How to Invest Money by George Garr Henry (finding audrey txt) 📖

industrial nation reveals the fact that business conditions undergo alternate periods of prosperity and depression extending in clearly defined cycles of substantially uniform length. By tracing the usual course of interest rates and of business conditions throughout one of these cycles, a general idea can be formed of the way in which the joint influences operate to produce price movements. To what extent the course of interest rates is a cause as well as a result of changing business conditions, we shall not attempt here to estimate, but will be content to note carefully the general course which rates for money pursue throughout the cycles. Immediately after a financial crisis, which usually closes an era of great business prosperity, money rates become abnormally easy. Within a few months from the climax of the crisis, money accumulates in enormous volume in financial centers. This is caused by the great diminution of business activity which renders unnecessary a large part of the circulating medium that was formerly required to transact the greater volume of business. To the extent to which this accumulation of money merely reflects a redundancy of currency as distinguished from real liquid capital, it can have little effect in encouraging the resumption of business activity. As time passes, however, and economies in operation commence to make themselves manifest, and especially as waste and extravagance are curtailed, the country as a whole commences to accumulate real liquid capital; that is to say, its total production leaves a surplus over the amount of consumption. In the state of business feeling which has been pictured, the undertaking of new business ventures or additions to existing properties would not be approved, so that the surplus wealth created finds its way into bank deposits as liquid capital. The competitive attempt to loan this capital at a time when borrowers are few produces merely nominal interest rates. This continues for some time. It is only gradually as confidence returns and as the spirit of initiative begins to reassert itself that some part of the liquid capital created each year is diverted into fixt forms. Here and there some enterprising group of men will develop a mine, lay a new piece of railway, or make some addition to an existing undertaking. For some length of time, however, the liquid capital of the country not only remains unimpaired, but is continually increasing. After a time a change comes. The annual surplus of production, tho larger than before, is only sufficient to provide for the new undertakings which the growing optimism demands. Interest rates rise moderately in response to the added demand for capital. A few years further along, as business activity increases and success appears plainly to wait upon new ventures, the demand for new capital with which to develop increased facilities and new enterprises exceeds the annual supply of wealth created. Prosperity having increased, another factor commences to assert itself. The spirit of economy and thrift which had prevailed throughout the years of depression gives place to extravagance, the demand for luxuries, and other unproductive forms of expenditure. While the total production is much greater than in the lean years, the margin of production is not proportionately as great, and this amount is insufficient to meet the demands upon it. The supplies of liquid capital stored up during the years of depression are resorted to, and they serve to provide the new capital for a few additional years. Interest rates at once reflect the encroachment upon stored-up capital, and their rise gives the first real warning of the country's true position. The optimistic business men do not heed the warning. After exhausting all the real capital available in the country, they proceed to borrow extensively from foreigners or from government banks—in this country from the national government through bank deposits. Every step which can be taken to induce foreigners to part with their capital is resorted to. If foreigners will not buy long-term bonds, short-term notes are created. If the foreigners refuse these, they are asked to make loans secured by the new bonds and notes. The rates of interest offered are so attractive that considerable sums are usually obtained, and the pressure of business activity continues further. Finally the day of reckoning arrives when some incident, usually unimportant in itself, first suggests to the lenders of money that their debtors whom they know to be overextended may not be able to pay their loans. The attempt to collect their loans produces a financial crisis which brings to an end the period of prosperity.

The foregoing is a description of the more important stages through which business conditions pass from crisis to crisis. Different cycles vary in particular details, but all agree in essential outlines. Sometimes special influences are at work which operate to shorten or prolong the cycle. The approach of a crisis will be retarded by inflation of the currency, for the excess finds its way into bank vaults and increases the volume of loanable credit. The effect of such inflation, however, is wholly disastrous, because the addition to the supply of capital is fictitious, not real, and only defers the day of reckoning for a greater catastrophe. On the other hand, the approach of a crisis can be greatly hastened by wars, conflagrations, and other agencies which destroy capital, and by attacks upon capital and the conduct of corporate business, for such attacks tend to render capital timid and produce the same effect as a violent curtailment of the supply. These are only some of the many influences which might become operative, but they serve to show the necessity for careful consideration of all the factors at work if a true conception of the condition and tendencies of business is to be formed.

From the general account given above of the successive phases of a credit cycle, it is possible to summarize the course of interest rates and the course of business conditions. Money rates become suddenly easy after a crisis, remain low or grow easier for a period of several years, and then rise continuously until the next crisis, advancing with great rapidity toward the close of the cycle. Business conditions remain poor or grow worse a few years after a crisis. Liquidation is taking place, prices are going down, and the uncertainty of the outlook causes diminished activity. Thereafter, however, conditions improve and activity increases with fair uniformity until it reaches the high tension of the period immediately preceding the crisis. The course of interest rates and the course of business conditions may both be deflected by the operation of special influences, but the general tendencies are substantially as outlined. The result of the operation of these joint factors may be traced in the market movements of any class of security desired. For the sake of simplicity, let us consider their effect in producing the market swings of the highest grade of investment issues and of the lowest grade, those which are affected only by money rates and those which are affected almost wholly by business conditions.

Emerging from the strain of the crisis at their lowest point, high-grade bonds, such as the best municipal and railroad issues, advance rapidly as interest rates decline, continuing their advancing tendency throughout the period of business depression which follows upon the heels of the crisis. As business conditions improve, their position, while perfectly secure before, is further strengthened and an added stimulus is given to their rise. About the middle of the cycle when the business outlook is very promising, and before interest rates have sustained any material advance, the prices of high-grade bonds are usually at their highest point. From that time forward they commence to decline, in spite of the increasing prosperity of the country, under the influence of rising money rates. They make their lowest prices in the midst of the crisis, when the strain upon capital is greatest and the outlook for business most unpromising.

The lowest grade of bonds, on the other hand (whose margin of security is least), do not commence to recover materially in price, in spite of the influence of low money rates during the hard times which follow the crisis, the influence of reduced earnings and the fear of default of interest holding them in check. As the outlook becomes brighter, they advance rapidly and continue to improve in price so long as they yield more than current money rates. At some point, difficult to determine in advance but usually well along toward the end of the cycle, they reach their high point and thereafter decline under the influence of the growing stringency in money.

Between these two extremes, every class of security is to be found. The better ones will tend to resemble, in their market movements, the course pursued by the choicest bonds; the poorer ones will approximate the lowest class. In every case, however, unless special influences operate to produce variations, the market swing of a given security should be easily conjectured by an investor who gives careful attention to the relative weight which is likely to attach to each determining influence.