a season of dull times brings to the business men in charge of industry. At the same time fixed charges preclude shutting down, except at a sure and considerable loss. The business men involved are constrained to go on, and in the absence of wide combinations in industry they are constrained to go on at such competitive prices as to preclude reasonable profits.
The question of fair prices and reasonable profits has some reference to current rates of interest. A "fair" rate of profits is such a rate as bears a reasonable relation to the current rate of interest, although this relation of profits to interest rates does not appear to be a strict one. Still, there undoubtedly is some reference to the current rate of interest as a sort of zero line to which profits should not decline. New investments are made on the basis of current rates of interest and with a view to securing the differential gain promised by the excess of prospective profits over interest rates.
In a period of depression the aggregate industrial equipment is, notoriously, not running at its full capacity; there are many idle and half-idle plants and many idle workmen. The concerns in question find themselves unable to do a full run of business at reasonable profits. Still, unless the depression is of exceptionally short duration, there is always some new investment going on. More or less of new capital continues to find its way into industrial business in competition with the concerns that are already in the field.126 In case of a protracted depression the aggregate of new investments so made may, in the course of years, amount to a very considerable addition to the industrial outfit, and the production of the new establishments may very appreciably increase the aggregate output. Indeed, the output of the new establishments is a notable factor in swelling the supply and keeping down prices. But the new investments made during the depression are profitable, at least at the start. Or even if this should be questioned when stated in this broad way, it will at least hold true that they are commonly entered upon with a well-advised expectation of their being profitable if the situation does not materially change between the time when the new venture was entered upon and the time when the new equipment has got under way. If the interval between the inception of the new enterprise and its completion is a long one, the situation may so change in the meantime as to leave it unprofitable even if it has been conservatively planned. There are also, of course, fraudulent enterprises which are not expected by their promoters to pay a profit on the investment; and there are probably, also, always some ventures entered upon during dull times with a view to being beforehand in preparation for better times. But after all has been said in qualification of the main proposition, it remains true that some new investment is going on with a well-advised expectation of reasonable profits on the basis of current costs, prices, and rates of interest.127 The rate of interest in times of depression may be unsatisfactory to lenders; it may be discouraging by comparison with the customary range of interest rates during better times. Still, the obstacle to business is not to be sought in an effectual discouragement of lenders, for in point of fact money is readily to be had on good security during any protracted depression.128
There is also the fact that investment is continually going on, which argues that the difficulty is neither that capital cannot be found for investment, nor that investment has no prospect of reasonable profits. Practically, no exceptional amount of fluent funds is withheld from the market, - except in time of panic, which is another matter. It may be added that the rate of interest need not be notably low in time of depression, just as, on the other hand, a period of business exaltation is not uniformly accompanied by a notably high rate of interest.
But a low or declining rate of interest is effective in the way of depressing the business situation, even though a depression may go on without it. The line of its bearing upon business depression, or at least one line, is as follows: Established business concerns (particularly corporations) engaged in industry have some appreciable fixed (interest) charges to meet - on leases, mortgages, and interest-bearing securities (preferred stock and bonds). These outstanding obligations and securities may have been negotiated, "floated," at an earlier period of higher interest rates and higher profits, or they may have been carried over through a period of higher interest rates. In the former case these interest charges are excessively high as compared with the present capitalized value of the property on which they rest, computing the capitalization on the basis of the present cost of replacing this property and the present interest charge which this cost of replacement would bear. In the latter case the original capitalization of the corresponding items of property will have undergone a practical (effective) recapitalization at a lower figure to correspond with the higher rate of interest prevalent during the interval in question; and in the subsequent period of low interest, the fixed charge on this recapitalization is excessively high as compared with the current effective capitalization of the property. The liabilities are excessive, in respect of their interest charges, as compared with the present earning-capacity of the property represented by them.129
What gives effect to this drawback for the business enterprises which have such fixed interest charges to meet is the fact that the new investments, and those concerns that have gone into bankruptcy or receivers' hands, come into competition with the old. These new or rejuvenated concerns are not committed to a scale of fixed charges carried over from a higher interest level; and these are therefore carrying only such interest charges as the current effective capitalization of their property will warrant, whether effective capitalization be taken to mean cost of production of the equipment, earning-capacity of the concern, or market quotation of its securities. These unincumbered competitors are presumed to be making reasonable profits at current prices, and their presence in the competitive market therefore precludes an advance of prices to such a scale as would afford a reasonable profit to the other establishments after paying their interest charges on what is, in effect, over-capitalized property.
This tentative explanation of depression applies only so far as the period of depression is a time of relatively low rates of interest. But depression does not uniformly coincide with low interest rates; besides which, there are other facts in the case which limit the applicability of the explanation formulated above. To explain protracted depression, e.g., this line of argument would be convincing only on the supposition of a progressively falling rate of interest, - a condition not commonly met with in a protracted period of depression.
But this explanation, applicable within a limited range of the phenomena that make up a period of depression, points the way to another class of considerations that go far toward explaining the rest. It appears that the phase of the difficulty covered by this explanation is traceable to a discrepancy between the accepted capitalization, the interest charges, and the earning-capacity. And it appears equally plain that the only remedy applicable to the case (barring a speculative exaltation of business) is a recapitalization of the concerns affected on a lower basis, to fit the lowered cost of production of the equipment and its lowered earning-capacity. But under existing conditions of law such a remedy cannot be applied to the interest bearing securities, - except by process of insolvency, - and it is very reluctantly applied to other capitalized wealth; besides which it is, practically, very difficult to effect such an avowed recapitalization as applied to the stock of incorporated companies, particularly in the case of those whose stock is ostensibly the capitalized value of their plant.
Such a readjustment of nominal value to actual value as shown by the facts of earning-capacity is continually going on, in some measure; but it does not cover the entire range of facts involved, and it is nearly always of the nature of a reluctant concession, following only after the need of it has become somewhat pressing. It can, therefore, in the common run of cases, not catch up with the progressive difficulty which it is designed to meet, in so far as the difficulty is of a progressive character.
A discrepancy between accepted capitalization and current earning-capacity, similar to the discrepancy discussed above but of a progressive character, arises under modern conditions apart from a fall in the rate of interest. The discrepancy pointed out and
