the expense of
creditors, they discourage saving and thrift.

“17--Rising prices, then, by promoting speculation
and extravagance, increase consumption, especially of
luxuries, and, therefore, stimulate production.

“18--Rising prices, then, result in what is real
prosperity for many industries; but what is for a
nation as a whole, artificial or sham prosperity--the
result of marking up prices rather than of increasing
production.

“19--With prices, wages, rates and industries always
imperfectly adjusted to the ever depreciating value
of gold, and with instability and uncertainty
throughout the financial world, there cannot but be
a great shifting around of values and of titles to
property.

“20--As this shifting is to the advantage of the
debtors--the rich--and to the disadvantage of the
creditors--the great middle class--it results in
rapidly concentrating wealth in the hands of a
comparatively few.

“21--For all of these reasons a prolonged period of
rapidly rising prices is reasonably certain to
become a period of unrest, discontent, agitation,
strikes, riots, rebellions and wars.

“22--A rapidly depreciating standard of value then,
if long continued, not only produces most important
results in the financial, industrial and commercial
world, but is likely to result in changes of great
consequence in the political, social, and religious
world.

“In view of all the facts, results and possible
consequences connected with the increasing output
and supply of gold, The Wall Street Journal was
right when, on December 4, 1906, it said that ‘No
other economic force is at present in operation in
the world of more stupendous power than that of gold
production.’”

IV

Money

From the viewpoint of the speculator, money conditions require constant consideration. It goes without saying that no sustained bull market is possible unless money conditions favor such a movement. We find that at the end of a period of inflation, the credit situation is always strained, while a general recession in business will usually cure the evil.

The student may enter this large and important branch of the subject as deeply as he likes. There are many excellent works dealing with the various phases of the subject, and the question has been so long and carefully studied by writers, that many important points have been established so definitely as to admit of little diversity of opinion.

The bank statement which is issued weekly by the New York Clearing House, is eagerly scanned by traders, but it is not always the case that this scrutiny is thorough or enlightening. The statement at its best, cannot be considered more than a barometer, and its showings are by no means exact, as it is based on a system of daily averages. That is to say, the banks figure their loans, deposits, etc., for each day of the week, and report the averages to the Clearing House. This method often leads to a false showing. Commenting on this fact, Mr. S. S. Pratt in his book, “The Work of Wall Street,” says:

“A striking illustration of the effect of the law of averages upon the Bank Statement was given in September, 1902. The statement of September 20 reported a loss in cash of $7,300,000, while the actual loss, so far as it could be estimated, was only $3,600,000. The statement of September 27th, on the other hand, reported a gain in cash of $1,790,000, while the apparent loss was $4,000,000. The former statement reported a deficit in reserve; the latter a surplus.”

It is the practice of many speculators to examine the bank statement merely as regards the changes made from week to week, without reference to the more important totals. A decrease in reserves is considered an evil, etc. There is something in this of course, but such methods and deductions are incomplete and insufficient. A decrease in reserves when the surplus is very large may be practically meaningless, while the same amount of decrease when reserves are small may be significant. It is a good deal like the difference between a man spending a dollar when he has a hundred, and spending his last dollar.

The most important general information to be gained from the bank statement, is by a comparison of loans with deposits, and specie with loans. We may thus arrive at a fairly correct idea of the state of trade and the expansion of credits. If we find that loans are in excess of deposits, and the percentage of specie small, we may, with certain qualifications, deduce inflation; while on the other hand, the extent of liquidation may be judged in case these conditions are reversed. As an example of this process, the following historical facts are given.

In 1890, twenty stocks listed on the New York Exchange were selling at an average price of about $87 per share. The percentage of loans to deposits was about 95% and the percentage of specie to loans about 20%. In November of that year, loans advanced to 102% as compared with deposits, and specie declined to about 18% of loans. The stocks mentioned declined to an average price of $64 per share, and later in 1901 to about $61 per share. From 1891 to 1893 there was some alternate improvement and retrogression in money conditions, all of which was accurately reflected in stock prices.

In 1893, the proportion of loans to deposits rose to about 109%, and proportion of specie to loans declined to 13%. The average price of the twenty stocks reached about $47 per share. (The panic of 1893).

In 1894, the proportion of loans to deposits fell to 80%, and specie to loans rose to 30%. This was due to the liquidation of 1893. Stock prices showed some betterment, rising to about $57 per share. The severe drubbing of 1893 had made public investors nervous, and had in many cases incapacitated them for stock market operations. That was to come later.

In 1896, the proportion of loans to deposits rose to 102%, and specie to loans fell to 10%. Stocks reached their lowest level in July of this year ($42 per share for the twenty stocks mentioned).

From 1896 to 1898, a gradual improvement was apparent. Through all this period stock prices faithfully reflected money conditions. In July, 1898, the proportion of specie to loans rose to 30% and loans to deposits fell to 83%. Stocks began advancing and in March, 1899, the average price of the twenty stocks considered, was about $85 per share.

In June, 1900, the average price of the twenty stocks considered, was about $75 per share. The proportion of specie to loans was about 22%, and the proportion of loans to deposits was about 90%. From January, 1901, until September, 1902, money conditions did not improve, but stocks continued to advance. There were large crops and a general wave of expansion and prosperity swept the country. In September, 1902, the proportion of loans to deposits was 99%, and the proportion of specie to loans about 17%. Meanwhile stocks were high--$128 per share for our twenty stocks. Conditions, though temporarily ignored, asserted themselves in 1903, and in September of that year, the average price of the twenty stocks was about $88 per share; the percentage of loans to deposits 101% and specie to loans 19%. The money situation had not changed materially, but the stock market was making a deferred payment.

In August, 1904, the proportion of loans to deposits had fallen to 90% and specie to loans had risen to 25%. The stock market was steadily advancing, and in January, 1906, stocks reached their pinnacle--$138 per share for the twenty securities considered.

It will be observed that while stock market movements do not always immediately reflect good or bad conditions in the financial world, the effect is ultimately felt. We are pretty safe in assuming that whenever loans are unduly expanded and the percentage of specie is small, these conditions must be corrected either by a halt in business or by liquidation; and the word liquidation here means a cleaning up in other lines, as well as in the stock market. It is sometimes the case that after the stock market has suffered a severe decline, there is little improvement in the monetary situation as shown in the bank statement. In January, 1907, for example, the percentage of loans to deposits was about 102%, and specie to loans about 17½%. The average price of twenty active stocks at that time, was about 130. At the present writing (June, 1907) those same shares have fallen to an average price of about 101, and there is no appreciable change in the relation of loans to deposits, or specie to loans. On June 8th, 1907, the bank statement showed loans to deposits 102%, and specie to loans a little below 19%. This state of affairs would naturally lead to the belief that unless we are vigorously assisted by some powerful factor, such as good crops, we now face a period where either a decided slowing up or an actual recession in general business is imperative. On this theory, fortified or modified by a study of extraneous effects, the speculator or investor may gain a valuable knowledge of probable future movements in the stock market. If he decides that the case is a bad one and that a set-back in business will occur, he may argue that, even if stocks are low in price, there is little hope of a material upward movement in any quarter. It would also be evident that the industrial shares would suffer more in price than the railroad shares; for, under present conditions, a decline in the price of products generally helps the railroad corporations to some extent by permitting advantageous purchases. For instance, if finished steel and iron products decline in price, the railroads might be enabled to carry out projected extensions to better advantage than otherwise, while the manufacturing companies would suffer a considerable loss of profits. It is, of course, true that a recession in business is felt in all lines, but as the selling rate of transportation is more fixed than prices of commodities, and as the producing companies gain less by a recession in the prices of the commodities they _buy_ than do the railroads, the industrial stocks are more adversely affected. This may appear as a sort of compensation for the fact that while rates for transportation do not advance as easily as prices of commodities, neither do they fall as rapidly in periods of depression.

In examining the bank statement as a barometrical showing of money conditions, it should be remembered that an increase in deposits does not mean an increase in cash. The bank statement may show an increase in loans of $1,000,000 and an increase in deposits based on these loans. That is to say, $1,000,000 may have been borrowed on commercial paper, and the proceeds passed to the credit of the borrowers. Commenting on this fact, Theodore Burton says:

“But in the modern development of banking the actual
money deposited is much less important in determining
the amount of deposits, because so large a share
of them represents credits obtained by loans, etc.
These credits are transferred upon orders executed by
depositors, and furnish a substitute for currency.
In proportion as payments and settlements are made
by checks, drafts, and bills of exchange, deposits
maintain an increased proportion to the amount of
currency in circulation. This class of deposits
increases prior to a crisis rather than diminishes,
because loans increase.

“In the reports of national banks, there is a
striking correspondence from year to year in the
volume of deposits and that of loans and discounts.
Deposits show more frequent fluctuations, but rise
and fall in general accord with loans and discounts.
This correspondence is easily explained. Another
distinction should be noted. Some deposits are the
result of completed transactions, and are based upon
the proceeds of sales made, amounts realized from
investments, etc. Others merely represent loans or
discounts the proceeds of which are entered to the
credit of the borrower. Before every crisis there is
an unusual proportion of deposits which are based
upon loans. If in bank statements there could be
separate columns for these two kinds of deposits, the
information afforded by their increase or decrease
would be much more valuable.”

This point shows the necessity of considering not only the proportion of loans to deposits but of specie to loans. On this point Mr. Burton says:

“A continuous decrease of specie attended by an
increase in outstanding discounts is always a danger
signal. The gap between the two may widen for months,
and even for years, and may fluctuate from time to
time, but a sudden change of large proportions, or
a steady decrease of the percentage of specie is an
unfailing indication of danger. The reason for this
is not hard to discover. The quantity of metallic
money in a country shows what part of its capital is
available as money for the payment of its obligations
to foreign countries, the final test of availability.
For this last named purpose credit money cannot be
used, but only money having intrinsic value--money
of the Mercantile Republic, as it is called by Adam
Smith.”

The conclusion reached therefore, is that an increase in loans and discounts with no corresponding increase in cash or with an actual decrease in cash, reflects a bad state of affairs, even when the advance in loans and discounts appears to be fully offset by deposits.

There is one feature which should not be overlooked. The very worst state of affairs may be shown in the bank statement during a period of great commercial activity and inflation in all lines. The reverse is also true. In 1894, following the panic of 1893, the percentage of loans to deposits fell to 80% and the percentage of specie to loans rose to 30%; but no bull market occurred. This was due to stagnation in all lines of business, a period of timidity and conservatism. In 1895, there were signs of a great improvement and the stock market started upward. This improvement, however, proved illusory and premature. Loans rose quickly to 95% of deposits and specie fell below 15% of loans. Then followed, in 1896, the new record of low prices.

In studying the bank statement for its effects on speculative prices, surplus reserves will frequently suggest danger or safety. If surplus reserves dwindle too near the vanishing point, the possibility of necessary retiring of call loans is apparent. (See “Bank Statement,” page 125).

It is possible to gain valuable knowledge by a careful examination of the bank statement. The points made above are, of course, only of a simple and elemental character. We may go on with our examination as far as we like and scrutinize not only totals, but the position of individual banks. Also, in order to gain a comprehensive perspective, it will be expedient to examine, not only the barometer of the New York situation, but the condition of interior banks. However, it is a pretty good idea to begin with the A, B, C’s.

High rates for call money and the calling of loans are responsible for many sharp market movements. A large class of speculators figure that when dividend returns are high and call money cheap and plentiful, they have a tangible influence working in their favor while they are long of stocks. If rates for call money are 2% and a stock returns 6% there is, eliminating speculation, an advantage of 4% per annum in favor of the marginal speculator. This advantage is not so great in carrying stocks on time loans, as rates for fixed periods are materially higher. There is always danger of a flurry in call money, however, and in the event of a wholesale calling of loans there arises the necessity of selling stocks, and a decline occurs. There is also present the element of manipulation in this quarter, and it cannot be gainsaid that many instances have occurred where funds have been suddenly withdrawn for the purpose of “shaking out” an undesirable following or of accumulating securities to advantage; and on the other hand, call money has frequently been made cheap in order to encourage purchases.

There are two periods of the year when the stock market is affected by disbursements of money in the form of interest and dividends. The two dates at which heavy disbursements occur, are January 1st and July 1st. It is a popular belief that just prior to each of these dates, money will grow “tight” because of the necessary provisions made by banks and other corporations to meet such payments. Following the actual distribution of funds, it is the theory that a part of this money will seek reinvestment in bonds and shares. A great many speculators argue that this would naturally produce stringency, the possible calling of loans, and consequently lower security prices in the latter half of December and June and an advance early in January and July. While this reasoning looks sound enough on its face, it is not at all dependable. It is certain that everything is discounted in advance of actual events in speculative circles, and the more widely such theories as the one mentioned are disseminated, the more dangerous and inoperative they become. Instances are not lacking in recent years, where the technical situation growing out of this reasoning, has not only nullified the theoretical action, but has resulted in actual reversal, i.e.: an advance just preceding disbursements and a decline at the time the distributed funds were presumably returning to investment channels. Numerous shrewd people, anticipating an advance in January and July, have attempted to take time by the fore-lock by effecting purchases in December and June. Their buying, being of a competitive character, not only carries prices upward prematurely, but creates a weak speculative long interest, subject to disappointment if funds do not reappear in the volume expected, or susceptible to attack by great manipulators.

There is another objection to this theory of periodicity. If the market is dull and stagnant, with little public interest, it behooves the large interests which have stocks for sale to bid up prices and create activity prior to the heavy distributions of funds. They may accomplish two things by this process. They make not only a higher level of prices at which to sell their wares, but create what is of even greater importance, an appearance of activity, prosperity and a newspaper market. It is strangely illogical, but unquestionably true, that people who would flatly refuse to enter a market at a low level of prices will rush in to buy ten points higher if the factors of bustle and excitement are present. Both the doctrine of common-sense and the calculus of probabilities would establish the fact that each advance brings us nearer the top, and each decline brings us nearer the bottom; but few men can train themselves away from the idea that an upturn already established does not indicate higher prices and vice versa. It is a sort of enthusiasm which a minority understand, however, and make good use of. The psychological effect of mere excitement is one of the explanations of the incontrovertible fact that the public usually buys at high prices and sells at low prices.

The acceptance of certain periods or seasons as a guide to either purchases or sales of stocks is, in the last analysis, merely a form of chart-playing. It is natural to evade a studious examination of the general business and monetary situation and to resort to a simple, albeit a superficial diagnosis, which, being insufficient and incomplete, is dangerous. It is suggested that while the double effects of contraction prior to distribution should be understood and examined, the only safe method is to go behind these temporary and periodical changes and study the whole basic structure comprehensively. We may find that money is in demand for the purpose of propping and sustaining an unsound business condition, and that it will in all probability fail to return in volume to the security markets. This occurred in January, 1907, and the believers in a “January rise,” were badly disappointed. Interest rates on money must also be given consideration. If the commercial world is striving to secure funds at a higher rate of interest than is offered on shares, money, or a good portion of it, will go where interest returns are greatest. And in this regard it may be said, that merely local interest rates are not always a good indication of money affairs in the business world. Not long ago, the writer, being suspicious of the claims of plentiful money and low rates in New York, investigated the matter through Western bankers and found that prime paper was being offered west of the Missouri River at much higher rates. This was made particularly significant by the fact that previously the borrowers had always been able to supply their needs at home, and that the loans, being offered through brokers, really cost about ½% more than was apparent on their face.

It is frequently interesting and instructive to examine the character of collateral behind loans, and find out how large a percentage of this collateral consists of stocks and like securities. Our stock market might appear to be in a sold out condition, when, in reality, a very bad technical condition obtained. The purely marginal speculative account in New York City, or other important centers, is carried on under certain flexible rules or customs as to the amount of money loaned on certificates; but in cases where securities have been widely purchased for cash by small holders, and, in the event of general tightness in money or depression in business, made the basis of loans in country banks, but we have, in fact, a very weak _marginal_ public account. The home banker will loan more liberally to his townsmen and will scrutinize the movements of prices or the stages of the market less closely than the city banker, and the certificates owned by small holders and deposited as collateral may, in the aggregate, represent an enormous line of shares. It would be quibbling to say that this situation represented anything less serious than a weakly margined public line. If the market declined materially, the bankers would be forced, in self-protection, to call for more collateral, and the result would depend, as in all other cases, on the ability of the individual holder to take care of himself. Such a condition existed in U. S. Steel stocks in the depression of 1903, and was pointed out at the time by the writer. The knowledge obtained was based barometrically on information obtained from a number of bankers in different localities.

While interest rates for both time and call money are frequently fictitious, or of a temporary and artificial nature, and no set rules can be laid down as to certain conditions in money and their immediate effects upon security values, it is not difficult to gain a general idea of underlying conditions. We have always at hand statistics which will reflect faithfully the fundamental basis of the entire world structure. But in this important division, as in most other branches of speculation, we often find that what is really important is absolutely ignored, while matters of little moment are harped upon, or even made the basis of operations. Thus, every habitue of brokerage offices eagerly watches the bank statement or the rates on call money, and knows nothing about the expansion of credits, even when such expansion has reached a point that would make a crisis appear inevitable. No better proof of this can be offered than the fact that our heaviest business and greatest inflation, have frequently gone merrily forward for a year or more under suicidal conditions. These conditions have sometimes been so obvious, so forcible, that it would appear impossible to view them with equanimity. In a majority of cases they were probably not viewed at all, and the thoughtful men who pointed out the danger have been called calamity howlers or pessimists. There is one great check to education in this direction: great financiers who are most conversant with actual conditions, seldom find it expedient to point out the facts. Sometimes they, themselves, wish to dispose of their holdings because of the obvious peril ahead and this process would not be facilitated by gloomy predictions. On the other hand, it is too often the case that these same gentlemen, finding it to their great advantage to disperse sunshine until their goods are sold, point assiduously to the excellent business of the present, and neglect to touch on the irrepressible future, which, after all, is the most important question to the investor or speculator.

V

Political Influences, Crops, Etc.

The possibility of legislation adverse to corporations is always present as a market factor, and at times severe declines have been recorded through such action. It is not always the case that such legislation is truly a bear factor, although it is fashionable to so interpret anything in the nature of legislative interference with corporate affairs. It is the writer’s opinion that a great deal of misunderstanding has recently arisen in regard to the attitude of certain party leaders toward the heads of great railroad corporations. The opinion has been widely fostered by opposing politicians and others that the credit of railroad corporations was being badly impaired, and the interests of stockholders jeopardized because investigations were ordered as to the methods of individuals or directorates.

It does not appear that any reasonable man could, as the stockholder of a corporation, or as a private citizen, object to having dishonest or sharp practices on the part of the active management of the property in question exposed and prevented. Where it is shown that an individual, in his capacity as the head of a business, has employed his office as a means of juggling stocks or reaping enormous personal gains, it cannot but be to the interest of stockholders to have such practices stopped. If the means at issue are honest and legitimate, the benefits reaped should go to the stockholders. It is impossible to reconcile any other plan with equity and common honesty. Let us look at the matter without the mystery that obscures the affairs of a great corporation.

Suppose a member of a certain firm, its manager, finding the firm in need of funds, secures money at a high rate, and at great profit to himself--is that right? Or is it the manager’s business to work entirely in the interest of the partners he represents? Is it possible for him to legitimately acquire personal profit of any kind in administering the affairs of the firm? It is not sufficient to point out that the manager’s action in securing funds redounded to the great benefit of the business concern, or that his capability and shrewdness were reflected in enormous partnership profits. His associates in business are entitled to all, not a portion, of the gains secured in the management of its affairs.

It is submitted that much of our recent legislation which is popularly supposed to have injured stock values has, in reality, aimed to protect the small holder and throttle the unscrupulous men who, while actually in their employ, were milking their business of millions. Legislation which effects publicity and simplicity in the affairs of corporations is an unmixed benefit to the small investors.

It is almost invariably the case that when a great decline in stock prices occurs, the set-back is popularly attributed to some factor which, in reality, had little to do with the reversal. In the decline of 1907, thousands of people attributed the inability of railroads to borrow money at low rates of interest almost entirely to hostile legislation. Apparently these rapid-fire thinkers did not know or realize that interest rates had risen the world over, that there was not a free money market in the world, and that money, instead of being withheld from 4% issues, was fully employed in other lines. Such, however, was the case; British Consols, French Rentes,--all the choice securities of civilized countries had kept pace with the declines in our own bonds and stocks; but these facts seem to be unappreciated.

It is true that adverse legislation sometimes seriously impairs the value of a security. A public utilities company, for example, which is forced to reduce its selling rate, is unquestionably injured from an investment point of view. Such legislation, however, may be weighed correctly by a little calm consideration, and it may be said that action of this nature is usually for the purpose of correcting abuses, rather than as a revengeful and confiscatory attack on vested interests. Measures which prevent a fair return on capital will perish of their own iniquity. So far as measures which are formed to prevent extortion are concerned, it is impossible to criticize them.

In order to correctly weigh the effects of legislative measures on security values and prices, we must therefore examine fairly what the legislation seeks to accomplish, taking care not to allow a contemporaneous price movement which may be due to other causes, to act as a verification of a false view. This error occurs very frequently; in fact, one of the most remarkable things about speculation is that the true causes of great movements are fully appreciated by the majority _only in retrospect_.

The probable market effect of legislative and political affairs can be correctly gauged only by examining the nature and importance of the issue in question. This is true not only of state and municipal action, but in regard to presidential elections. There is a popular idea that it is dangerous to buy stocks on the eve of a new presidential campaign, but there is not much in history to uphold the view. True, in a majority of cases, a decline has preceded such a contest, but there have been frequent reversals of this action, and we have had too few elections to attempt any chart-playing on this influence. Such a guide would be empirical.

The issues involved in a presidential contest, however, may sometimes influence prices. Here again a careful examination of facts and probabilities will generally uncover the truth. If the nominee of one party stands on a dangerous platform and the outcome of the contest is in doubt, we may well dispose of shares if for no better reason than that the element of danger is present. Danger, whether or not it is finally realized, is a bear factor, just as safety is a bull factor.

Tariff agitation should be accorded careful consideration by the speculator. This is particularly true as regards the effect on industrial corporations. A reduction of the present tariff on Iron and Steel, for instance, would materially lower, if not destroy, the value of many of the common stocks of steel manufacturing corporations. A very clear and comprehensive work on this subject is mentioned in the bibliography on page 183.

No cut and dried rules or suggestions can be offered as to the effects of political or legislative issues on prices. Each point must be scrutinized as it arises, and judgment formed thereon. Sympathetic movements will sometimes occur because of apprehension or misunderstanding, but such effects will be short-lived.

_Crops and Crop Failures._

The question of crop failures is of great importance. It is not difficult to form a fairly correct idea as to the ultimate yield. The estimates of the Government sometimes go wide of the mark, but it must be remembered that they are _estimates_ and nothing more, and that conditions may change somewhat after the figures are compiled. The speculator is frequently confused by the conflicting opinions of private experts. It is probably safer to disregard the various authorities and pin one’s faith to the computations of the bureau at Washington. These official documents have been criticized at times, and no doubt the criticism has been warranted, but they form our most dependable source of information and will improve as time rolls on.

A crop failure, or a short crop, invariably brings forth much fallacious vaporing from the rooters of Wall Street. They are as bad in their efforts to obscure the truth as are the crop-killers with their fabrications. A crop failure is a serious thing and must be faced as such. The contention which is always heard in lean seasons, that the evil has been counter-acted because of the large reserves of Wheat, Corn or Cotton in farmers’ hands is ridiculous. Farm reserves are wealth. They have already found their place in the business structure. In many cases the money they represent has already been spent in the form of credits. Nor do high prices for cereals or cotton overcome the evils of short production. Small crops mean decreased employment for laborers; a diminution of per capita purchasing power, and increased cost of living. They also mean smaller tonnage for the railroads, and consequently decreased earnings.

And in examining crop prospects, we should consider the fact that each year’s normal crop should be larger than the one preceding it. This is distinctly shown by tracing production back for a term of years.

There will, of course, be fluctuations in this gradual increase, but the tendency is certain. We may also consider that as railroads are constantly extending their lines and increasing their facilities, it follows that increased production in the commodities they transport is necessary to their well being.

And short crops the world over in the same year have the same elements of economic evil. The purchasing power of the world is reduced, and even if we ourselves make fair crops and export them at high prices, the world’s poverty is felt in lack of demand for other exportable surplus. The civilized world is too closely knit together in its affairs to permit of the entire localization of the effects of a serious property loss.

A lean crop year can probably do more to temporarily injure the actual _value_ of railroad shares than can any other single influence bearing on prices. Tonnage is affected both ways, so is passenger traffic. There is less grain or cotton to haul to the markets, and, as purchasing power has been reduced in the affected localities, there is less freight to haul back to the producers. In the last analysis, the products of a community represent to a great extent the mere exchange of these products for other luxuries and necessities, and the effect of decreased production is a two-edged sword, so far as the transporting companies are concerned.

_Accidents._

The effect of accidents on stock prices has been fully discussed in a former work, and the contention offered that accidents could no more be provided against, or considered, in the investment or speculative world than in any other walk of life. It is also thought that accidents are more frequently the _excuse_ for movements than the _cause_ of them. If a market is in a bad technical or general condition, the slightest adverse happening may create panic; while if the foundation is sound, even a great calamity, such as the San Francisco earthquake, will cause only a temporary halt. The man who speculates correctly has little to fear from accidents.

In the following section of this work, the writer
has undertaken to touch on such features as appear
of most interest and benefit to the speculator or
investor. Some of the matter presented, such as the
question of dividend dates, will appear to many
readers so simple as to be unnecessary, but it is
true, nevertheless, that many very elementary facts
are misunderstood or unappreciated by a large class
of public participators.

VI

Puts and Calls

Puts and Calls, or “privileges,” have long been popular with a certain trading element, either as a protection against loss in commitments already made, or as a positive method of trading.

The theory and operation of privileges may be easily understood by considering them in the light of insurance, the money paid for them as a premium, and the funds received in case the privilege is exercised, as a loss paid by the insurance company. It will be understood, that in speaking of the _seller_ of puts or calls, the insurance company is referred to, and that the _buyer_ represents the insured party.

The _buyer_ of a call has the right to _call_ for his shares or commodity, at the price named in the contract at any time before its maturity. The _seller_ of a call fixes a certain price at which he agrees to _deliver_ stock, specifies the duration or time limit of the contract, and receives from the buyer a certain sum or premium.

For example: United States Steel Common is selling at $40 per share; A, the seller, offers a call on 100 shares at 43, good for ten days, at a price of say, $100. B, the purchaser, pays the $100 and receives a contract from A as specified above. Now suppose that at any time before the expiration of the period named, Steel Common advances to 50. B can call for the delivery of 100 shares of Steel at 43, and by selling it, reaps a profit of $700, less the cost of the privilege, ($100), and the brokerage. Used as a protective measure on short sales, the result would be the same, as $700 would have been saved. That is to say, if A is short of Steel at 40 and it advances to 50, his call has acted as insurance against any loss over and above the $300 represented by the rise from 40 to 43.

The “put” is exactly the reverse of the “call,” and is insurance against a decline; or, in other words, an agreement to receive shares at a specified price on or before a certain date.

Using the same illustration as before, let us assume that the price of Steel Common is 40, and that A, the seller, offers a put at 37, good for 10 days, at a price of $100. B, the buyer, is now insured against any loss which may accrue through a decline below 37 in the ensuing ten days. If he is long of the stock and it declines to 30, he may deliver his shares to A at 37, or if he has purchased the “put” as a speculation, he may buy 100 shares in the market at 30 and deliver to B at 37, netting a profit of $700, less the price paid for “put” and brokerage.

One of the favorite methods of trading in privileges is to buy or sell against them when the price named is reached. For example, say B holds a ten day “put” on Steel Common at 37, and the market for the stock declines to 36 in five days. He may now buy 100 shares at 36 on the theory that he has regained his original outlay of $100 and has a possibility of profit through market action in the remaining five days, while there is no possibility of loss. If the market advances to, say 38, he may sell the one hundred shares purchased, and on another decline to 37 or 36 may again purchase, repeating the operation indefinitely during the life of his put. The “Call” is, of course, made the basis of short sales on an exact reversal of this process. This fashionable form of exercising privileges is facilitated by the fact that “puts and calls” issued by members of the New York Stock Exchange, are generally accepted by brokers as “margins”; B having paid A $100 for a “put,” as illustrated above, could, if Steel declined to 37 or below that figure, buy 100 Steel and give his broker the privilege issued by A, in lieu of a marginal deposit. The broker is satisfied, as he gains a commission, and in the event of a further decline in the price of Steel can call on A to receive the stock at 37 when the option expires.

Another popular form of trading in privileges is to buy or sell half the amount named in the privilege when it becomes “good” through market action. If B holds a “put” on 100 Steel at 37, he may, at that price or below, buy 50 shares. He is now in a position to profit by either an advance or a decline. If the price advances to 40 he has three points profit in the 50 shares purchased. If, on the other hand, the market declines to 34, he still gains 3 points on 50 shares, for his “put” protects him against a loss in the 50 shares purchased and he can purchase another 50 shares at 34 and deliver to A at 37. In short, when he makes his 50 share purchase at 37, he is both short and long of the stock and must gain on a movement either way in the market price.

A “Straddle,” as the term is applied to privileges, is a combined “put and call”. The purchaser gains on a movement in either direction. The general rule is that the gain is to be represented by a market change representing an excess of the amount paid for the “Straddle.” Thus if A sells to B for $250, a straddle on 100 shares of Steel, when the current market for the stock is 40, B is in a position to gain by either an advance above 42½ or a decline below 37½.