THE STOCK EXCHANGE FROM WITHIN

THE
STOCK EXCHANGE
FROM WITHIN

BY
W. C. VAN ANTWERP

Garden City New York
DOUBLEDAY, PAGE & COMPANY
1914

Copyright, 1913, by
William C. Van Antwerp

All rights reserved, including that of
translation into foreign languages,
including the Scandinavian

31ST THOUSAND

First printing, Jan., 1913.
Second printing, Apr., 1913.
Third printing, June, 1913.
Fourth printing, Feb., 1914.

PREFACE

In so far as these pages reflect the thoughts of a busy stockbroker, distracted by many duties and lacking in literary skill, they have but little merit and the writer entertains no illusions regarding them. But in the many quotations from the writings of the world’s foremost economists that are here presented, and in the various legal and historical precedents cited, perhaps it is not too much to hope that this book possesses some slight value as a contribution to the vexed and vexing discussion of the Stock Exchange, and that it may serve in some degree both to dull the sharp edge of uninformed criticism and to strengthen the hands and hearts of loyal friends of a greatly misunderstood institution. The public is asked to disregard the utterances of demagogues and self-seekers and to consider facts. That done, the American spirit of fair play may be confidently relied upon.

The Stock Exchange authorities have had no hand in the preparation of the work, nor does it bear their endorsement. I say this lest it be thought an official apologia. Had it been such, the work would have been much more skillfully done, and its value greatly enhanced.

The Author.

CONTENTS

CHAPTER I
THE FUNCTIONS OF THE STOCK EXCHANGE

Every now and then some one who has not given much thought to the matter asks the questions, “Of what real use is the Stock Exchange?” “What does it accomplish?” “Is it a necessary and useful part of our economic life, or is it merely a means of promoting speculation and gambling?” These are fair questions, and they are asked in good faith. To be sure they have been answered many times by writers on economic subjects, but the trouble is that in our hurried American life we do not read the economists, preferring to get our impressions from the hasty utterances of some one who knows no more about it than we do.

The study of any form of economic development, like the study of sciences and philosophies, requires infinite patience. But the “man in the street” is bored to death by such methods; he wants to take a short cut to his conclusions; merely tasting the Pierian spring he hurries on to judgments that are superficial, haphazard, and often crude and blundering. And yet at bottom this man, a good citizen with an open mind, invariably wants the truth. He may be too busy to dig it up himself, but he knows it when he sees it, and once he has grasped it he has no patience with those who seek to turn him from it. To this average man, who holds in his hands the balance of power in America, I venture to say something about markets.

The first thing a man asks when he wishes to buy is “the price.” Every minute of the day, all over the world, that question is on men’s lips. As it is a necessary prelude to all forms of trade, it follows that everything that enters into the making of prices becomes at once of primary importance. The more scientific the price, and the nicer and more accurate the making of it, the better the bargain for both buyer and seller and for trade generally, bearing in mind the distinction between prices, which are temporary and move rapidly—and values, which are intrinsic and move slowly. The price of a thing is what you can get for it; the value is its real worth to you, and hence it cannot be defined or measured, since a thousand considerations may enter into it, such as caprice, sentiment or association. If real values could be determined, they would necessarily be identical with prices, but as they cannot be ascertained in ordinary commodities of trade, prices become the really essential considerations and values the subordinate ones. Let us see, then, how prices are made, for this is one of the reasons why exchanges exist.

If you want to buy, let us say, a piano, you go to the dealer and ask the price, and as he is the only person in the neighborhood who deals in pianos, you must either accept his offer or look elsewhere. But to look elsewhere takes time and labor; dealers in pianos are widely separated; moreover, there is no open competition among them such as you would like, and so finally when you have bought you feel perhaps you have not secured your money’s worth. You would have secured a much better bargain, no doubt, had there been twenty dealers in the room competing with each other, and a still better bargain had their number been fifty, or a hundred, or two hundred, because that would mean competition, and the more competition there is, in close contact and governed by rigid business rules, the more certain the approach to a perfect price. Everywhere in the world fairs and other gatherings of merchants are held at periodic intervals because people demand them in their effort to secure proper prices by competitive bidding and offering. One of the first travelers to penetrate the heart of Africa found among the natives this phenomenon of trade, showing that it is instinctive; indeed, it may be traced to the earliest known period in the history of any people. If you arise before daybreak in London and go to Billingsgate and Covent Garden, or in Paris to the Halles Centrales—Zola’s “Ventre de Paris”—you will find there the modern type of these markets in their utmost perfection.[1]

This is why Exchanges exist, not only Stock Exchanges, but market-places of all kinds: Buyers seek the largest market they can get in order to obtain the lowest prices; sellers, in order to obtain the highest prices; and so it was learned long ago that economy of time and labor, as well as a theoretically perfect market, could be best secured by an organization under one roof of as many dealers in a commodity as could be found.[2] Bear in mind that this result, moreover, is best accomplished when the organization is so controlled by rigid rules of business morality as to insure to every one who does business there, great and small, rich and poor, an absolutely square deal. In such a market every purchase is made with the most thorough acquaintance with the conditions involved. Each dealer, each broker, each speculator, strives to obtain the best knowledge of the supply and demand, and the earliest news that may affect it, and each buyer or seller has an equal and a fair opportunity to profit by the resultant effect on the market of all these various agencies. The larger the body of brokers and traders, then, the more accurate the standards of value thus created. It is a pity you could not have bought your piano under such conditions.[3]

Demagogues have set the agricultural classes against Wall Street and against Exchanges, but producers everywhere, in default of exchanges, are forming quasi-exchanges of their own. Every day we hear of combinations, Farmers’ Alliances, rural co-operative movements, etc., each designed to regulate the market for eggs, butter, potatoes, and such things, and each having for its purpose the very functions which govern a Stock Exchange in its own field—namely, the establishment of a fair price under the nearest possible approach to ideal conditions. It is now proposed in Congress that the Department of Agriculture shall collect and transmit to the agricultural districts by telephone and telegraph all available information concerning price movements, markets, and centres of supply and demand, this again embodying the essential functions performed in its own field by a great exchange.

In practice, of course, there can be no exchange to deal in perishable products of the farm, and this is a pity, because if such an exchange were practicable we should hear less of our old friend the cost of living. Why? Because at present the market for these commodities is controlled by commission dealers and by middlemen. The producer and the consumer are alike at the mercy of these people; the price is fixed by them; the number of bona fide dealers actually bidding against each other is limited, in many instances there is no competition whatever; the producer and the commission dealer are, moreover, widely separated; the man who sells has few sources of information, and it is the business of the dealer who buys to see that he gets none; the small producer therefore has to submit to a great inequality in price, and often to downright cheating. There is no standard. There are no rules governing the dealer, and no high-minded board to enforce his honesty. Naturally this sort of thing contributes to the cost of living, since the commission dealer, on his part, regulates his profits just in proportion to the ignorance, cupidity or remoteness of the farmer, while the middlemen, of whom there are sometimes three or four, apply the same iniquitous processes to the ultimate purchaser—who happens to be you or me. Every thinking man knows that this is rank economic error.[4]

A friend of mine owns a thousand-acre farm in the Shenandoah Valley, where he raised this year 10,000 baskets of peaches. He decided to seek one buyer, and he found him in the person of a Baltimore canner, who went down to Virginia, inspected the crop, and contracted for the lot on a basis of $1 for firsts, 70 cents for seconds, and 40 cents for thirds, delivered at Baltimore. Shortly after, the market was flooded with peaches from Georgia, and the Baltimore man, seeing that the crop would be plentiful, promptly “welched” on his trade, basing his action on the absurd contention that “firsts” should be three inches in diameter, although as every one knows peaches of this size are almost never to be had. This action threw all the grower’s peaches into third class, which delivered at Baltimore would have netted him about 10 cents a basket.

In desperation he looked elsewhere, West, North, and South, only to hear the same monotonous answer from commission men, “we won’t buy, but we will handle your crop on a commission of 10 per cent.” Meantime the crop was ripening. To make matters worse the railroad levied a prohibitive price, and refrigerator cars were not to be had. Finally there was nothing left but to ship by express and trust to the commission men to treat him honestly. The final accounting showed that on his first shipment he netted 5½ cents a basket, and on his second, 15 cents, not counting the expense of picking, packing, and hauling. So much for the producer. The consumer fared no better, for he had to pay $1.25 per basket for this fruit; one of this producer’s friends actually purchasing a portion of this very consignment at that rate. The difference therefore between 15 cents and $1.25 contributes some food for thought as to the cost of living.[5]

Now contrast this experience of a grower having no exchange facilities with that of the Western farmer who deals directly with a Grain Exchange. The farmer can sell his crop, even though it has not been planted. Whenever he sells, and under whatever conditions, he enjoys the authoritative establishment of a price, fixed as clearly as matters are fixed in law. Moreover, the price at which he elects to sell is the best price, the fairest price, and the most scientific price that human agencies can arrive at, because it is made by world-wide competitive bidding at the hands of skilled men in Chicago, in New York, in Liverpool, in Berlin, in Odessa, and in the Argentine, all competing by cable and telegraph. Think of the confidence he enjoys, and the liberty of action; think, too, what it means to him to know that the Exchange through which he deals is a body of honorable men, governed by rules, bidding publicly under one roof.

But, you will say, this is all very well in its application to a grain or cotton exchange, but how does it apply to the Stock Exchange? You concede that scientific price-making for commodities like grain and cotton is highly necessary, but you do not see that the same necessity exists for stocks and bonds. You feel, no doubt, that the one has to do with food and raiment and is therefore indispensable, while the other merely serves to stimulate speculation and gambling, and hence is altogether unnecessary. Now, in order to explain the error in this point of view, let us first see how bits of paper, called securities, came into being.

Long after Europe had emerged from the dark centuries following the fall of the Roman Empire, the needs of states and governments impelled their rulers to resort to credit, and it was discovered that the simplest way to do it was to issue securities, that is to say, certificates of the debt. Next, it was found that in order to insure success for these operations, a market was required. Intermittent or temporary sources from which credit could be obtained was not enough; constant sources of credit were essential, and, as these constant sources lay in the savings of the people, public markets in which investors could tell the value of their investments from day to day followed as a natural course.[6]

As time went on—necessarily the evolution was gradual—it was learned that companies having to do with all forms of business enterprises might also be formed on the same basis. The development of the world’s business outgrew its infancy days of private partnerships, and corporate organization of necessity took their place, now that the discovery of credit, through the use of securities, had pointed the way. This corporate organization, which combines the small savings of thousands into large sums and gives to the masses an intelligent directing force at the hands of highly trained experts, depends for its existence on the sale of its securities.

In order to understand that there can be no industrial progress without the issue of securities let us consider the locomotive engine. When in the early 1800’s it became apparent that this contrivance could be used to operate an entirely new method of transportation, people looked upon it, at first, as an interesting but quite useless contrivance, because to build railroads was an expensive undertaking and nobody had enough money to finance it. The inventor’s genius was not sufficient; another power was necessary to take it out of purely scientific hands and give it practical impulse. That power was credit; the way it was obtained was through the issue of securities, and the way securities were made popular vehicles of investment lay in providing a daily market for buyers and sellers.

As a natural result, organization followed. Capital was consolidated, the rights of owners were established, a great impulse was given to various new forms of inventive genius and powerful commercial enterprises of all kinds sprang into being. With this development the market-places or Stock Exchanges without which capital could not have been enlisted kept pace. It was found that transactions in the securities which represented the people’s money should be rendered easy, quick, and safe, and that the very essence of the Exchange’s functions consisted in protecting the people who were the actual owners of the enterprises by rules that would insure this result.

If we look about us to-day we find in all the great centres of the world Stock Exchanges at work in this important field. We find that just in proportion to the confidence which a country feels in the strength and uprightness of such a market, so enterprise goes forward with vigor, and so the national wealth increases. The success of one enterprise in its appeal to public credit through the medium of the Stock Exchange invariably leads to another; thus commerce and industry develop. Securities in America alone, aggregate the enormous total of forty-three billion dollars.[7]

Now, as our country’s entire physical properties are valued at one hundred and thirty billions, it is apparent (after making allowances for securities that are held by holding companies and hence are duplicated in the foregoing estimates) that the nation’s securities represent more than a third of the nation’s wealth. Again, almost two million people are owners of these securities. The Journal of Commerce and Commercial Bulletin published Dec. 26, 1912, official statistics for 247 of the large corporations. This tabulation revealed the fact that the stock of these 247 corporations alone was owned by more than a million stockholders, and it is therefore quite safe to infer that the number of shareholders in all American companies approaches, if it does not exceed, two million. I think it will not be disputed that where two million people own a third of the nation’s wealth, they are entitled, just as the farmer is, to a perfectly constructed price-making machinery that will enable them to invest their savings, or sell their holdings. Having learned the difficult lesson of saving their money and the still more difficult one of increasing their surplus capital by judicious investments, are not these people entitled to the safeguards afforded by a Stock Exchange? “There is no other way in which true prices can be made,” says Mr. Horace White. “If the quotations so made are not precisely the truth in every case, they are the nearest approach to it that mankind has yet discovered.”[8]

Think a moment. Until the last century property and trade were so insecure that, if a man saved money, he had to hide it, or lend it through money-brokers at such usurious rates as would compensate him for what he lost in bad debts. When Dr. Samuel Johnson wrote his dictionary in 1776 no such word as “investor” was known to the English language in a financial sense. There were pirates by sea in the old days and brigands on land. “Sovereigns and nobles,” says the editor of the Economist, “extorted loans only to repudiate them; governments supplied their needs by debasing the coinage, or by issuing worthless money.”[9] To-day all this is changed by banks and Stock Exchanges. Yet, despite these great inventions, capital is and always will be timid, and the small investor particularly must be protected and safeguarded in every possible way.

These small investors, no less than the large ones, require great convenience and promptness for their operations; they live in such widely remote parts of the country as to necessitate the placing of full reliance on prices made by the Stock Exchange; they must have the most accurate information; they must know that their brokers are working to obtain the best knowledge of supply and demand; they want prices fixed by the most scientific competition and by the largest possible number of competitors—brokers, speculators, and investors alike; they require a market in which they can sell and get their money at once; above all things they must know beyond peradventure that they are dealing with reputable men who uphold a fine standard of honor. These are added reasons why the Stock Exchange exists.[10]

If it did not exist, there would be no standard market for a large part of the country’s material wealth, indeed, as we have seen, a very great deal of this wealth could not have been created at all. At the risk of repetition let me say that the investor on the one hand, and the patent or the railway on the other hand, have nothing in common. Left to themselves, they would never meet; they would be useless, because resources and money must be brought together in order to create wealth. A primary function of the Stock Exchange is to bring them together, and by standardizing prices, create values. Similarly, the investor, without the Stock Exchange to guide him, would have nowhere to turn for a fair price secured by competitive bidding. He might turn to his local banker, or to individual and unorganized brokers, and trust to their honesty to invest his savings for him, but the local banker and the isolated broker would then be in the same position as the commission dealer and the middleman who played such havoc with that peach crop. It is painful to conceive such a situation.

Worse than that, without a Stock Exchange to create standards and define the difference between good and bad investments, very many simple people would be at the mercy of an army of dishonest promoters and bucket-shops, for the modern invention of securities has brought with it dangers and pitfalls. The United States once swarmed with these bandits—they are now rapidly being driven to cover—but they still ply their trade in other countries, where they flourish as “banks” or “investment” companies. These chaps, to quote the editor of the Economist (London), “have bought a lot of rubbish, usually called ‘bonds,’ from shaky industrial concerns or from half bankrupt states and municipalities of South America. They have bought, let us say, the 6 per cent. bonds of the Yoko Silk Company in Japan at 60, which they sell you at 90, the 5 per cent. bonds of the Brazilian Province of —— at 55, which they sell you at 75, and a few other similar bargains. They tell you that if you spread your risks scientifically over different countries you will be perfectly safe. You perhaps do not realize that none of these securities which you are advised to buy are quoted in the London Stock Exchange. If they were the game would be impossible.” Which is only another way of saying that if there were no Stock Exchanges to uphold worthy enterprises and discourage bad ones, there would be no limit to the frauds practised upon gullible investors. And if this is true of a tight little island like England, how doubly true it is in a great country like ours where investors are so widely scattered.

The foregoing pages will serve to show the inquirer that what is happening in commerce, is happening in the securities which represent that commerce. Because commerce goes on expanding, securities must necessarily keep pace and the Stock Exchange must perforce grow in importance. That much maligned individual, the speculator, now regards the whole world as his field and is eager to enter foreign markets wherever there are opportunities. In 1910 more than three billion dollars of British capital were invested in American railways alone, returning one hundred and twenty-five millions annually in interest and dividends, to say nothing of the English millions in our lands, mines, and industrial enterprises. We too are large holders of foreign securities, and the list of such holdings increases yearly. But it may be accepted as a fact that this enormous mass of corporate securities would not have found ownership had there been no Stock Exchange to market them, and standardize them, and establish daily prices for them, and give them the certificate of character that makes them ideal collateral for obtaining credit.

Dr. W. Lexis, of Gottingen, like all other economists, recognizes the fact that Stock Exchanges are economic necessities. Here are his opinions:

“The existence of a broad, continuous market is an economic necessity in the modern scheme of widespread investment of capital. Even though the market-place is largely filled with speculators, it is plain that the greater the number of traders in securities, the greater will be the facility for buying and selling any quantity of securities. The stock market is a powerful aid in floating new issues of public securities. The speculative market takes them at once and keeps them in the floating supply until they have shown their value. The stock market also renders a useful service in giving a continuous guide to the success or failure of industrial undertakings, and the worth of their securities. The more speculators there are trading in any particular security, the greater is the opportunity to learn the real conditions of the undertaking. Private investors, from a study of the speculative market in the securities they own, receive in this way a continuous market opinion on the condition of the corporations in which they are shareholders.”[11]

Another great service rendered by the Stock Exchange is the means it affords of readily transferring securities from hand to hand. To appreciate the importance of this fact you have but to think of the difficulties and delays that attend the transfer of other forms of property that do not enjoy Exchange facilities. Real estate, for example, is a most excellent form of investment. But suppose the owner of real estate wants to sell in a hurry, what then? There is no large organized market, there is no way by which through competitive bidding, he can place a correct estimate of the importance of current events upon the price of his land. In the urgency of his needs he may easily be misled by “smart” or unscrupulous advisers, and this risk increases in direct proportion to his remoteness from large market centres.

The holder of securities listed on the Stock Exchange is quite differently situated. He is altogether independent. He knows the price of his holdings every hour of the day. He is exposed to no fraud, and at the mercy of no rumor and no unscrupulous dealer. He has positive assurance that in case of necessity, at a moment’s notice, he can obtain at the prevailing price the value in cash of every Stock Exchange security in his box. The ticker gives him instantaneous quotations. All the newspapers publish authorized prices for his benefit, and, as we have just seen, these quotations are not a one-man affair, but the combined judgment of thousands of experts, bulls and bears, bankers and brokers, speculators and investors, all over the world, bidding and offering against each other by cable and telegraph and recording the epitomized result of their bidding in the prices current on the Stock Exchange. Such a man knows, moreover, that the price thus established is not merely the opinion of all these minds as to values to-day, but that it represents a critical look into the future. He knows, indeed, that financiers everywhere have in mind prospective values rather than present values, and so he acquires a double advantage in regulating his own action by the light of the superior knowledge thus freely given him. The importance of this “advance information” cannot be overestimated, and furnishes us with another reason why Stock Exchanges exist.

In 1906, for example, business conditions in this country were the best ever known. Good crops, big earnings, and general optimism prevailed. But Stock Exchange securities did not advance in the last half of the year, because trained financiers began to foresee the first signs of trouble ahead. In the early months of 1907 this knowledge became more general, and a severe decline took place, notwithstanding the fact that the business of the country at large continued to be excellent. “What is the matter with Wall Street?” was the question in the press and on the lips of the uninformed, but Wall Street, or rather the Stock Exchange, was merely fulfilling its function as a barometer and foretelling the coming storm.

At the height of the autumn panic, on the other hand, when the press was filled with dire forebodings and the ignorant layman was frightened out of his wits, securities stopped declining and began to rise because the Stock Exchange mind saw that the worst was over. The brightest financial students in the world then began another process of discounting the future; the barometer plainly foretold the end of the disturbance. And all this information—a fundamental law of price movements which indicated clearly when the trouble was coming and when it had ended—was given gratis to the world in the daily published quotations of Stock Exchange securities.

In another chapter I shall describe the method by which the Stock Exchange protects its patrons, the public. As this is of particular importance in connection with the matters just cited, I call the reader’s attention to the remarks of Prof. S. S. Huebner, Ph.D., of the University of Pennsylvania.

“Importance must be attached to the protection and safeguards which organized Stock Exchanges give the stock and bond holder, in regulating brokerage transactions and maintaining a standard of commercial honor among brokers.... In this connection it should be remembered that the constitution of nearly every Stock Exchange defines the object of the Exchange as follows: ‘Its object shall be to furnish Exchanges, rooms and other facilities for the convenient transaction of business by its members, as brokers; to maintain high standards of commercial honor and integrity among its members, and to promote and inculcate just and equitable principles of trade and business.’ No person can be elected to membership until he has signed the constitution of the Exchange, and by such signature he obligates himself to abide by the same, and by all subsequent amendments thereto. The value of this organization becomes apparent when we take account of the gigantic frauds perpetrated upon innocent investors through advertising campaigns by persons unaffiliated with any recognized Exchange, or by certain members of unorganized curb markets....

“All Stock Exchanges provide for the arbitration of disputes which may occur between members, and if both parties are willing, between members and their customers. They also prescribe rules governing the nature of contracts, the making of all offers and bids, the registry and transfer of securities on the transfer books of the corporations, and the conditions upon which securities may be listed upon the Exchange for trading purposes. Practically all stock Exchanges also require that all transactions must be real, and that no fictitious or unreal transactions shall be permitted; that discretionary orders cannot be accepted by brokers; and that every member of the Exchange must keep complete accounts, subject at all times to examination by the governing committee or any standing or special committee of the Exchange, and under penalty of suspension, no member may refuse or neglect to submit such accounts, or wilfully destroy the same. Nor may any member, under pain of suspension (a serious penalty, involving not merely the loss of the rights and privileges of membership, but also the stigma attaching to the member as a factor in the business community), be guilty of ‘any conduct or proceeding inconsistent with just and equitable principles of trade.’”[12]

One of the most important functions of the Stock Exchange is, as we have seen, the almost automatic ease with which it directs reservoirs of capital into channels of usefulness in the world’s industry and commerce. The layman may feel that this use of the Stock Exchange does not affect him as an individual, but it does, and vitally. Every merchant and every manufacturer, great and small, all over the world, is directly benefited by it. One may see, for example, securities of railway equipment companies quoted for weeks at a low level. This shows that the business of these companies is not profitable, and it serves to discourage owners of capital from undertaking new enterprises in that direction, because the securities of such companies cannot be sold. Moreover, it shows investors, as plainly as words can tell, that this is an unsafe and unprofitable form of investment.

Reverse the situation, and lines of industry are revealed where high and advancing prices of securities indicate a rising tide of business, with an outlook for large profits in the future. Capital then takes hold cheerfully; there is a market for the new securities and a proper basis for fresh commercial development, because investors and speculators have learned from the published daily quotations of these Stock Exchange securities that there is good warrant for the flow of capital into such channels, and that a reasonably safe return will follow an investment in them. In commenting upon these functions of the Stock Exchange, Mr. Conant says: “Through the publicity of knowledge and prices, the bringing of a multitude of fallible judgments upon this common ground, to an average, there is afforded to capital throughout the world an almost unfailing index of the course in which new production should be directed.” Through the mechanism of the Stock Exchange, therefore, the public determines the direction in which new capital shall be applied to new undertakings. In this way our great railways were built, our Western country opened to progress, and our vast industrial undertakings made possible.

“The stock market acts as a reservoir and distributor of capital, with something of the same efficiency with which a series of well-regulated locks and dams operates to equalize the irregular current of a river. The hand of man is being stretched out in the valley of the Nile to build great storage basins and locks, and the waters which flow down the great river may be husbanded until they are needed, when they are released in small but sufficient quantities to fertilize the country and tide over the periods of drought. Something of the same service is performed for accumulation of capital by the delicate series of reservoirs, sluice gates, and locks provided by the mechanism of the stock market. The rate of interest measures the rise and fall of the supply of capital, as the locks determine the ebb and flow of the life-giving water. The existence of negotiable securities is in the nature of a great reservoir, obviating the disastrous effects of demands which might drain away the supply of actual coin, and preventing the panic and disaster, which, without such a safeguard, would frequently occur in the market for capital.”[13]

Some day, no doubt, the United States will become a great creditor nation, as England is, and then the field of these operations will be extended to other countries. When that time comes we shall take a hand, through the machinery of the Stock Exchange, in the development of new and immense fields of human endeavor just as London does to-day. To what extent could capital exports of such tremendous economic significance continue if so useful and so indispensable an institution as the Stock Exchange were abolished or interrupted? It was Burke who said that “great empires and little minds go ill together,” and so it is with great markets and little critics. There can be no worthier purpose in the commercial world than the upbuilding of a great centre of credit designed to finance material enterprise, enrich the world, and extend the benefits of civilization to new lands and new people, based upon the credit supplied by the banker, the money provided by the speculator and investor, and the safeguards afforded by the Stock Exchange. And yet, curiously, the greater the effort in these directions, the greater the criticism. Just in proportion to the perfection with which all these agencies equalize prices, economize time and effort, and protect the public, so they seem to attract attention, comment, and attack.[14]

In Wall Street, according to this viewpoint, everything is tainted, sinister, reprehensible, covetous and unscrupulous, just as it follows the onward march of invention, science, and progress. This sort of criticism will not, of course, continue. The man in the street—the average layman to whom I have ventured to address this chapter will learn sooner or later—in point of fact he is learning now—that the questionable practices in Wall Street which started all this hubbub, and which were a natural and a human accompaniment of the slowly developed technique of this or any other business, have now been effectually stopped. It has been a very long time, for example, since Jay Gould ran his printing-press for Erie certificates, and that incident cannot possibly happen again. The Keene type of manipulator has gone, never to return. “Corners,” too, have seen their last day on ’Change, and so also have other artificial impediments in the way of natural supply and demand. It has been years since the Cordage scandal, and the Hocking Coal incident marked the end of that form of manipulation. Yet there are persons who talk of these things as though they were daily occurrences, overlooking the fact that the New York Stock Exchange, by its own efforts put a stop to the evils complained of, and will never tolerate their return.

McMaster in his “History of the People of the United States” tells us that in the early days in New England public sentiment was so aroused against the legal profession that lawyers “were denounced as banditti, as blood-suckers, pick-pockets, windbags and smooth-tongued rogues.” At that period in our history feeling ran so high against banks and bankers that Aaron Burr was only able to procure a charter for the Manhattan (Banking) Company by resorting to the subterfuge of naming it, in the Act, “a Company to furnish the City with water.” No doubt all this rancor and hostility seemed a very serious matter to the lawyers and bankers of those days, just as the criticism of to-day strikes home to members and friends of the Stock Exchange.

The lawyers made many mistakes a century and a half ago when the code and its practice were imperfectly understood in this country; so it was with the early history of banking; and so in our time Wall Street and the Stock Exchange have made the mistakes which any gradually developing form of enterprise must make. But these mistakes are dead or dying, and, in their place, no doubt, there will come a better understanding all around. When that day dawns the thoughtful American will realize that the particular rôle which the Stock Exchange plays in promoting all forms of commercial endeavor is a boon such as no country in the history of earlier days ever enjoyed. He will contemplate his country’s progress with pride; he will rejoice in its capacity to outstrip other countries; he will acclaim its advancement toward the proud position now held by England, the banker and the clearing-house of the world. And he will learn—this thoughtful citizen—that material achievements like these cannot be attained without a market for capital and a market for securities.[15]

CHAPTER II
THE USES AND ABUSES OF SPECULATION

Somewhere in each one of us lurks Stevenson’s spirit of “divine unrest,” the parent of speculation. To-day, as in wise old Greece in the morning of the world, philosophers sit under every tree, speculating upon the phenomena of the universe, and upon the practical application of them to the needs of humanity. Thus Archimedes came to know of things that we now call Copernican, seventeen centuries before Copernicus was born; thus Columbus and his argosy sailed into the great unknown, speculating upon an irrational and even shocking exploit; thus Pasteur saved to France through the meditations of his speculative mind a sum greater than the cost of the Prussian war and the colossal indemnity that followed it.

And so the “divine unrest” goes on and on, impelling men to speculations and explorations of the physical world and of the world that lies beyond our primitive senses, with here and there a high achievement, and now and then a miserable failure, but always on and on. The hypothesis of the spectacled professor blossoms into a boon; the dream of the inventor becomes a benefaction; the forlorn hope of the explorer points the way to wealth. Things that were speculations yesterday become realities to-day. To-morrow?—nobody knows. In a free field, not bounded by formulæ nor restricted by law of God or man, with money to encourage it and enterprise to spur it on, what may come from the speculations of the future passes understanding.

Now speculation is an all-embracing word, overworked, threadbare, and worn to the bone. Originally it meant “to see”; then “to view,” “watch,” “spy out”; then “exploration” or “contemplation.” When thrift came into the language and men ceased burying their gold, it began to take on a new meaning. The spirit of legitimate adventure, that entered men’s minds when the Most Christian Kings abandoned brute force and repudiation, led men to buy things in the hope of selling them at a profit. It was risky business at first, and capital, then as now, was timid. The High Finance of the Middle Ages was not easily forgotten. But little by little channels through which enterprise might flow into wealth came into being, and confidence came with them. This was called speculation.

By the time Adam Smith wrote his “Wealth of Nations” (1776) the word was firmly fixed in the language. “The establishment of any new manufacture,” he said, “or any new branch of commerce, or of any new practice in agriculture, is always a speculation from which the projector promises himself extraordinary profits.” How the early channels of speculation broadened into great rivers, how confidence grew as the art of making money and increasing it developed, how credit became established, how speculation led to the opening of new countries and the extension of immense advantages, through civilization, to the people of those countries—all this is a fascinating story. And yet the speculation of to-day is no different in its elementals from that of the early Greeks; the same spirit of “divine unrest” that spurs on the philosopher in his study stimulates the explorer of strange lands, beckons on the engineer and the builder of railways, and attracts the capital of the adventurous investor. We cannot stop it if we would, because hope, ambition, and avarice are fundamentals of human nature. The police cannot arrest them; they are fixed and immutable.

If there is more speculation in material things to-day than there ever was before, it is because there are more things to speculate in, more money to speculate with, more people to speculate, and more machinery, like telephones and telegraphs, to facilitate speculation. Capital, credit, and new undertakings grow day by day and open new avenues of possible profit. The per capita wealth of nations, growing by what it feeds on, constantly seeks new fields for enterprise and adventure. The intelligence of the people increases by leaps and bounds, and goes peering curiously into all the little nooks and crannies of the world for opportunities of gain—the apotheosis of speculative enterprise.

All forms of human endeavor in material things are, or were at their beginning, speculations. Every ship that goes to sea carries with it a speculation, and leaves another one behind it at Lloyds. Every man who insures his life or his house buys a speculation, and every company that insures him sells one. The farmer speculates when he fertilizes his land, again when he plants his seed, and again when he sells his crop for future delivery, as he often does, before it is planted or before it has matured. The merchant contracts to fill his shelves long before spring arrives; he is speculating. The manufacturer sells to him, speculating on the hope or belief that he will be able to buy the necessary raw material, and again on the labor, the looms and the spindles necessary to make the delivery. In the South the grower of cotton and in Australia the grower of wool are likewise speculating on the probability of a crop and on the price at which they may sell to this manufacturer. It sounds like “this is the house that Jack built” in its endless chain of sequences; a chain, indeed, and one no stronger than its weakest link. Interfere with any part of it, and the whole commercial structure which it binds together falls apart. The grower, the manufacturer, and the merchant must speculate.

There was twofold speculation on the part of our great financial barons who built our transcontinental railways, for they had to reckon not only upon the probability of profit in their undertakings but likewise upon the willingness of other speculators—you and I—to assist them by buying a part of the securities which represented the outlay. To be sure it so happened that many of these vast speculations at first proved unsound. Some of them were a little premature; others pushed too far; they brought disaster upon the speculators who had put money into them. And yet who shall say that our great railways have failed to enrich the world and spread the comforts of civilization? “But for a verdant and evergreen faith,” says a recent writer, “salted with the love of risk and adventure for their own sakes, how could mountains be bored and waters bridged? If there were not superstition there could be no religion; if there were not bad speculation there could be no good investment; if there were no wild ventures there would be no brilliantly successful enterprises.”

This is not hyperbole; it is fact. The world of business and enterprise must go on; it cannot stop. As it goes on capital must be enlisted, which is another way of saying that speculators must be attracted. The only way that has been devised to attract them is through the medium of certificates of ownership or evidences of debt, called securities. But the business does not end there, for, as we have seen in the previous chapter, the capital of speculators will not take hold unless a market is provided. They want to know where they stand; before they venture upon the troubled waters of new enterprises they must be assured of a public market, a harbor where they can get ashore quickly if storms are brewing.

The only plan that the ingenuity of man has thus far devised to meet this emergency is a Stock Exchange. One man, or two, or a hundred cannot make a market, because the immense volume and variety of these securities make it impossible for any unorganized handful of brokers and dealers to determine a fair market price. What is required, and what the man whose capital is wanted insists upon, is an organized body of brokers, speculators, and investors competing keenly, seeking to buy cheap and sell dear, gathering and disseminating all the news, and so sharpening the judgment and stimulating the higgling of buyers and sellers as to bring prices to their legitimate level and give them stability. Ten thousand competitors in this business of bringing prices and values together are of course better than one thousand; a hundred thousand would be better still. The Stock Exchange supplies this want, and will continue to supply it until a better plan is devised.[16] Meantime, since it has grown to its present stature by forms of speculation necessary to the maintenance of enterprise, any serious interruption of the facilities it affords will bring enterprise to a standstill and cause the whole sensitive structure of credit to collapse in terror. Let Professor Seligman explain this matter:

“If a railway or other industry, in launching a new enterprise, had to depend on the chance investors at the time of the issue of the securities, it would be seriously hampered. The mere knowledge that at any moment there will be a ready sale on the Exchange greatly increases the circle of purchasers, many of whom may not intend to be permanent investors. The Stock Exchange aids the investment of capital, as the Produce Exchange aids the production of finished commodities. Business orders and corporate needs are intermittent, because they depend on temporary exigencies; the risks at one end, at all events, are eliminated by the unintermittent, continuous market which regular speculation affords. The Cotton Exchange was the result of the disorganization of the cotton trade after the Civil War; speculation in all other staples has in the same way been the consequence of the efforts of the manufacturer to avert the risks of intermittent and spasmodic fluctuations in the raw material. The result of regular speculation is to steady prices. Speculation tends to equalize demand and supply, and by concentrating in the present the influences of the future it intensifies the normal factors and minimizes the market fluctuation. Speculation so far as it has become the regular occupation of a class, differentiated from other business men for this particular purpose, subserves a useful and in modern times an indispensable function.”[17]

Here we have an authority who tells us that speculation in securities, no less than in raw materials, is “an indispensable function” if business is to go ahead. The last census shows that 32½ per cent. of the population of the United States is composed of laboring men, not counting agricultural workers. This large army of men is by no means independent; on the contrary it is strictly dependent on the ability of others to give it employment. Shut down the factories, curtail the operations of railways, close the mines and quarries, stop building and new construction, and in greater or less degree suffering and privation among these large masses must ensue.

Now go a step further, and we find that the managers of these railways, mines, and factories, are in turn dependent—wholly dependent upon capital. They cannot go ahead with the extensions and improvements necessary to efficiency without borrowing money; and credit, in turn, will not come to their support unless a broad market is provided, through the Stock Exchange, for the securities which represent these obligations. Hence we see that just as every farmer in the West and every cotton-grower in the South must have a stable market for his products, so every laborer in our great industrial field is directly concerned with the maintenance of a stable market for the securities of the company that employs him. The interests of one are the interests of all, and speculation, in one form or another, underlies all industrial progress. “Complaint is made of the evils of speculation,” said the greatest of French economists, “but the evils that speculation prevents are much greater than those it causes.”[18]

Now that we have reached a point in our discussion that brings us face to face with the so-called “evils” of speculation on the Stock Exchange, let us pause and consider the difference between speculation, which is held by many to be abhorrent, and investment, which is generally thought right and proper. The first thing we encounter is the shadowy and indistinct boundary line that separates the one from the other. Does any one know where the one begins and the other ends? France has more conservative investors than any other country, yet, as Mr. Hirst puts it, the most critical and hidebound buyer of French rentes is a speculator in the sense that he not only wishes his purchase to yield him interest, but also hopes and expects that sooner or later he will be able to sell out at a profit, all of which is legitimate, proper, and human. The first question every man asks when the time comes to invest is, “Is this a good time for investment?” “Am I buying cheap?” by which he means “Are these investments likely to enhance in value?”

He may have bought Spanish bonds at low prices during the war between Spain and the United States—a somewhat speculative investment—and in his purchase he believed himself an investor in a strict sense. Yet, when those bonds recovered to a normal basis and he sold out at a profit, was it speculation, or investment, or a little of both, that defined the trade? British consols are low to-day, and there is of course no safer investment, but the investor who buys them is influenced by the fact that a long period of peace seems to lie ahead, with reduced expenditures for armament and hence with diminished borrowings by the Government leading to a substantial recovery in the price of these solid securities. Such a man is “speculating” on England’s abstention from war, on its limitation of military and naval expenditures, and on the probable effects of these matters on the price of his consols.[19]

The truth seems to be that all investment is speculation, differing from it in degree but not in kind. This salient fact was recognized as long ago as 1825, when, despite the comparatively limited field for investment enterprise, McCulloch saw what was coming and grasped the true idea of the part speculation and its handmaiden, investment, were to play in the industrial renaissance. Coming at a time when speculation was new, and subjected, as all innovations are, to widespread criticism and doubt, his words have prophetic significance.

“It is obvious that those who indiscriminately condemn all sorts of speculative engagements have never reflected on the circumstances incident to the prosecution of every undertaking. In truth and reality they are all speculations. Their undertakers must look forward to periods more or less distant, and their success depends entirely on the sagacity with which they have estimated the probability of certain events occurring, and the influence which they have ascribed to them. Speculation is, therefore, really only another name for foresight; and, though fortunes have sometimes been made by a lucky hit, the character of a successful speculator is, in the vast majority of instances, due to him also who has skilfully devised the means of effecting the end he had in view, and who has outstripped his competitors in the judgment with which he has looked into futurity, and appreciated the operation of causes producing distant effects.”[20]

A quarter of a century later we find England’s foremost thinker sounding the same clear note. John Stuart Mill was by no means a hermit philosopher feeding on theories. Traveler, sportsman, business man, statesman, and author, he saw things broadly and wrote for practical men. “Speculators,” he said—and he was speaking of the “greedy” ones who buy and sell for gain—“have a highly useful office in the economy of society. Among persons who have not much considered the subject there is a notion that the gains of speculators are often made by causing an artificial scarcity; that they create a high price by their own purchases and then profit by it. This may easily be shown to be fallacious.” He then shows, what I have outlined elsewhere, that the market is larger than any speculator or group of speculators, and, if this was true in 1848, I think it will not be disputed that it is quite true to-day.

Continuing, Mill says: “The operations of speculative dealers are useful to the public whenever profitable to themselves. The interest of the speculators as a body coincide with the interests of the public; and as they can only fail to serve the public interest in proportion as they miss their own, the best way to promote the one is to leave them to pursue the other in perfect freedom. Neither law nor opinion should prevent an operation, beneficial to the public, from being attended with as much private advantage as is compatible with full and free competition.” Mill makes no distinction here between investors and speculators; they are one and the same. In any case it is conceded that speculation is what makes the markets to-day, since 90 per cent. of the transactions that take place daily on the world’s Stock Exchanges are speculations pure and simple. And this is a good thing. Before we go on with our subject, let Professor Emery explain why, and bring the teachings of McCulloch and Mill down to our own day:

“Speculation has become an increasingly important factor in the economic world without receiving a corresponding place in economic science. In the field in which it acts, in the trade in grain and cotton and securities and the like, speculation is the predominant influence in determining price, and, as such, is one of the chief directive forces in trade and industry. But treatises in the English language on general economic theory and conditions have given very little space to this influence, which is fundamental in the world of economic fact....

“It is true that forty years ago speculation was far less important than it is now, and there was, therefore, more justification for disregarding it. Professor Hadley has given due consideration to the new conditions which prevail in modern business. At the same time it should be remembered that McCulloch, already in his day, had grasped the true idea of the function of speculation, a fact shown by the incorporation of his treatment of the subject into his chapters on Value. Wide as is the influence of speculation, its force is felt primarily in the field of prices. By making prices it directs industry and trade, for men produce and exchange according to comparative prices. Speculation then is vitally connected with the theory of value.

“From the point of view of theory, therefore, it is incorrect to attach so little importance to the function of speculation; in practice it is impossible to deal intelligently with the evils of the speculative system without first recognizing its real relation to business. Both the writer and the reformer must reckon more than they have yet done with the fact that speculation in the last half century has developed as a natural economic institution in response to the new conditions of industry and commerce. It is the result of steam transportation and the telegraph on the one hand, and of vast industrial undertakings on the other. The attitude of those who would try to crush it out by legislation, without disturbing any other economic conditions, is entirely unreasonable.”[21]

Now we come to the evils of the business. That there are evils, really serious ones, no one will deny. To be sure many of the phases of speculation that are called evils are not evils at all; the statements made concerning them have what Oscar Wilde termed “all the vitality of error, and all the tediousness of an old friend,” and yet, although the prevalent criticism is often stupid and superficial, there are undeniably offensive forms of speculation that one would like to see suppressed. Speculation is a comparatively new phenomenon, and it has brought with it dangers and pitfalls. So also have automobiles, electricity, and steam engines. But while the Stock Exchange has created the arena for the display of these abuses, it has not originated them “except,” as a recent writer puts it, “in the sense in which one may say that private property has originated robbery.”

The great evil of speculation consists in the buying of securities or real estate or anything else with borrowed money, by uninformed people who cannot afford to lose. Its commonest form in speculation in securities is what is known as “margin” trading, this name being derived from the fact that the buyer, instead of paying cash in full for his purchase, deposits only a fractional amount of its cost, which is intended to serve as a margin to protect the broker from loss, while the broker pays the remaining sum necessary to complete the actual purchase. Thus the speculator may deposit $1000 on securities costing $10,000, while the broker furnishes the additional $9000. It is a system in use everywhere; on the London Stock Exchange it is called “Cover,” on the Paris Bourse, “La Couverture.”

There is no fixed amount of margin called for by brokers, as circumstances differ widely with the character of the securities dealt in, the standing of the buyer, and the condition of the market; but in a broad way it may be said that members of the New York Stock Exchange exact a margin equivalent to ten points on middle-grade speculative issues, twenty points on high-priced and erratic securities, and five points on very low-priced shares that move slowly. There are, of course, certain securities on which no payment short of actual outright purchase in full would be accepted by reputable brokers, while on the other hand, in the case of securities that fluctuate but slightly, such as our government, state, or municipal bonds, a 5 per cent. margin would be ample. This is also the practice in London and Paris, generally speaking. In Paris the Agents de Change always insist upon a greater margin than the Coulissiers, or outside brokers, and here members of the New York Stock Exchange invariably pursue the same policy.

This affords an opportunity to say that the local evil of stock speculation arising from insufficient margins is one that may be laid at the door of outside Exchanges rather than the “Big” Exchange, as it is called, because, in the minor Exchanges, margins are notoriously small, and the smaller the margin the greater the number of “victims.” Indeed, if it were not for this practice it would be difficult for members of smaller Exchanges to exist at all. In so far as speculation in securities may merit criticism, this tendency to attract poor people by the bait of slim margins is undeniably a very real evil, and one which can only be corrected by the brokers themselves. The Hughes Committee, after devoting much time and labor to this matter, put its conclusions in these words:

“We urge upon all brokers to discourage speculation upon small margins, and upon the Exchange to use its influence, and if necessary its power, to prevent members from soliciting and generally accepting business on a less margin than 20 per cent.”[22]

Every one connected with the New York Stock Exchange knows that this suggestion, like all the others made by the Commission, was received with approval by all hands, and, if a hard and fast rule could have been devised to meet not merely the spirit but the letter of the recommendation, the Governors of the Exchange would have put it into instant operation. But there are difficulties in the way, and one of the duties of the Governors is to consider very carefully all sides of each perplexing question that comes before them, not merely in the interests of the Stock Exchange, but with due regard to the common law and the interests of the public. Margin trading is a matter of contract, and “the right of one private person to extend credit to another,” as the Chairman of the Hughes Commission himself points out, “is simply the right to make a contract, which, under the Federal Constitution, cannot be impaired by any State Legislature.”[23]

Here is a very considerable difficulty in the way of restricting margin trading, and one that is not fully understood by the outsider. He is prone to speak of contracts thus made as “gambling transactions,” missing altogether the essential point that there is a vast difference between a transaction with a contract behind it, enforceable at law, and one that has to do with bucket-shops and roulette, in which there is no contract, and is expressly prohibited by law. No matter what his intent may have been when he bought, and no matter what margin the broker accepted—the buyer has the right to demand his securities at any time, and the broker must always be prepared to deliver them; conversely, the broker may compel the buyer to pay for and to receive the securities he has bought. Motives and methods have nothing whatever to do with the transaction.

The broker who buys for a client to-day does not know, and sometimes the client himself does not know, whether the securities are “bought to keep,” or are to be sold to-morrow; similarly the broker has no means of knowing whether the client, who deposited a ten-point margin at the time of his purchase, will or will not deposit another ten points to-morrow, and continue such payments until his securities are wholly paid for. In the large majority of cases the intent of the speculative buyer is to sell as soon as he can get a satisfactory profit, but that does not make him a gambler by any means. Why? Because, if he bets $1000 on a horse race, one party to the transaction wins and the other loses; whereas, if he deposits $1000 as margin against a stock speculation and makes a profit of say $500, the broker loses nothing by paying him that profit when the account is closed. No property changes hands in the one case, while, in the other, actual property is purchased and held ready for delivery on demand. The law is clear in classifying the operations of bucket-shops with gambling transactions, because in a large majority of instances no actual purchase is made; the “buyer” merely bets in that case as to what subsequent quotations will be; the “trade” is between two principals, one of whom must lose if the other wins.

The Hughes Commission, as I have said, went very fully into all these matters. It was in session six months, and many witnesses were examined. After considering all the pros and cons of margin trading, the experience of England and Germany in dealing with speculation, the three-years’ debate in Congress on the Hatch Anti-Option Bill, and the voluminous reports of the Industrial Commission, the conclusion was reached “to urge upon all brokers,” as shown in the paragraph cited, a general agreement on margins of not less than 20 per cent. It must be borne in mind that this was not in the nature of a formal recommendation, but rather as the expression of a hope that some measure of reform might be accomplished if such concerted action by brokers were feasible.

That members of the New York Stock Exchange endorse this view goes without saying. They realize more fully than is generally known by the public that indiscriminate and reckless speculation by uninformed people who are beguiled into it by the lure of small margins is an undoubted evil that should be checked, and they are doing what they can to check it by discouraging such operations. For example, it would be very difficult to-day for a woman to open a speculative account with any reputable firm of brokers on the major exchange unless she were well known, peculiarly qualified for such transactions, and abundantly able to support them. Accounts will not be accepted from clerks or employees of other brokerage houses or of banks and other corporations in the Wall Street district; indeed, such transactions are expressly forbidden by the rules of the Exchange. No accounts will be accepted from any one who is not personally known to one of the firm’s partners—and the practice resorted to in earlier years of employing agents to solicit business under the nominal title of “office managers,” “bond department managers,” and all that sort of technical subterfuge, is likewise forbidden.

Members of the Exchange are not permitted to advertise in any way save that defined as of “a strictly legitimate business character,” and the governors are the judges of what is legitimate. The layman has but to glance at the bare and colorless announcements made by Stock Exchange houses in the advertising columns of our newspapers to see how rigidly this rule is enforced; indeed 90 per cent. of the members do not advertise at all. Best of all, speculation on “shoe-string” margins is now almost eliminated from the major exchange. The houses that notoriously offended in this respect ten and fifteen years ago are to-day inconspicuous in the day’s dealings. Their business is gone—in its very nature it could not last long—and if rumor be credited its demise carried with it a part of the capital of the firms involved. It was a lesson and a warning. All these instances serve to show that the Stock Exchange is doing what it can to remedy this evil, and, if circumstances arise in which more can be done, the governors and members will be found a unit in enforcing whatever restrictions are necessary.

At the moment it is difficult to see how an inflexible rule of 20 per cent. margins could be put in practice without seriously interfering with really sound business. A telegraphic order may be received from a customer of the utmost responsibility who may happen to be in Europe. Any stockbroker, and any business man in mercantile trade, would be glad to execute for such a person all the orders he chose to entrust, regardless of margins. In such a case no question of motive enters into the transaction; it may ultimately prove to be a speculation pure and simple, or the buyer may cable instructions to deliver the securities to his bank, in which case it would seem to be an investment; but, regardless of that, an insistence by the broker on a 20 per cent. margin would be silly, and would merely drive the business elsewhere or prevent it altogether.

Numerous instances of a similar sort might be cited to show how difficult it would be to enforce margin prohibitions in all these perfectly legal contracts. Germany tried it in the law of 1896, with disastrous consequences, which I have described elsewhere. It is a matter that will always be a fruitful topic of discussion, yet it differs in no essential respect from the practice of a speculator in real estate who pays down a small percentage of a purchase price and borrows the balance on mortgage. It is similar to what the merchant does when he fills his shelves with goods bought with a fractional payment in cash and the balance at some future date. In all these cases involving property let me repeat that the deposit of a specified sum by the principal and an agreement or contract with the broker is a perfectly valid transaction.[24]

That newspaper criticism and attacks by social mentors should go to extreme lengths in deprecating stock speculation by crude, greedy, and unsophisticated people is perhaps, after all, a perfectly useful function, and if such critics err in going to great extremes, that too may be set down as right and proper, for it is perhaps better to go too far than not to go far enough. The interests of the Stock Exchange are the interests of the whole country; its welfare depends upon an intelligent and thrifty people; its aims are public-spirited and patriotic. Whatever it may lose in the way of business from ignorant and silly people who are driven out of blind speculative undertakings leading to losses which they can ill afford, it will gain tenfold in imparting sound information through candor and publicity. On the other hand, unless we are prepared to abolish property altogether, do away with the instruments of credit, and suppress all forms of trading designed to supply our future requirements, we may as well reconcile ourselves to the inevitable and take what comfort we may in the reflection that prudence, thrift, and foresight are not to be eliminated, merely because the proletariat below stairs sometimes indulges in speculation and suffers the consequences of its folly.

“Finally,” writes Professor Emery, “the question must be faced of the effect of eliminating the public from the speculative market even if it could be accomplished. It is supposed sometimes that such a result would be all benefit and no injury. On the contrary, the real and important function of speculation in the field of business can only be performed by a broad and open market. Though no one would defend individual cases of recklessness or fail to lament the disaster and crime sometimes engendered, the fact remains that a ‘purely professional market’ is not the kind of market which best fulfils the services of speculation. A broad market with the participation of an intelligent and responsible public is necessary. A narrow professional market is less serviceable to legitimate investment and trade and much more susceptible of manipulation.”[25]

One of the difficulties with which men have to contend in a big country like this is the apparent inability of large masses of the people to understand other large masses. Distances are so great, occupations so diverse, and enterprise so confining, that one whole section of the country may not and often does not know what another section is doing. Men are too busy to learn by travel and reading that which, in the interest of the whole country, they should thoroughly understand. Thus it happens that a section of the country given over, let us say, to agricultural pursuits, having first acquired the notion that speculation in securities is only a form of legalized robbery, assumes that to New York City and the New York Stock Exchange is confined a greater part of the stock speculation of the world. We have seen the fallacy in the first of these hasty conclusions; the second may easily be explained away.

Yankee speculation in securities is not a marker to speculation in London, where the day to day trading vastly exceeds ours, and where the “Kaffir Circus” of 1894–5 and the “Rubber Boom” of 1909–10 exceeded any similar outburst ever known in America. France is the most prudent and thrifty of nations, yet the Panama mania which collapsed in 1894, although followed by a period of the utmost repentance and conservatism, found a parallel in the crazy French speculation in Russian industrials which crashed in 1912. There was an extraordinary speculation in Egyptian land and financial companies in Cairo in 1905–6, which, in proportion to the number of participants, greatly exceeded any boom in New York. China awakens slowly, but, once its political reforms are effected, a field of extraordinary speculation will open there without a parallel in history. The Chinaman is not only a shrewd and competent business man, but he is, Mr. Hirst tells us, “a confirmed and incurable” speculator. “From time to time,” says this writer, “the Shanghai Stock Exchange becomes a scene of the wildest speculation, and it is safe to predict that, when a new China is evolved, Stock Exchanges will spring up in all the large towns. Of this, a foretaste was afforded in the spring and summer of 1910, when Shanghai caught the rubber infection from London. All classes and races took part, but the native Chinaman plunged deepest. When the break in prices came, one Chinese operator was so heavily involved that, on his failure, many of the native banks had to suspend payment, with the result that for months the trade and credit of this great shipping and business centre were disorganized.”[26]

I mention these incidents to show that speculation is not confined to geographical limits. It is all a part of the “divine unrest” inherent in each of us, and it develops and grows intense just in proportion with the march of the civilization it serves to benefit. In new countries, as in China, it may often go too far; sometimes in old countries it oversteps the bounds of prudence, but any student of these phenomena knows that, as economic processes become understood by the masses, the intervals of time between the panics that result from over-speculation grow wider and wider.

Another mistake of those sections of the country that do not understand the Stock Exchange results from the indiscriminate blending of that institution with Wall Street. Let us hear from Mr. Horace White on this point. He was the chairman of the last committee that investigated the Stock Exchange; he is one of our foremost economists, and he may be assumed to understand his subject:

“There is a widespread belief that Wall Street and the Stock Exchange are one and the same thing, and that all the fluctuations on the Exchange are caused by Wall Street. This is an error as glaring as it would be to suppose that all the water in the Mississippi River comes from the adjacent banks, ignoring the innumerable streams and rills that contribute their quota from countless unseen sources. Wall Street and the Stock Exchange are two different things. The men on the floor of the Exchange are the agents of others, executing the orders which they receive both from Wall Street and from other parts of the habitable globe. Some of them speculate on their own account, but the speculating members of the Exchange are divided into bulls and bears. They do not all push in the same direction at any one time. They simply aim to anticipate, each for himself, the drift of financial public opinion in order to take advantage of it.

“This is what Wall Street outside of the Exchange does; and the only advantage which speculators in Wall Street have over those in other parts of the country is derived from larger capital, more direct and ample sources of information, and greater skill and promptness in the use of it. Wall Street speculators are likewise divided into bulls and bears pushing against each other; and all their advantages do not save them from making mistakes, which often result in losses proportioned to the magnitude of their operations. The ‘rich men’s panic’ of 1903 was such an instance. The panic of 1907 was another. It is sometimes said that Wall Street can put prices on the Stock Exchange up or down at its own pleasure. This is a delusion.”[27]

Members and friends of the New York Stock Exchange view with apprehension the periodic attacks upon their great institution made by those who, for reasons not to be discussed here, wish to attract popular attention. But there is no reason why these matters should excite alarm. The Exchange purified itself long ago of the old abuses, new ones as they occur meet with severe disciplinary measures, and it has a certificate of good character in the report made to the sovereign State of New York by the Hughes Commission. This commission has stated explicitly that margin trading is a matter of contract guaranteed by the Federal Constitution. It is not conceivable that any legislature can ignore such a report, by such a commission, nor is it possible that, in such event, any court could be found to uphold legislation directed at random against an institution that bears the endorsement of all students of economics.

One has but to read the decisions of the courts to see that the matter of non-interference with the great Exchanges, on technical grounds, has become a fixture in our jurisprudence. “The Exchanges,” said Judge Grosscup of the United States Circuit Court, “balance like the governor of an engine the otherwise erratic course of prices. They focus intelligence from all lands, and the prospects for the whole year, by bringing together minds trained to weigh such intelligence and to forecast the prospects. They tend to steady the markets more nearly to their right level than if left to chance or unhindered manipulation.”[28] In somewhat similar vein Justice Holmes of the United States Supreme Court, said: “Speculation ... is the self-adjustment of society to the probable. Its value is well known as a means of avoiding or mitigating catastrophes, equalizing prices, and providing for periods of want. It is true that the success of the strong induces imitation by the weak, and that incompetent persons bring themselves to ruin by undertaking to speculate in their turn. But legislatures and courts generally have recognized that the natural evolutions of a complex society are to be touched only with a very cautious hand, and that such coarse attempts at a remedy for the waste incident to every social function as a simple prohibition and laws to stop its being, are harmful and vain.”[29]

With these opinions before them, so long as the governors of the Stock Exchange continue their policy of a wise and dignified administration in the interest of the public they serve, there is nothing to fear. Corrections, remedies, improvements, and reforms will be found to be necessary from time to time—some of them are necessary at this moment, and the governors are hard at work on the task. To accuse them of indifference or neglect of duty is to deny them that form of intelligence which enables a man to protect his property. Their splendid institution has grown to its present importance and power through economic development that could not have been foreseen nor prevented. Speculation on a large scale has accompanied its growth, and contributed to it; and speculation, as we have seen, is a highly desirable and useful part of all business. This speculation numbers among its adherents people in all parts of the world who have a perfect right to speculate, and who do vastly more good than harm in their operations.

It has also attracted a great many people who have no business to speculate, and who would be prevented from doing so if it were possible. The ignorance and cupidity of these people is so great, and the pitfalls provided them by unscrupulous, methods outside the Exchange are so many and various that something has to be done to protect them. The Stock Exchange does not encourage them, but it recognizes that they have legal if not moral rights, and it stands ready to help them. It gives to such people the same information that it gives to the richest investor in the land. The securities in which it deals are known to be free from taint; all forms of crookedness are prohibited; every transaction within its walls is made openly, as a result of free competitive bidding, and published broadcast to the world. What more, and what less, can be done? Has there ever been a time in the world’s history when property and trade were so secure, and when speculation, which makes property and trade, was so jealously safeguarded?[30]

CHAPTER III
THE BEAR AND SHORT SELLING

The operations of “bears” in the great speculative markets and the practice of “short selling” are riddles which the layman but dimly comprehends. Buying in the hope of selling at a profit, and if need be, “holding the baby” for a long time and “nursing” it until the profit appears, is simple enough; but an Oedipus is required to solve the enigma of selling what one does not possess, and of buying it at a profit after the price has cheapened. It is the most complicated of all ordinary commercial transactions. How the thing can be done at all is a mystery; how such a man can serve a really useful economic purpose by this process is unfathomable. The layman who tries to figure it out thinks there is an Ethiopian somewhere in the wood-pile; the thing is unreal and fictitious. The only way he can understand it is to turn bear himself and learn by experience.

Why there should be so many bulls and so few bears can only be explained on the ground that optimism is the basis of speculation, and hope the essence of it. Yet the market can only go two ways: it is quite as likely to go down as up. Since sentiment should have no place in speculation one would think there should be as many bears as bulls, more of them, in fact, because the market almost always goes down faster than it goes up, and because nine out of ten of the unforeseen things that occur result in lower prices.

Accidents like diplomatic entanglements, rumors of war, earthquakes, and drought are constantly occurring to upset the plans of bulls and bring fat profits to bears in a hurry, while matters that bring about higher markets are generally things long anticipated, in which the profits that accrue to the bulls come about slowly and laboriously, and always with the attendant risk that a disturbance in any corner of the globe may bring on a sudden smash that will undo the upbuilding of months. In theory, therefore, there should be at least as many bears as bulls in all active markets, but in practice the large majority are always bulls, to whose sanguine and credulous natures the bear is a thing apart—a gloomy and misanthropic person hovering about like a vulture awaiting the carrion of a misfortune in the hope of a profit. Naturally the layman cannot understand him, and would like to suppress him.

Despite the fact that the odds seem to favor the bears, there is an old and true saying that no Ursa Major ever retired with a fortune. Wall Street has seen many of them, and with perhaps one exception the records agree that the chronic pessimists have not succeeded. Fortune seems to have smiled on them at intervals; in the country’s early days of construction and development mistakes were made that brought about disaster, but in the long run such tremendous progress has resulted in America as to defeat the aspirations of any man or group of men who stood in its way. The big bears, as a rule, have “over-stayed the market.” Imbued with the hope that worse things were in store, they have been swept away by the forces they sought to oppose. One of them, a power in his day, was so obsessed with the notion that all prices were inflated, that he has been known to sell stocks short “for investment.” One night when a lady at his side remarked on the beauty of the moon, he is said to have replied with that absent-minded mechanical skepticim inherent in the bear, “yes, but it’s too high; it must come down.”

One would think the ideal temperament for a speculator would be absolute impartiality, with an open mind uninfluenced by sentiment, ever ready to take advantage of all fluctuations as they occur. The ups and downs of a stock market always show, on average long periods, a practically equivalent swing each way, so it would seem that the speculator most likely to profit by these fluctuations would be one without preconceived prejudices, ready at all times to turn bull or bear as the occasion required. As a matter of fact, this type is the rarest of all, being confined, generally speaking, to the professional “traders” on the large exchanges, necessarily a very small minority of the speculative group, yet withal perhaps the most uniformly successful. These men, it must be understood, are not speculators, but traders, a nice distinction involving “catching a turn,” as opposed to the speculative habit of “taking a position.”

In active times I have known one of them to operate simultaneously in the New York Stock market, in the cotton market, and in the wheat market, trading at the same time in London and Paris, “shifting his position,” or “switching” from the bull to the bear side twice in a single day, and closing all his trades at three o’clock with a total net profit of less than a thousand dollars on a turnover of 30,000 shares, to say nothing of the transactions in cotton and grain. It goes without saying that to do all these things in one day requires a curiously mercurial temperament, and calls for nerve and celerity altogether foreign to the average speculator. Such a man, moreover, contributes but little to the making of prices and values, which is the function of large markets; his chief economic usefulness lies rather in the enormous revenues he pays to the State. The man whose operations I have just described contributed in a single year $75,000 to the State Government in stock-transfer taxes.

The scientific way to measure the value of speculators in wide markets is to consider the bull as one whose purchases in times of falling prices serve to minimize the decline, and the bear as one who serves a doubly useful purpose in minimizing the advance by his short sales and in checking the decline by covering those sales. All these operations serve useful economic purposes, since the more buyers and sellers there are, the greater the stability of prices and the nearer the approach of prices to values.

This, as I have said, is the scientific way to look at it, and the correct way, but the popular way is something quite different. From this point of view the man who sells property he does not immediately possess is thought to be a menace, who depresses prices artificially and works a disadvantage to the investor or, in the produce markets, to the producer. Nothing could be more fallacious than this, because of the fact that just as every routine sale of actual stock requires a buyer, so every short sale by a bear requires a purchase by him of equal magnitude. And it is precisely these repurchasing or “covering” operations of the bears that do the utmost good in the way of checking declines in times of panic or distress.

When there are no bears, or when their position is so slight as to be inconsequential, declines are apt to run to extreme lengths and play havoc with bulls. One often hears among acute and clever speculators the expression “the bears are the market’s best friends,” and, though this may seem incongruous, it is quite true. In the month in which these lines are written there has occurred, for example, a really severe break in prices on the Stock Exchanges at London, Paris, and Berlin, arising from the periodic Balkan crisis. This decline ran to disproportionate extremes, and, in fact, approached such demoralization that more than 300,000 shares of American securities held abroad were thrown on the New York market for what they would bring. The reason for the severity of this decline was easily explained. The outstanding speculative account at all European centres, while not actually unwieldy, was almost entirely in the nature of commitments for the rise. There was no bear account. Therefore all Stock Exchanges were supersensitive since they lacked the steadying influence which covering by the bears invariably brings about. The bears are then, in truth the market’s best friends, and the more there are of them, the better for all concerned when trouble comes.

Throughout all the political agitation in Germany which culminated in that disastrous failure, the Bourse Law of 1896, there appears to have been very little opposition to the bear and the practice of short selling; nevertheless in that section of the law which prohibited dealings for future delivery the bears found their activities restricted. The law has now been amended, having proved a wretched fiasco, but in the decade which attended its enforcement it was curious to note the unanimous cry that went up in Germany for the restoration of the bear. His usefulness in the stock market no less than in the commodity market was recognized; his suppression was deplored. It was found that just as his activities were restricted so the tendency toward inflated advance and ultimate collapse was increased. The market became one-sided, and hence lop-sided; quotations thus established were unreal and fictitious. Moreover there was an incentive to dishonesty, for unscrupulous persons could open a short account in one office and a long account in another, and if the bear side lost they could refuse to settle on the ground customarily resorted to by welchers.

“The prices of all industrial securities have fallen,” said the Deutsche Bank in 1900, “and this decline has been felt all the more because by reason of the ill-conceived Bourse Law, it struck the public with full force without being softened through covering purchases”—i. e., by the bears. Again, four years later, when the law was still in force, the same authority states “a serious political surprise would cause the worst panic, because there are no longer any dealers (shorts) to take up the securities which at such times are thrown on the market.” The Dresdner Bank in 1899 reported that the dangers arising from this prohibition cannot be overestimated “if with a change of economic conditions the unavoidable selling force cannot be met by dealers willing and able to buy.”

“Short sellers do not determine prices,” says Professor Huebner. “By selling they simply express judgment as to what prices will be in the future. If their judgment is wrong they will suffer the penalty of being obliged to go into the market and buy the securities at higher prices. Nine tenths of the people are by nature ‘bulls,’ and the higher prices go, the more optimistic and elated they become. If it were not for a group of ‘short sellers,’ who resist an excessive inflation, it would be much easier than now to raise prices through the roof; and then, when the inflation became apparent to all, the descent would be abrupt and likely unchecked until the basement was reached. The operations of the ‘bear,’ however, make excessive inflation extremely expensive, and similarly tend to prevent a violent smash because the ‘bear,’ to realize his profits, must become a buyer. The writer has been told by several members of the New York Stock Exchange that they have seen days of panic when practically the only buyers, who were taking the vast volume of securities dumped on the exchange, were those who had sold ‘short,’ and who now turned buyers as the only way of closing their transactions. They were curious to know what would have happened in those panic days, when everybody wished to sell and few cared to invest, if the buying power had depended solely upon the real investment demand of the outside public.

“In reply also to the prevalent opinion that ‘short selling’ unduly depresses security values, it should be stated that ‘short sellers’ are frequently the most powerful support which the market possesses. It is an ordinary affair to read in the press that the market is sustained or ‘put up’ at the expense of the ‘shorts’ who, having contracted to deliver at a certain price can frequently easily be driven to ‘cover.’ Short selling is thus a beneficial factor in steadying prices and obviating extreme fluctuations. Largely through its action, the discounting of serious depressions does not take the form of a sudden shock or convulsion, but instead is spread out over a period of time, giving the actual holder of securities ample time to observe the situation and limit his loss before ruin results. In fact, there could be no organized market for securities worthy of the name, if there did not exist two sides, the ‘bull’ and the ‘bear.’ The constant contest between their judgments is sure to give a much saner and truer level of prices than could otherwise exist. ‘No other means,’ reports the Hughes Committee, ‘of restraining unwarranted marking up and down of prices has been suggested to us.’”[31]

So much for the functions of the bear in markets that deal in invested capital. In the commodity markets he becomes of even greater value, indeed, he is well-nigh indispensable. Mr. Horace White, who was the Chairman of the Hughes Investigating Committee, cites this instance: “A manufacturer of cotton goods, in order to keep his mill running all the year round, must make contracts ahead for his material, before the crop of any particular year is picked. The cotton must be of a particular grade. He wishes to be insured against fluctuations in both price and quality; for such insurance he can afford to pay. In fact he cannot afford to be without it. There are also men in the cotton trade, of large capital and experience, who keep themselves informed of all the facts touching the crops and the demand and supply of cotton in the world, and who find their profit in making contracts for its future delivery. They do not possess the article when they sell it. To them the contract is a matter of speculation and short selling, but it is a perfectly legitimate transaction.

“To the manufacturer it is virtually a policy of insurance. It enables him to keep his mills running and his hands employed, regardless of bad weather or insect pests or other uncertainties. The same principles apply to the miller who wants wheat, to the distiller, the cattle-feeder, and the starch-maker who wants corn, to the brewer who wants hops and barley, to the brass founder who wants copper, and so on indefinitely. Insurance is one of two redeeming features of such speculation; and the other, which is even more important, is the steadying effect which it has on market prices. If no speculative buying of produce ever took place, it would be impossible for a grower of wheat or cotton to realize a fair price at once on his crop. He would have to deal it out little by little to merchants who, in turn, would pass it on, in the same piecemeal way, to consumers. It is speculative buying which not only enables farmers to realize on their entire crops as soon as they are harvested, but enables them to do so with no disastrous sacrifice of price. When buyers who have future sales in view compete actively with each other, farmers get fair prices for their produce.”[32]

And, it may be added, the same satisfactory result is attained when bears who have sold the farmer’s crop short come to cover their short sales by buying in the open market; their buying steadies the market if there is a tendency to decline; if the market is strong, their buying helps make it stronger. In either case they are the farmer’s best friends, because the farmer profits as prices advance.

Speaking of farmers, it is well known that much of the opposition to short selling and dealing in futures in the large markets finds its chief advocates among the Western and Southern politicians whose constituents are the agricultural classes. These gentlemen fulminate strongly against the New York Stock Exchange and the grain and cotton exchanges, and in currying favor with their bucolic supporters they do not hesitate to condemn margin trading, short selling and every other phase of speculative markets. Yet it does not occur to them, or, if it does, they dare not refer to it, that in forming pools and combinations to hold back their wheat and cotton their constituents are doing the very thing which they so strongly condemn in speculative centres. The farmer is, of course, richer than he ever was before, but nevertheless he grows his wheat to sell, and only a few can carry it for any length of time without borrowing from the banks. The farmer who goes into one of these pools with wheat valued at $10,000 and who borrows $8000 on it from his local bank, is nothing more nor less than a speculator in wheat on a 20 per cent. margin, and the same horrid appellation describes the cotton-planter who resorts to similar practices.[33]

Now, of course, there is no moral reason why a farmer should not speculate if he chooses, but what touches us on the raw is his Phariseeism in doing for himself what he professes to abhor and condemn in others. One is tempted to say unkind things to the farmer at such times, to remind him, for example, that he is to-day the most backward and unprogressive factor in American business life. Despite the fact that the Department of Agriculture has spent $100,000,000 on his education in the last twenty years, he has not yet begun to learn what the German, Dutch, and French farmers learned years ago in intensive farming, nor has he mastered the art of cattle-raising in anything like the degree it is understood in the Argentine. Nature has smiled on him; he waxes fat with her bounty, but he does not keep pace with the growth of the country. Although enhancing prices are paid him for his product, he is unable to raise a crop proportionate in any degree to the facilities put at his disposal in the way of fertilizers and machinery. One would like to “rub it in” on the farmer, but one doesn’t, “because” as a recent writer puts it, “the farmer is a farmer, and therefore not a person to be lectured like a mere banker or broker in Wall Street.”

To the farmer, the politician, and the layman generally, short sales of cotton or grain are understood, approved, in fact, if the grower happens to be the one who profits by them. But substitute stocks and shares for wheat and cotton, and talk of “operations for a fall,” and the layman thinks he smells a rat. He sees the bale of cotton or the carload of wheat actually moving; it is a concrete thing; it appeals to his senses, it is comprehensible. But talk to him of bits of paper called stock certificates, and by a curious process he concludes that a short sale has no basis of reality and is therefore menacing and improper. He persuades himself that short selling ought to be prohibited by law, and, since Wall Street harbors the chief offenders, he finds in the nearest politician a handy ally to assist him. These gentlemen, who obstinately refuse every other medicament, could be cured of their ailment by a strong diet of economics. They become subjects of medical, rather than financial, interest. They should dip themselves into Conant and Leroy-Beaulieu; they should cool off in the pages of Bagehot and Emery; and, by the time they have got into the soothing columns of the Hughes Commission’s report, they will be ready for new points of view.

As a preparatory lesson: suppose a speculator buys from a commission merchant a carload of coal of a specified grade. The coal is not in the possession of the commission merchant, but he knows where he can get it, and he knows that he can deliver it on the date agreed upon. Accordingly he sells it short, and enters into a binding contract which, happily, the courts construe to be perfectly legal. Now suppose the same purchaser wishes to buy 100 shares of Pennsylvania Railroad stock. All Pennsylvania stock is the same, that is to say any 100 shares of it is just as good as any other 100 shares of the same property—the number on the certificate is of no importance whatever.

The dealer to whom he applies does not happen to have 100 Pennsylvania on hand, but he knows where he can get it, and he knows that he can deliver it to the purchaser on the following day. So he sells it short, and all that remains to complete his part of the contract is the actual delivery. He is then a bear on Pennsylvania stock. He may, if he chooses, go into the open market and buy the stock at once, so that he will be able to deliver it in the easiest and most direct way. Or he may feel that by waiting he may be able to buy at a lower price than that at which he has sold it, hence, in order to make the delivery promptly, he borrows the hundred shares from one of his colleagues, to whom he pays the market price as security for the temporary loan of the certificate.[34] In a day or two the price of the stock may have declined, whereupon the bear goes into the market and buys the 100 shares of Pennsylvania at a price, say, 1 per cent. lower than that at which he sold it.

When this certificate is delivered to him next day, he delivers it in turn to the man from whom he borrowed the original 100 shares; his security money is then returned to him, and the transaction is closed. It is just as real a transaction as any other, and just as legal. Moreover, since it is always possible to buy, but not always possible to sell, the active presence in the market of large numbers of bears who must buy, whether they want to or not, is the very best policy of insurance that a holder of securities could have.

Many years ago there was a law on the French Statute books, subsequently repealed, prohibiting short sales. M. Boscary de Villeplaine, a deputy chairman of the association of stockbrokers, was conversing with Napoleon regarding a pending discussion in the Council of State looking to the repeal of the law. “Your Majesty,” said de Villeplaine, “when my water carrier is at the door, would he be guilty of selling property he did not own if he sold me two casks of water instead of only one, which he has?” “Certainly not,” replied Napoleon, “because he is always sure of finding in the river what he lacks.” “Well, your Majesty, there is on the Bourse a river of Rentes.”[35]

Napoleon felt, no doubt, that there was something inherently wrong in selling short; even as these lines are written, counsel for a Congressional committee is attempting to make witnesses admit that the practice is “immoral.” But why, where, how is it immoral? It pervades all business; no question of morals or ethics enters into it at all. The man who sells you a motor-car has not got it; he accepts your money and enters into an agreement to deliver the car next spring because he knows or believes that he can make it and have it ready for delivery at that time. Meanwhile he has sold short. A gentleman of my acquaintance has sold thousands of storage-batteries on the same basis, although plans for them have not yet been designed to meet the specifications. At Cape Cod the cranberry-growers sell their crop before it has begun to mature; all over the land contractors and builders are “going short” of the labor and materials which, at some time in the future, they hope to obtain to fulfil the terms of their agreements. Are all these worthy people “immoral”?

If it is immoral to sell for a purpose, it is equally immoral to buy for a purpose; in each case the purpose is the hope of a profit. Buying for a profit is approved by every one; why not selling? In both instances you have bought or sold for a difference in price; the sequence of the events in no way involves a question of morals, since there is no ethical difference and no economic difference between buying first and selling last, and selling first and buying last. Moreover, in selling short you do no injury, since you sell to a buyer, at his price, only what he wants and is willing to pay for.[36]

All suggestions of impropriety in short selling are grotesque in their absurdity. But suppose, for purposes of argument, that economic errors of some sort were actually involved in this practice. How could it be regulated or controlled? As the governors of the Stock Exchange stated to the Hughes Commission in 1909, short selling is of different descriptions. There is the short sale where the security is held in another country and sold to arrive pending transportation. There is the short sale where an individual sells against securities which he expects to have later, but which are not in deliverable form; and in this connection I call your attention to the recent sale of $50,000,000 of Corporate Stock of the City of New York where deliveries were not made for a period of about three months, and which stock was dealt in enormously, long before it was issued.

“If a market had not been provided for it under those conditions,” said the governors, “the loan could not have been placed. Then, again, there is the short selling of stock against which different and new securities are to be issued; the vendor knowing that he is to receive certain securities at a distant date, but desiring to realize upon them at this time. Beyond this, there is the regular selling of short stock, either by parties who do so to hedge a dangerous position upon the long side of the market, or the sale purely and simply with the intention of rebuying at a profit, should circumstances favor it.”

Finally, there is the investor with stock in his strong-box actually paid for and owned outright. He may wish to sell in a strong market with the hope of repurchasing at lower prices, but for reasons of his own he may borrow the stock for delivery rather than deliver the securities bearing his own name. Technically he is short; he is a bear. But in his case, as in that of the others here cited, how can this perfectly proper method of doing business be “regulated” or interfered with in any way? I do not think it necessary to pursue so palpable an absurdity.

It has been said that the bears often resort to unfair methods to bring about declines in prices, circulating rumors designed to alarm timid owners of securities and thus frighten them into selling. That this is done every now and then is undeniable, but the opportunity of the bear in these matters is very limited, and may be easily and speedily investigated, whereas similar practices, by the bulls in inflating values by all sorts of grotesque assertions and promises are by no means so easily run to earth, and do incalculably more harm.

The bear who drags a red-herring across the trail now and then interrupts the chase, but he cannot stop it; the genial optimist who has a doubtful concern on his hands, with a pack of enthusiastic buyers in full cry at his heels, is a much more serious matter. Good times and bull markets engender many questionable practices of this sort. “All people are most credulous when they are most happy,” says Walter Bagehot; “and when much money has just been made, when some people are really making it, when most people think they are making it, there is a happy opportunity for ingenious mendacity. Almost everything will be believed for a little while, and long before discovery the worst and most adroit deceivers are geographically or legally beyond the reach of punishment. But the harm they have done diffuses harm, for it weakens credit still further.”[37]

If this book were written for people instructed in economic matters there would be no occasion to dilate upon the usefulness of bears and the value of short selling, but since we are addressing laymen who do not understand how the bear can be a useful factor, we may venture to say once more that insurance is the chief advantage in his operations. Ex-Governor White’s contribution to the subject, which I have quoted in this chapter, is strongly supported by Mr. Conant, who shows that valuable progress in opening new countries and developing new industries is often made possible by “bearish” operations designed to “hedge” or insure the new undertaking against loss.

“The broker who has a new security which he desires to place from time to time in the future, making possible, for instance, the opening of a new country to railway traffic, protects himself against loss resulting from future changes in market conditions by selling other securities for future delivery at current prices. These securities will realize a profit when the date arrives for delivery if the market has in the meantime become unfavorable, and will offset the loss upon his new securities. They will have to be bought at a loss if the movement of prices has been upward, but the upward movement will afford a profit upon the new securities which he is seeking to place upon the market. Thus, to quote Georges-Levy, ‘there is a genuine insurance, which the broker will have himself organized and on which he will willingly pay the premium for protection against any accident.’”[38]

An instance such as this serves to show the difference between gambling and speculating, terms that are often misapplied by critics of stock markets. A gambler seeks and makes risks which it is not necessary to assume, and which, in their assumption, contribute nothing to the general uplift. But the speculator—in the instance just cited, a bear who sells short—volunteers to assume those risks of business which must inevitably fall somewhere, and without which the mine, or the factory, or the railroad could not be undertaken. His profession, and the daily risks he assumes, call for special knowledge and superior foresight, so that the probability of loss is less than it would be to others. If he did not do it—if there were no bear speculators—the same risks would have to be borne by others less fitted to assume them or the useful projects in question would not be undertaken at all.

So general is the employment of these hedging or insurance operations that in the case of cotton—to cite but one instance—the business is regarded by practically all cotton merchants as an absolute necessity under modern methods of conducting business. “An idea of the value of the hedging function may be obtained,” says Herbert Knox Smith, Commissioner of Corporations, “when it is stated that in Great Britain banks very generally refuse to loan money on cotton that is not hedged. Moreover, it is almost universally conceded that, since the introduction of hedging, failures in the cotton trade, which had previously been frequent, have been materially reduced as a direct result of the greater stability with which transactions in spot cotton can be conducted.”[39]

In conclusion it may be noted that as early as 1732 an attempt was made in England to prevent short sales by law, that the law was recognized a mistake and subsequently repealed. To-day there is no law on the English Statute books restricting speculation in any form. In America the New York State Legislature enacted a law in 1812 and the Federal Government in 1864, both designed to prevent short selling. These laws have also been repealed and they will not be revived. The bear has come to stay. As a spectre to frighten amateurs, he may continue for a time to stalk abroad o’ nights; as a necessary and useful part of all business he is a substantial reality. And he is not “immoral.”[40]

CHAPTER IV
THE RELATIONSHIP BETWEEN THE BANKS AND THE STOCK EXCHANGE

“A million in the hands of a single banker is a great power,” said Walter Bagehot; “he can at once lend it where he will, and borrowers can come to him because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all; no one knows where to find it or whom to ask for it.” This explains the power of Wall Street. Money flows there for the same reason that water flows downhill. The great agricultural districts of the West, for example, will gather from their crops this year several hundred millions of dollars. They have no real economic use for all this money in the farming districts; the large commercial and industrial undertakings that help to make America rich and powerful are not in that neighborhood.

Particular trades settle in particular districts, and the money they require must be sent to them from other districts. “Commerce is curiously conservative in its homes;” the steel trade concentrates in and around Pittsburg, the grain trade at Chicago, wholesale merchants in special lines are always to be found huddled together in our big cities in neighborly intimacy; and once a trade has settled in one spot it remains there. The millions that go West to pay the farmer must therefore go elsewhere to pay others as fast as a demand for money arises, because the price that will be paid for it elsewhere is greater than the price it will bring in the farmer’s pockets. This is doubly true because, as we have said, there are no imperious demands for money for commercial undertakings in the farmer’s neighborhood, and, even if there were, home enterprises are seldom attractive; curiously enough there is a familiarity about them and their local promoters that breeds contempt. Besides, these millions are scattered in small sums all over the agricultural States; there is no cohesion, no concentration.

What then becomes of these vast sums? They are deposited in the local banks, and the local bankers, who are wisely permitted by law to deposit three fifths of their legal reserves in a city bank, promptly transfer the funds that are not required at home to the bank that will pay interest on them. In this way large capital accumulates, and when we say this is a wise provision of the law we mean that scattered reserves in local country banks are of no more avail in emergencies than the five-dollar bills in the people’s pockets; but, gathered into one great central fund that will aggregate a sum large enough to provide every solvent bank and business house with ample support in times of distress, they accomplish a purpose worth talking about.

This is the way they do in Europe, but say “Central Bank” in America, and people are frightened out of their wits. They say politics would dominate it; “the interests” would control it. The bigness of things seems to paralyze them. But to attack a thing merely because it is big and powerful is no argument. In a country full of big things it does not ring true; it is un-American, and, as for the bogy of a centralized banking control, there is infinitely more of it in New York to-day, under the existing system, than there could possibly be under the plan proposed by the original Aldrich measure. However, the idea of a great Central Bank is not the subject under discussion.

When money flows into the New York banks the popular notion seems to be that it is used to facilitate speculation on the Stock Exchange. But this is only one of its many sources of employment. It will supply the payroll at Pittsburg, it will ship grain to Europe, it will discount the bills of merchants, it will return to the West and South when they call for it to move the next crop. If Canada or Europe wants it, and bids high enough for it, they will get a share of it. Wherever capital is most profitable, there it will turn; it will rapidly leave any country that cannot pay for it. It is the old simile of water finding its own level. The first step consists in gathering the idle hoards of individuals into banks; the next consists in centralizing these deposits where they will be available for other sections of the country that have use for them.

In order to attract these funds and so facilitate the business of the country smoothly and economically, the New York banks are accustomed to paying 2 per cent. interest on such deposits. Critics who seem to feel that there is something objectionable in the laws of gravitation, would prevent country banks from depositing in the cities by forbidding the payment of interest on deposits by national banks. But the laws that govern national banks, as Mr. Horace White suggests, are not the laws that govern State banks and trust companies, and, as these would gladly pay the 2 per cent. interest on deposits, they would be given an unfair advantage.[41] Critics also say that country banks should not be allowed to keep three fifths of their reserves in city banks, but then they would be at a disadvantage with the State banks in their neighborhood, since the prohibition would not apply to them. Moreover, if country banks were not thus permitted to deposit three fifths of their reserves, what would they do with their funds? For long periods the money would remain idle, and idle funds are as unhealthy for the community as they are for the banks.

There is no other way but for the country banker to take care of his customers first, and then send as much of his surplus as the law permits to the centre that will pay him the best return and the safest return. This is good business; it makes money; it is sound economics. And before the critic goes into a paroxysm over the fear that speculation in stocks will absorb all this wealth once it finds its way to New York, let me remind him, to cite but one instance, that short-time commercial paper, representing actual commodities moving to market, has the first call. The Minneapolis miller’s ninety-day bill, accepted by a reliable merchant and based on an actual carload of flour, has in all normal times a preferred claim on the banker’s funds.

This discounting of commercial paper is the ideal function of banking, to quote Mr. White, and if there were always a sufficient supply of good bills to absorb all the bank’s loanable credit, with an inflow of cash from maturing bills equal to the outgo of new ones, there would be no occasion for bankers to look elsewhere to keep their funds mobile—and the critic would be out of work.[42] But this does not often happen, because the bank’s loanable funds normally exceed the amount of acceptable paper, and at such times the banker makes advances on goods or securities, and, if goods and securities are not pressing for loans, he will place his funds elsewhere, where a demand exists. But securities for which there is always a ready market are such thoroughly good collateral for loans that bankers are glad to get them.

The stockbroker is, in a way, a dealer in merchandise. Whether he buys for investment or for speculation—and remember that the boundary line between investment and speculation is often shadowy and indistinct—he pays cash for everything he buys. He then seeks advances of credit upon his wares just as the merchant does, supplementing his own capital and the deposits (margins) of his customers with call or time money from the banks. To deny him these facilities is exactly the same as to deny credit to a merchant; both are doing a perfectly legal business, and both contribute to the economic welfare of the community.

The popular idea is that loanable funds thus borrowed by Stock Exchange houses constitute a diversion of money from the merchants who need it. Not so. Even if the banks were disposed to use all their loanable funds in mercantile loans and discounts they could not do so, because a part of these funds may be called for at any time, and it is not good banking to lend too large a proportion of call money on time. The merchant wants 30, 60, and 90 day money, and he wants it at a rate not to exceed 6 per cent.; the stockbroker is compelled by the nature of his business to borrow a large part of his money on call, and he pays whatever the banks choose to charge for it. Incidentally it may be said that no usury law is violated, even if 100 per cent. is charged, because the New York law legalizes any rate of interest on call loans of $5000 and upward, secured by collateral.[43]

As a matter of fact, far from being put at a disadvantage by the banking methods that provide call loans to Stock Exchange houses, the merchant or manufacturer enjoys banking facilities which the Stock Exchange may never hope to enjoy. The merchant is able to secure banking accommodations upon his personal credit, that is, by discounting his own promissory notes or single-name paper unsecured by pledge of collateral. But the stockbroker, however ample his resources and his credit, can only obtain loans upon collateral securities. Any attempt to resort to his personal credit or his personal paper would be construed as a confession of weakness, and his good name at the banks would suffer accordingly.

Persons who conjure nightmares over the practice of the banks in loaning surplus funds to stockbrokers are deceiving themselves. Instead of losing by this system, every merchant and manufacturer in the land profits by it in greater or less degree. The stockbroker deals in the bonds and shares of great railway and industrial companies, which, in order to succeed, must be able to sell their certificates to the public and so raise the money necessary to provide the extensions and new construction that are constantly demanded by the public. If fresh capital could not be enlisted in this way, additions and improvements would cease. The merchant who requires the railroads to ship his goods, and the manufacturer whose demands for new side-tracks, cars, and other equipment are unceasing, are therefore directly interested in the maintenance of a broad and stable speculative market for securities at all times, because in that way only are funds to be raised for the requirements of trade and industry. There would have been no railroads in this country had there not been speculators to build them, nor could the money have been raised had there not been other speculators to buy the shares with the aid of the banks.

Prevent the banks from lending money to facilitate stock-market operations and business ceases; interfere with it or hamper it and confidence is impaired, and when these things happen the industrial system collapses in terror. Such has been the experience of modern times. Until a system is devised whereby large undertakings may enlist public support in other ways than by offering securities in our great Exchanges and by maintaining a market for them there, it is useless to talk of interfering with that necessary relationship which exists between the banks and the stock market. On the one hand we have the cobwebs and windy sophistries of politicians and doctrinaires; on the other hand the test of proved effectiveness in the conduct of business. And the country’s business cannot stop; it must go ahead.

In the last six years more than a billion shares of stock have changed hands on the New York Stock Exchange, together with bonds of a market valuation exceeding five billions of dollars, and, under the rules, each purchase made was paid for in full by 2:15 P.M. of the day following the transaction. If all these purchases had been made for cash—i. e., if every customer of every brokerage house paid in full for his purchases, there would be no use for bank loans to brokers; there would be no speculation, and hence no progress. Securities purchased in the six-year period quoted were, in the majority of instances, bought on margin, that is, they were only partially paid for by the purchasers, the balance required being furnished by the broker from his capital and by the banks from their loanable funds.

There is a popular fallacy as to the amount of actual cash required to finance these enormous Stock Exchange transactions; persons who are not well informed often entertain the impression that it is much larger than it really is. As a matter of fact considerably more than 90 per cent. of the business of the banks is done through the Clearing House, an institution designed, as every one knows, to minimize the transfer of actual cash and to simplify the payment of balances. If these clearings seem large—they are, in fact, twice as large in New York as in all the other cities of the Union added together—it is not alone because more speculation in securities takes place in New York, but because this happens to be the centre where many other cities balance their claims against each other.

Furthermore, when critics who do not understand the subject look askance at the volume of loans of the New York banks, they must remember that the lending power of such institutions is always four times greater than the supply of money in its vaults. The reserve of 25 per cent. which the banks are required to maintain means that every million dollars of actual cash added to their funds renders possible an expansion of four million in loans, and every withdrawal of funds involves a proportionate reduction of these loans. These matters are self-evident. The point to bear in mind is that through this expansion and contraction of loans stock-market operations are increased or diminished by almost automatic processes. “Money talks” is an old aphorism. In this case it is not money that talks, but credit, and the credit extended to stockbrokers by the banks is always wisely regulated to meet conditions as they arise.

The customer of a brokerage house buys, let us say, 1000 shares of St. Paul at 120, on which he deposits a partial payment or margin of $15,000. The bank will loan to the broker 80 per cent. of the market value of the stock, or $96,000, which, added to the $15,000 deposited by the customer, leaves $9000 which the broker supplies from his firm’s capital. The broker gives to the bank, with the securities, a note on one of the bank’s printed forms, which gives the bank absolute authority to sell the collateral whenever the margin shall have declined to less than 20 per cent. This note is so sweeping in its terms, and gives the bank such complete power, that a reproduction of it, in small type, would fill two pages of this book.

It empowers the bank to sell as it pleases—if the broker fails to pay the loan on demand, or to keep the margin at 20 per cent.—all the securities in the loan; it authorizes the bank to seize any deposit the broker may have in the institution; the bank may itself purchase all or any part of the securities thus sold, and all right of redemption by the broker is waived and released. This instrument would seem, per se, a pretty strong hold on the broker, but the bank’s security does not end there. In making the loan the bank knows that the borrower is a member of the New York Stock Exchange, and that presupposes capital, with at least one Stock Exchange membership, worth to-day about $60,000. It knows, too, that a fundamental rule of all Stock Exchange brokers is to protect the bank at all hazards, not merely because the personal honor of the broker is involved, but because the business could not be conducted otherwise.

It is apparent from a consideration of all these elaborate precautions that the lending of funds to stockbrokers is a safe business, indeed in all the criticism directed against Wall Street methods I have not yet heard it questioned. The department of the bank entrusted with such matters watches the tape with vigilance to see that the 20 per cent. margin is not impaired; if it should happen to be impaired, the broker’s messenger is almost always on hand anticipating with his additional collateral the call that the banker will make. So excellent is Stock Exchange collateral, thus secured and thus protected, that the losses resulting from this class of business are infinitesimal. I am not a banker, but I hazard the opinion that it constitutes, in fact, the minimum risk in all the departments of the bank’s business.

In any case, when trouble comes and panic conditions prevail, it requires no stretch of the imagination to say that the stockbroker’s loan is a better loan than that of, let us say, the silk merchant, for he, perhaps, cannot easily repay. He is under immense liabilities in various directions and he has many obligations; whereas the stockbroker feels every minute of the day that his first duty is to the bank; the customer who owns the securities in the loan must either deposit sufficient margin or the broker will sell him out, in which case the loan at the bank is paid off. Finally, it may be added that in the October panic of 1907, when merchants’ failures were announced daily, and when certain banks and trust companies closed their doors, not a single failure was announced on the New York Stock Exchange.

Another objection often lodged by critics of present-day banking conditions, has to do with the practice of New York banks in the over-certification of brokers’ checks. These over-certifications are held to be objectionable because the National Banks are forbidden by law to certify for a sum greater than the drawer has on deposit. In practice it works out this way: The broker’s clearing-house sheet of to-day tells him what payments he has to make, so on the following morning he acquaints his bank with the fact that payments are to be made necessitating certifications beyond the amount of his deposit. He then sends to the bank the promissory note of his firm, payable on demand, and the bank credits his account with the proceeds. As the day advances the broker’s checks come in and are credited to the account, which is always balanced and the note paid off before the close of the day’s business. The risk is nominal.

Of course a few hours elapse between the certification and the receipt of the broker’s checks, and in this brief interval it would be possible for a dishonest man to abuse the privilege extended him, but the fact that such a thing does not happen affords tenable ground for the belief that it will not happen. The bank does not deal with an individual, but with a firm, and it knows that the firm has a membership in the Stock Exchange, with a cash balance on deposit in the bank that extends the accommodation. Any banker will bear witness that the business is quite satisfactory and that it involves no loss. Moreover, this certification of stockbrokers’ checks is essential to the maintenance of broad speculative markets, and, whether that portion of the public that criticises the practice likes it or not, speculation is a necessary part of our business life.

It may be pertinent to remark in this connection that the law prohibiting these certifications by National Banks is unnecessary and unwise, as is evidenced by the facility and safety with which it is honored in the breach. State Banks in New York are under no such restriction, nor has it occurred to our lawmakers that a necessity for the prohibition exists. The experience of these banks in the matter of certifications, like that of the National Banks, shows that the business is safe and sound. If the merchant discounts his paper for thirty, sixty, or ninety days, why prevent a similar accommodation to stockbrokers for an hour or two? Both are engaged in a strictly legitimate business upon which the welfare of the community in greater or less degree depends, and the fundamental purpose of a bank is to promote and encourage such business. That is what banks are for, and bank officers are supposed to know something about how, when, and where accommodations may be extended with safety to all concerned.

Mr. Horace White cites the year 1909 as an illustration of the employment of loanable bank funds by brokers which brings up another point. For long periods in that year, money loaned on call on the floor of the New York Stock Exchange at 1½ per cent., while our banks were paying 2 per cent. to the interior banks to which the money belonged. This does not necessarily mean that the banks were losing money; because the greater part of these funds was employed in time loans and in commercial discounts at 3 and 4 per cent., thus raising the average income rate. There is also to be considered the unearned increment which the bank gains by “holding” its depositor, even though no large profit accrues from the funds thus deposited.[44]

As the ratio of reserves to liabilities at that time was much above the legal requirement, it might be inferred from this and from the 1½ per cent. rate that money was easy; but it was not, as many persons in commercial pursuits learned when they tried to borrow it. There was a great deal of money that was not being used in daily business, and one of the reasons was that the period was one of distrust. Stockbrokers got funds at 1½ per cent. while many other borrowers were required to pay stiffer rates, because the banks that controlled the money market—i. e., the loanable funds—were unwilling to part with them except for short periods and on instantly marketable security, and this state of mind on the part of the New York bankers was shared by the bankers of Europe. It was good banking, because it was prudent and conservative. In other words, at a time when danger threatened, bankers in all important centres of the world regarded Stock Exchange collateral as ideal security, and, as we have seen, the aggregate of their loanable funds pressing on the market kept call rates down to 1½. If in times of doubt and distrust this form of collateral proves its safety, is it not a fair hypothesis that it is safe at all times?

If the critics are correct in their contention that pressure of easy money in the New York market holds out inducements for foolhardy speculation on the Stock Exchange, the year 1909, just cited, should have witnessed a great boom in securities. If speculators could borrow at 1½ per cent. on securities that netted 5 and 6 per cent., the theory of our adversaries is that this disproportion entices a large number of people into such speculative ventures that inflation takes place, followed by collapse. That nothing of the sort occurred shows that critics, like other less gifted persons, may err; it shows, too, what every thoughtful person knows, that booms are not created on the Stock Exchange, which merely reflects in its dealings external conditions of all sorts, among them psychological processes which neither brokers nor money markets may hope to control. As a matter of record, 1909 showed but little increase in the volume of business transacted on the Stock Exchange as compared with 1908, and the increase, such as it was, represented nothing more than a natural recovery from the paralysis following the débacle of 1907, plus an investment of funds at attractive levels. The same state of affairs prevailed in 1910. From June to December of that year call money rates almost never exceeded 3 per cent., and time money might be had at from 3½ to 5, yet far from stimulating speculation—far from revealing an excessive employment of bank funds by stockbrokers—transactions both in shares and bonds dwindled to insignificant proportions.

Cheap money is by no means a “bull argument” from the Stock Exchange point of view, because it arises from dull conditions in commerce and industry, and there can be no boom in the securities which represent the nation’s business unless mills and factories and railroads are prosperous. There have been more bull markets with tight money, or with money in the neighborhood of 6 per cent., than in cheap money markets of the sort just described. This is not equivalent to saying that a prolonged rise can be conducted through a period of dear money. As a matter of Stock Exchange experience such a condition seldom arises, because the Stock Exchange discounts the future, foresees those economic conditions that spell prosperity for the country, and advances the prices of securities on a money market that has not yet felt the demands of improved conditions.

In June, July, and August, for example, conditions may warrant a hope of bountiful harvests, while general business is dull and idle money abundant. Such a prospect is always discounted, other things being equal, by a rise in securities, and money that is not yet required to market the crops thus finds employment as loans on Stock Exchange collateral. Later on, when reviving business leads the interior banks to call their New York balances, the depository banks meet the demand by calling loans and by advancing rates. The speculative movement on ’Change is then checked or reversed just in proportion to the demand for money elsewhere. It may continue for a while if the discounting process has not been complete, or if there remains a wide disparity between interest rates for money and net returns on securities; or if the independent resources of the city banks are large enough to furnish comfortable interest rates even after the westward drain has commenced, but, generally speaking, “the move is over,” to quote the vernacular, by the time business men want their money. Nine times out of ten any monetary strain that results thereafter is not due to speculative operations in securities nor to any other cause attributable to the Stock Exchange.

A word should be said here concerning the Stock Exchange Clearing House, because just as the Clearing House of the associated banks ascertains and pays the balances of its members with a minimum outlay of coin and legal tender notes and with great economy of time and labor, so the Stock Exchange Clearing House stands the strain of an enormous business, reduces the volume of checks and deliveries, and relieves both the banks and the stockbrokers of an amount of risk and confusion that would be well-nigh intolerable.

In order that the layman, for whom these pages are written, may understand what this means, it may be said that if 500,000 shares of stock are sold in a day on the Stock Exchange, and if we assume the average price of these stocks to be 50, the checks paid out on that day would be $25,000,000, and in a year at that rate certifications would be necessary involving the stupendous total of $7,500,000,000. This clumsy if not impossible method the Clearing House was designed to avoid. Moreover, the actual daily transfer of such a volume of securities is largely obviated by the Clearing House system, and thus another and highly important economy is effected.

The Stock Exchange Clearing House is managed by a committee of five members of the Board of Governors of the Exchange. Each day the seller of stocks sends to the office of the buyer his “deliver” ticket, and the buyer sends to the seller his “receive” ticket, this transaction constituting a “comparison” by both parties, and an evidence that the transaction has been entered on their books. Before 7 P.M. of that day these tickets, and the sheet comprising the record, are sent to the Clearing House. This sheet contains a “receive” and “deliver” column, with all the transactions in each security grouped together, and with a balance—i. e., a debit or credit, struck at the bottom. If there is a credit, a draft on the Clearing House bank is attached; if a debit, a check for the balance accompanies the sheet.

When the Clearing House receives this sheet a simple and a very ingenious process ensues which relieves the broker of a great deal of trouble, risk, and labor. If he has bought and sold, let us say, an equal amount of stock, comprising numerous transactions, instead of having to draw checks for all these separate trades, the Clearing House settles the whole day’s transactions by a single check for the actual balance. If his numerous purchases and sales do not balance, and if there are various lots of stock to receive and deliver, the Clearing House eliminates a host of intermediaries and puts him into direct touch with one firm to whom he delivers, and with one from whom he receives. He may have had no transaction with the firms thus arbitrarily assigned to him; that makes no difference. The books of the Clearing House always balance; somewhere a firm is entitled to a receipt of stock, and somewhere another firm will be found to deliver it to him.

Nothing could be simpler and more economical than the manner in which the two are brought together. In such a system, the number of shares actually delivered is reduced by the Clearing House to one third of the number represented by the broker’s actual transactions, while the amount of money which he must command to meet his daily engagements represents, on an average, only 25 per cent. of the actual capital that would be required were it not for the excellent system thus afforded him. Persons who wonder at the magnitude of Stock Exchange transactions, and who jump to hasty conclusions as to the actual capital involved, may well reflect upon the manner in which this method reduces to a minimum the stockbroker’s drafts upon the banks.

In a larger sense, if the critic in these matters affecting the relationship of banks to stockbrokers feels aggrieved at what he thinks is an improper diversion of funds, he must remember that the comparative scarcity of capital to-day—which is at the bottom of his complaint—is not due in any sense to Stock Exchange speculation, for there has been almost no extensive speculation in this quarter from 1907 down to November, 1912. To find the cause of the scarcity of capital—and it is unquestionably scarce—he must consider the immense destruction of tangible wealth in the last decade, and the extraordinary tendency to convert floating forms of capital into fixed and immobile forms.

The amount of money expended in State roads since automobiles came into popularity is probably ten times more than it was before; at the election in November, 1912, a fresh total of $50,000,000 was voted for “good roads” by the electorate in New York State. The building of the Panama Canal has cost or will cost about $365,000,000; all over the country large municipal or state works are under construction; here in New York the contract for the Erie Canal calls for $150,000,000, and for the city’s new water-supply system—the Ashokan basin and the Kensico reservoir—$177,000,000, each contributing a share to the depletion of the normal supply of working capital. Meantime, to cite another instance, Congress appropriates $160,000,000 to pensions in a single year, and $40,000,000, as a recent writer puts it, “for that particular form of graft which consists in giving a $30,000 post office to a thirty-cent village.” The railroads of the country alone require to-day sums of money equivalent to the working capital represented by all our bountiful harvests of 1912.

Aside from these matters the critic should remember, in fair play, that the currency famines which occur with periodic frequency in our country are due in large measure to the non-elastic nature of the currency, to its persistent absorption by the Treasury, and to the rigid restrictions which these abnormalities impose on the volume of banking credit. Conditions such as these contributed in no small measure to our last great panic, and led to a premium on currency that made us a laughing-stock among the nations. There has been no such money delirium in England since the Napoleonic wars; no such condition in Germany since the empire was founded, and nothing approaching it in France, even in the commune and the war with Prussia. Yet in America we go on wobbling uncertainly under the makeshift act of 1908, with its currency associations and its emergency measures, and with the added fear of what may come when the Act expires in 1914.

The situation in America is substantially this: Business drives ahead at a tremendous pace, with perils on every side, chiefly anxious to be undisturbed. Matters run along smoothly for a while; then something happens—there is too much optimism or too much confidence—and a smash. It is not due to speculation in securities, because, as in 1907, the stock markets are the first to see what is coming and to discount it. But speculation in lands, or in manufacture, or in railroad construction go on and on; there is too much work for the dollar to do; the currency system breaks down; here and there a financial institution closes its doors; public confidence is shattered, and the whole credit system is disturbed.

Then there arises a noble army of critics who, with the best intentions but with insufficient knowledge and study, set to work to remedy conditions they do not understand by methods untried and unpractical, that only add to the general confusion. More harm than good results when the physician, brusquely entering the sick-room, tells the patient he is a very sick man, denounces the lobster that poisoned him, and departs with a general condemnation of shellfish, but without prescribing suitable remedies. Persons who denounce the relationship existing between banks and stockbrokers are in most instances upright citizens of high character, but until a little patient study of conditions has enabled them to speak with authority upon matters that are necessarily complex and delicate, they cannot accomplish any really useful purpose. “The wicked are wicked, no doubt,” said Thackeray, “and they go astray, and they fall, and they come by their deserts; but who can tell the harm that the very virtuous may do?”

The three leading groups of banking interests in Wall Street are said to represent $500,000,000 of available capital each; the deposits in what are called the “trust banks” amount to between $700,000,000 and $800,000,000, while the banks of the whole country hold deposits of $16,000,000,000. The savings banks now hold $4,450,822,522 which is owned by 10,009,804 depositors.[45]

As we have not yet reached the point of abolishing property altogether, we may concede that these great combinations can do for individual business and for the country at large what cannot be done without them. They furnish the large sums which, from time to time, are required by the Government, the State, the town, the manufacturer, the tradesman, and the speculator, and to each of these—especially the speculator—the tremendous development of this country is due. Because of speculation in securities, the 26,000 million dollars’ worth of capital represented on the New York Stock Exchange by the stocks and bonds of railroad and industrial corporations have found a public market through which necessary capital has been raised, and the total increases yearly by about one billion dollars. This is “big” business, to be sure, but it is the bigness of the whole people, for the welfare of each is the welfare of all.

Such large affairs naturally set people thinking; men want light; they want to know, entirely aside from the doctrines of political platforms and stump orators, to what extent the relation of capital to business meets the test of proved effectiveness and economic worth. Especially do they seek information in this oft-discussed matter of speculation in securities and of the bank’s relationship to it; and here, fortunately, there is no lack of results by which that relationship may be tested.

Pragmatism tells us that as phenomena appear, become mighty, and persist in accordance with natural processes, so they demonstrate their ultimate good and their obvious usefulness. In its especial application to the matters we have discussed, pragmatism teaches us to wait for results in estimating a particular business method, and then to study it in its relation to all business. Applying this test to the use of loanable bank funds by those who deal or speculate in the things that represent American enterprise, we find that the very existence of these enterprises depends upon the maintenance of these methods. Finally, both the banks and the Stock Exchange are the trustees of the property of others, and in that capacity their reciprocal relations are certain to be attended by greater caution than if they dealt in a freehanded way with their own property. The magnitude of their undertakings spells responsibility, and responsibility breeds sobriety.

CHAPTER V
PUBLICITY IN EXCHANGE AFFAIRS; CAUTIONS AND PRECAUTIONS

If a list of “don’ts” were compiled for the public that is interested in the Stock Exchange, the first prohibition would be “don’t believe all you read in the newspapers”; at least do a little independent thinking before jumping at conclusions. The relationship between the Stock Exchange and the metropolitan press is, with perhaps one exception, cordial in the extreme. The newspaper man is a thinking person; if he were not he could not hold his job. He knows, for example, that the Stock Exchange is an indispensable part of the machinery of modern business; he is aware of the fact that it maintains a high standard of probity. He would be the last man to attack the institution unfairly, and he is the first to defend it, editorially, when misconceptions and unfounded suspicions are rife.

But on the other hand, newspapers want news; their circulation and the popularity of their advertising columns depend upon the skill and ability with which they parade before the public everything that happens. If a politician or a clever and ambitious lawyer makes a startling charge against an institution that occupies a conspicuous place in our affairs, that is news, and the newspaper must print it. In order to make the news attractive to the jaded palate of its readers the dry-as-dust parts must be skimmed off, and seasoning added in such peppers and vinegars as the occasion permits, with a final dash of spice in the shape of pungent headlines that will arrest and hold the appetite.

Somewhere off in the dim recesses of the editorial page there may be a sober (and deadly dull) analysis of the matter, revealing the politician or the notoriety-seeker in his true colors, but this is often ignored by the reader. What he wants with his morning coffee is his daily thrill, and he finds it under blatant headlines on the first page. Because he wants it, and because he won’t be happy till he gets it, the newspaper gives it to him on a generous scale. Until we arrive at a Utopian state in which art, religion, and kindred abstractions satisfy the mind to the exclusion of fires, riots, suffragettes and Stock Exchanges, we cannot blame the newspapers for giving us what we want, nor the politicians for helping the good work along.

And yet, as Mr. Bryce pointed out in his lectures at Yale on “The Hindrances to Good Citizenship,” this willingness to accept as conclusions the scare-heads in newspapers which are not, and never were intended to formulate serious opinions, lays us open to the charge of indolence; “the neglect to think” thus becomes a serious phase of a deficient sense of civic duty. In countries where men are imperfectly educated, or in rural districts where means of acquiring knowledge are small and scant—where men lead isolated lives out of reach of libraries and learning—they ask advice of the priest or the village schoolmaster, and thus vicariously discharge the duties of citizenship without any real knowledge of the problems before them and without contributing to the solution of those difficulties to which the ever-increasing complexity of our civilization gives rise.

Now if we apply this line of thought to the study of such economic problems as arise in our country from time to time, we find that the same conditions apply. We fancy ourselves immeasurably better off than the uncultured frontiersman who must rely for his information upon the priest or the schoolmaster, but in our dumb submission to the rant of the hustings and the scare of the headlines are we really discharging the functions of good citizenship? Are we not indolent? I can have a lively sympathy for the half-breed in the Canadian woods seeking information as best he may, but for the man in our populous and cultivated communities who is too lazy to turn to our great public libraries for light on the vexed and vexing economic problems of the day, contenting himself with the half-baked opinions of demagogues and quacks—for such a man it is difficult to say a good word. There is hope for the one; the other is the most menacing and discouraging type in our citizenship.

Take up the morning newspaper almost every day and we find the crude essence of this misinformation paraded in a way that makes us sorry for a public that cries for such stuff. A custodian of public funds, collected for the purpose of erecting a monument, is found very recently to have squandered the money entrusted to him. One of his co-trustees, who must have been somewhat lax in his duties, bewails the loss and seeks to enlist sympathy for himself by hazarding the opinion that “the money must have been lost in speculation in that hell-hole, the Stock Exchange.”

This from a former army officer and a gentleman, who subsequently states that he has no idea what became of the funds, but “cannot think of any other explanation.” “Hell-hole” and the “Stock Exchange” constitute a good repast; the headline artist contributes his quota to the feast, and so a portion of the public that feeds on this meat arises from the table with the satisfying conviction that another awful indictment has been leveled at the Exchange, notwithstanding an utter absence of proof or evidence of any kind tending to show that the delinquent trustee had lost a dollar in Wall Street. And suppose he did so lose it, what then? Is the Stock Exchange or any other market-place a “hell-hole” merely because a thief whom nobody suspects squanders his money there? Suppose he had spent it in automobiles, or in real-estate speculations, or in campaign contributions, or in foreign missions, would the same amiable characterization apply?

Another familiar instance of making Wall Street the scapegoat is seen in the “explanations” of defaulting bank clerks. “When a young bank employee,” says a financial journal, “with a wife and two children in Flatbush, and a salary of something less than $2000 a year, takes to entertaining angels, more or less unawares, in the Great White Way, and matching his trained financial mind against ‘bankers’ of another kind, he always blames Wall Street when the inevitable smash comes. He has been ‘speculating in stocks,’ he says. He thinks, and a great many people equally silly agree with him, that he thereby shifts the blame for his extravagance and folly to other shoulders. Entirely well-meaning people, without the slightest conception of the real purposes for which the financial centre of a nation exists, say: ‘Here is another indictment against sinful Wall Street. Let us kiss away the tears of this misguided young man, who now promises to be good.’ They never think of asking the misguided young man to show documentary evidence of his losses, which of course every broker must necessarily provide, and must keep in duplicate as a matter of record.”[46]

A police officer whose salary has never exceeded $3000 a year is arrested, and it is shown that he possesses a fortune of $100,000. Where did he get it? Why, he made it in the course of nine months of remarkably successful speculation in Wall Street, and one of his henchmen, too stupid to know that everybody in Wall Street keeps a set of books, promptly came forward to endorse this explanation. Proofs were sought by the authorities, and the lie was, of course, exposed, but the readiness with which the frugal officer sought to fall back upon this hoary explanation shows that it is a permanent fixture of the crook’s property-room, and that in the stage-setting for his sordid accumulations there must be the familiar Wall Street background.

Another notorious pastime, that seems to be well known to every one but the officers of the courts, consists in the practice of fraudulent bankrupts in producing in court a mass of worthless securities as evidence that the bankrupt’s money has been “legitimately” lost in speculation. The certificates thus exhibited are beautifully engraved memorials of defunct mining concerns, sold at so much a pound by well-known dealers. It is related that a person who wished to keep ever before his eyes a lesson and a warning once papered the walls of his house with a wagon-load of this junk, which he was able to purchase at less than the price of ordinary wall paper.

Any scamp who intends to “lie down” on an unprofitable contract can buy $1,000,000 nominal of the stuff at waste-paper rates. He is assured of the sympathy of his family and friends, and, if it does not occur to the lawyers to inquire who his brokers were, and when, where, and how these purchases were made, he stands a good chance of going the way of all undetected swindlers, notwithstanding the fact that documentary evidence of his purchases, if there were any, is always available. In this way another indictment is framed against Wall Street in the minds of thoughtless people. They seem to ignore the obviously improbable nature of the story, preferring rather to make Wall Street the scapegoat, and by “Wall Street,” in the majority of cases, they mean the Stock Exchange, yet the Stock Exchange had no more to do with it than Trinity Church, at one end of Wall Street, has to do with a stevedore’s crap-game at the other end.

So far as concerns the case of the crooked bank clerk, it is perfectly well known, or at least it should be, that no member of the New York Stock Exchange is permitted under its rules to have any speculative or investment relations whatever with employees of banks or trust companies, or of other brokerage houses. The Exchange authorities enforce this rule to the letter. Disgrace and expulsion faces the man who would attempt it. More than that, members are unusually careful in investigating customers’ accounts for reasons involving their own safety in actions that may be brought in the courts; so rigorously is this care exercised that accounts are repeatedly refused where the bona fides of the customers are not fully understood by at least one of the firm’s partners.

Furthermore, any negligence on the member’s part in this important matter, or in other matters affecting the general welfare of the Stock Exchange, places him at once within the all-embracing grasp of that one of the Exchange’s by-laws which has to do with “any act detrimental to the interests of the Exchange.” This is a large order, and its importance is well understood by the members. They know, and all those who so freely criticise the Stock Exchange could find out if they inquired, that the power of the Board of Governors to supervise every action of its members is vastly greater than any power that could be vested in the courts. There are constitutional limits to the authority of common law; there are no limits whatever to the powers of the governors in dealing with members.

This leads us to consider another popular criticism of the Stock Exchange, based on its unwillingness to abandon its present organization and incorporate under State regulation. The public seems to feel that this reluctance to submit to State or Federal control shows that the institution is trying to conceal something, yet nothing could be further from the fact. The Exchange does not incorporate because the interests of the public, which it is bound to conserve, would suffer enormously by such a step. “In its present form,” says the Wall Street Journal, “the Stock Exchange is a private organization. It can inspect any member’s books at any moment. If it suspects him of wrongdoing it can tap his telephone wire, and has done so in the past. It can terminate his membership for conduct which no legislation could possibly touch. One reason, in fact, for its admittedly high standard of probity is the power, at once democratic and despotic, exercised by the Governing Committee elected by all the members.

“But if the Stock Exchange were reorganized under State supervision, much of this power would be taken away. Members would possess rights which no governing committee could ignore. They could resort to practices legally right and ethically wrong, which under the present system would be visited by swift punishment. Any member of the public, now, who can show the Stock Exchange committee an act by a broker toward him legally defensible but morally wrong, can secure that broker’s expulsion from the Stock Exchange. Under State incorporation he could only obtain redress by prolonged litigation.... No legislative safeguards are needed. The Stock Exchange now possesses a power of supervision over its members which neither Congress nor the State legislature could give. The only power our lawmakers really possess in the matter is to limit that supervision; and for this, if for no other reason, the Stock Exchange should fight incorporation to the last, and should take every proper means of publicity to range public opinion behind it.”[47]

An instance in which Wall Street in general, and the Stock Exchange in particular, occasionally comes under the ban of more or less hysterical public condemnation, results from the work of company promoters and swindlers, wholly outside the Exchange’s jurisdiction. In spite of the vigilance of the postal authorities and the police, every now and then a swindler finds his way into this forbidden ground, and here he plies his trade. Sometimes it is a land scheme, sometimes it is timber, recently it was wireless telegraphy, often it is a gold mine.

The promoter of these enterprises does not permit himself or his affairs to come under the scrutiny of the banks, the Stock Exchange, or the Clearing House. He fights shy of the curb market as it is now organized, and avoids the watchful eye of the metropolitan newspapers that enjoy the pastime of exposing frauds. His ways are ways of darkness. His methods are mailing lists; his victims are that numerous progeny born every minute; the lure is the engraved letter-head with its “Wall Street,” its list of “Directors,” and its subtle assurance that this precious property now literally “given away” bears the endorsement of the elect, and is known and approved by the whole financial community.

Whenever he can do so, the artful gentleman behind this bait contrives to have a market for his wares. He cannot do this anywhere in New York, for the curb market, once the refuge of the swindler, is now closed to him, thanks to the improved morale of the curb brokers themselves, and to the recommendations of the Hughes Investigating Committee. Consequently the dishonest company promoter is forced to manufacture his market in another city, where fluctuations in the price of his wares are made to order, usually on a rising scale, without interference by the authorities.

More often still, this market and its rising prices do not exist at all; in any case it is only a fraudulent attempt to excite the cupidity of speculators into the belief that there is active trading in the particular stock offered for sale. “The mines,” says the Chairman of the Hughes Committee in discussing these swindling operations, “are situated in distant places, as Nevada, Alaska, Canada, Mexico, and even in South America. In proportion as they are remote, inaccessible, and subterranean, they are attractive to the class whom Tacitus had in mind when he said: “Omne ignotum pro magnifico.”[48]

The halcyon days of these enterprises are now drawing to a close. Their field of operations is becoming more and more limited, the postal authorities are redoubling their energies, the newspapers are closing their advertising columns, and the victims who have birthdays every minute are, it is hoped, growing wiser. In any case immense losses have been incurred, and immense harm done. To appreciate the extent of it, one has but to look over the circle of one’s own acquaintances, and count the worthless specimens of the engraver’s art that have found a resting-place—permanently, I fear—in homes ill-prepared to house them. Each one of these chromos has left its sting—each one has excited a bitterness and resentment that, in the misdirected anger of losers who will not see their own folly, is too often flung at Wall Street and at the Stock Exchange.

The bucket-shop method is better known and easier to detect—hence it is rapidly being exterminated. “Bucketing,” as it is called, usually flourishes in small towns at a considerable distance from New York. Formerly it thrived in the larger cities, even those adjacent to the Metropolis, but it has now been driven from these places. It professes to trade in stocks for its customers, and its office windows are usually decorated with signs that indicate, though they do not always say so plainly, that the house is identified with “the Stock Exchange.”

It allows its customers to trade on what is called “a two-point margin,” that is to say, the buyer or seller is “wiped out” when the market has fluctuated two points against the price at which the trade is made. The word of the house must be accepted for the veracity of its prices, which, however, are supplied to it by telegraph from New York. Bear in mind that these prices are not telegraphed to the customer, but to the mysterious persons in the rear office of the shop. They call themselves brokers—this bucket-shop fraternity—but they are not brokers in any sense by which that elastic term is used. They have not even the “redeeming vices” of gamblers; they are swindlers.

The trader in such a place starts with all the odds in favor of the house. To be exact he pays two commissions and the market “turn” is against him ab initio. If the stock is 100 bid, 100¼ asked, he buys at 100¼ always. If he sells at the same quotation, he sells at 100. He could not sell in the former case at 100¼, nor buy in the latter case at 100, so he starts ¼ per cent. “to the bad.” If, then, he bought at 100¼, when the price is 98¼–½, his two-point margin is exhausted, although the price has actually declined only 1¾ per cent. Thus he is required to bet heavy odds on what is really no better than an even money chance, even allowing that the prices are honest.

But they are not honest, because in the large majority of such transactions the prices are “rigged,” that is to say, the bandits who run the shop run it to win and not to lose, and “fix” the prices accordingly. The player is thus required to give odds by laying 3 to 4 not on what the price of a stock will be, which is ruinous enough in all conscience, but on what his opponent will choose to make it! Since we are talking of gambling now and not of any real transaction, we may as well adopt the vernacular of the fraternity and say plainly that the bucket-shop man holds the stakes, cuts, shuffles, and deals the cards, and then telegraphs you what your hand is. And the loser at this joyous pastime thinks he has been robbed by Wall Street.

The game works against the player in yet another sense, as the Wall Street Journal points out, for when you buy stock you are entitled not merely to the stock itself, but to all the privileges which it carries, and not the least of these privileges is the effect which your purchase will have on the market. That is to say, if ten thousand purchasers throughout the country should buy even small amounts of a certain stock on a given day, the combined effect of all these purchases would undoubtedly lift its price on the Stock Exchange, and thus we see that each buyer’s action carries with it a privilege of no inconsiderable proportions. But the keeper of the bucket-shop does not buy any stock for you at all; he merely makes a bet with you as to what the price will be—and so, having robbed you of your money, he now robs you of the privilege which goes with your money, since the alleged purchase of a million shares of your stock in bucket-shops would not have the slightest influence on its price at the Stock Exchange.

The man who has saved money by his own enterprise and thrift is a fool if he gives his savings to mining “bonanzas” through the itching palms of promoters, or to bucket-shops through the lure of slender margins. The very fact that promoters always play upon the theory that distance will lend enchantment to the view, and solicit their funds solely by means of prospectuses, should be a sufficient warning to the most credulous. A word to his banker, or a letter to any responsible institution in Wall Street, will supply him with the necessary information and save him from the possibility of loss.

As to the bucket-shops, if he is in doubt, he has but to follow the same procedure. The New York Stock Exchange authorities will gladly tell him whether the so-called “banker and broker” is really a member of the Stock Exchange, and the local bank nearest at hand will expose any fraud if it is called upon for information. As to the two-point margin bait, it is a good rule that the smaller the margin asked for, the less strength there is behind the house that asks it, and just in proportion as the margin requirement diminishes so a suspicion of the solvency of the firm should become fixed in the mind of the customer. This warning applies to stockbrokers no less than to bucket-shoppers. If the stockbroker takes from you a ten-point margin, and from somebody else a two-point margin, you may be sure your money is being used to finance the other customer’s trade, and you should lose no time in withdrawing your funds from such a house.[49]

I often think that those who so freely criticize the Stock Exchange would have applauded it could they have witnessed the fight between the Exchange and the bucket-shops. In England, because telegraphs are a Government monopoly, the transmission of prices by or to bucket-shops is effectually barred, and the same is true of the telephone. But in this country the transmission of prices by wire is not a breach of law, and the difficulties that have attended the attempt to suppress the transmission of racing news by wire to poolrooms shows that even if it were prohibited there would be great difficulty in its enforcement.

Notwithstanding these obstacles, however, the Stock Exchange labored zealously to close bucket-shops long before the officers of the law became active, and, while the work thus done was not published broadcast, it was none the less effective. Many a bucket-shop proprietor doing business a few years ago under a high-sounding company title probably never knew what hit him when the raid took place. It was the strong arm of the Stock Exchange working unostentatiously that did it, and in that good work it saved from further losses a large number of innocent people who used the establishment with no knowledge of its real character.

As long ago as 1875, in its contracts with the telegraph company, the Stock Exchange began restrictive measures to prevent its quotations from reaching the bucket-shops. In 1878 still more forcible measures were employed, and in 1882 positive steps were taken by which the Exchange authorities personally inspected the telegraph company’s quotation contracts with its patrons. To-day this is carried to such an extreme in the determination to protect the public from the impositions of those who might in devious ways convey these quotations to improper hands that even members of the Exchange may not install wires from their offices to outsiders until the proper committee of Stock Exchange authorities has viséd the application.

Meanwhile, a secret-service has been at work, silently ferreting the hidden, underground channels in which the bucket-shop is forced to conduct its operations. Thanks to this good work and to that now done along similar lines by the Federal authorities, this form of rascality is rapidly disappearing. Is it too much to hope that at least a part of the unmerited criticism of the Stock Exchange by the victims of bucket-shops may also disappear?

In heading this chapter “Cautions and Precautions,” my purpose was not merely to warn the credulous outsider against the news items of the day as related to the Stock Exchange, nor was it solely to point out to him the pitfalls and dangers that exist under the Wall Street mask. I had in mind also a word of caution to Stock Exchange members themselves. That these gentlemen are more sinned against than sinning is, or it should be, apparent to anybody who has taken the trouble to learn the A B C’s of the business. Such a man knows that Stock Exchanges occupy an important place in the mechanism of modern business; he knows, too, that just in proportion as their functions enlarge and the scope of organized markets increases, so persons will be found who foolishly or dishonestly abuse the facilities there afforded.

“Reflection,” says a recent writer, “seems to have little part in the intellectual equipment of the assailants of organized markets. The fact that the stock market is sometimes abused by people who know nothing of its purposes or are incapable of understanding the mighty influences which dominate it, is no reason for considering it as a harmful excrescence on the body politic.”

This fact established, one who has been a member of the Stock Exchange for many years may, in a spirit of complete loyalty to the institution, comment freely on some of the mistakes within the Exchange itself, errors of judgment or sins of omission that have given to the popular criticism of the day its one supporting prop. Admitting mistakes freely is the surest way of correcting them; frequent reminders of them serve to keep one on guard against their recurrence. The history of deposit banking, for example, has been, like the history of the Stock Exchange, a story of gradual development to meet growing conditions, and this is true also of the history of note issues, joint stock companies, clearing houses, cable transfers and of all the instruments that enter into that economic structure which gives mobility to capital and flexibility to credit.

In the very nature of things the development of each part of this gradually devised machinery has been attended by mistakes, by errors of judgment, and by occasional wrongdoing, yet we do not condemn the national banking system because there were once wildcat banks; we do not utter hasty judgments on stock-companies because in other days they were badly organized and incompetently managed; we do not withhold our support from railways because they once erred by pushing too ambitiously into projects that ruined innocent stockholders; we do not abandon our form of government because there was once civil war. No, but we try to keep all these things in view in order to profit by them, and to see to it that they do not happen again. We say of individuals that no man’s vices are sufficient reasons for not admiring his virtues. Why not apply the same code to business?

One of the mistakes of members of the Stock Exchange in the past has been in trying to do too much business on too little capital. This is a subject that calls for plain speaking, since it directly caused two Stock Exchange failures in recent years, failures that were, I am sorry to say, essentially the result of dishonesty. Every Stock Exchange house is looking for business, and a house with small capital sometimes gets more than it should attempt to handle. Such a house borrows from the bank, as all houses do, and allows its bankers a 20 per cent. margin; so far so good. But it accepts business from its customers on a 10 per cent. margin, and this means financing the difference out of the firm’s capital. If the capital is large, the business is safe, but if it is small, the house finds itself “loaded up,” as the phrase is, and is then in such a predicament that it must either summon enough moral courage to refuse business altogether and so advertise its limitations, or abandon its moral courage, sell its customer’s stocks “short” and incur the risk of buying them back cheaper.

The latter course is dishonest; it is in fact nothing more or less than a form of “bucketing,” since the customer must lose for the broker to save himself, while, if the customer wins, the broker may not be able to pay. This is not a common practice of course—first, because 99 per cent. of the members are absolutely honest; second, because the majority of those who carry accounts on the books of Stock Exchange houses are wise enough to acquaint themselves with the firm’s resources and to withdraw when too much business becomes apparent, and, third, even though a broker were not himself essentially honest, he would not dare expose himself to the expulsion and disgrace that would attend exposure. Nevertheless, the thing has been done, and it may conceivably occur again. How then may it be avoided?

As the Stock Exchange is, as we have seen, an unincorporated body with a set of rules which no legislature and no court could enforce without depriving a man of his constitutional prerogatives, it is obvious that this and all other reforms must come from within; all the many reforms that are constantly lifting the Exchange to a higher level come from that quarter. There are 1100 members of the Stock Exchange and perhaps 600 of these are engaged in active commission business. A committee of the governors can enter any member’s office at any time, and demand every book or record without reserve. It has absolute power to compel him to do anything that in its wisdom seems desirable. If he is doing too much business on too little capital, he can be forced to restrict, or to retire from business altogether. Failure to comply immediately means expulsion and a peculiarly stinging disgrace. Naturally in the face of these despotic powers any plan of mutually guaranteeing brokers’ accounts, such as that employed by Lloyds in London, or by the Agents de Change on the Paris Bourse, would seem unnecessary.

The remedy lies, first with the members themselves in striving to attain continually to a higher standard of business morality, and second with increased watchfulness by the committee having this matter in charge. In point of fact it is apparent that both these solutions are now being employed to a greater extent than ever before. The two failures that occurred some years ago as a result of this iniquitous practice hurt the Exchange, and stung the members to the quick. It can never happen again if the vigilance of the governors can prevent it, and yet every now and then a bank fails even under the watchful eye of the bank examiner. No committee and no group of committees can watch the books of 600 houses engaged in a business in which the dividing line between sound and unsound business may be crossed and recrossed with surprising suddenness many times a day. The members themselves must look to this, and that is what they are doing to-day, as never before, with an earnestness begotten of real pride in their great organization.

If they do not do it, if they relax in any degree the vigilance upon which the proper conduct of their business depends in this important respect, they will be forced sooner or later to resort to the plan of guaranteeing the accounts of their fellow members, or to submit to that form of government incorporation or regulation which must impair, if it does not actually destroy, their usefulness. Members must also see to it that manipulation in its improper forms is driven out of the Exchange, and that every conceivable precaution is taken in the listing of new securities. These matters I shall discuss elsewhere. Meantime it is cheering to note that Stock Exchange failures, whether arising from this or any other cause, are diminishing in number. In London, at the account day immediately following the failure of the house of Baring, thirty Stock Exchange houses announced their inability to meet their obligations. Certainly the New York Stock Exchange has not witnessed so many failures in ten years.

One of the many excellent results of the work of the Hughes Committee from the standpoint of the Stock Exchange was the publicity that came of it. Critics of the institution had long found fault with it because of its atmosphere of aloofness, the air of mystery that seemed to surround it, its silence under attack, and its apparent unwillingness to defend itself from adverse comment. This reticence, however, while it did harm, was more apparent than real. In so far as the Stock Exchange is concerned the advantages of publicity have long been recognized. The difficulty has been in having its purposes and its methods properly attested by competent authority in a way that would enlighten the public and carry conviction. Members and friends of the Exchange feel very strongly that in this day and age, when the spirit of publicity is in the air, the Stock Exchange should fall in line with a resolute determination to assert itself and make itself heard on all proper occasions.

If a sub-committee of Congress retains as counsel a shrewd lawyer who by devious ex-parte methods reads into the record and thence into the newspapers only such biased and prejudiced information as will do harm to the Exchange, while rigidly excluding all that properly belongs there by way of refutation and explanation, energetic steps should be taken to remedy this obvious injustice by invoking that spirit of fair play which is essential to any judicial inquiry. These are not the days of the Inquisition. We have progressed beyond the point of the Star Chamber. Members of the Stock Exchange know that they will receive fair play from the newspapers whenever they seek it, but they cannot expect to find their side of the case stated unless they themselves take the necessary steps to secure its presentation. And the way to do this is to proceed with energy and determination against every avenue from which the malicious slander or the insidious suggestion emanates.

The time has passed to sit supinely under every sinister attack and imagine that a consciousness of rectitude will suffice as an answer. Let the Exchange bestir itself. If, as happened very recently, a judge on the bench can so lose his poise as to say to a common thief at the bar, “You have committed a petty theft and you must go to jail—but had you gone down to the Stock Exchange and stolen a million you would go free”—such an unworthy utterance should be handled promptly and without gloves by the Exchange authorities, and the same course of treatment should be applied vigorously to every thoughtless minister of the gospel and every cheap politician who, because the Exchange has so long remained silent, may think that such silence entitles him to utter any libel that comes to mind. The newspaper that publishes the original utterance of this judge or that preacher will publish also the steps taken by the Exchange to bring him to book, and even though the slanderer may escape the consequences of his act through the technicalities of the law, or otherwise, the knowledge that the Exchange is at last aroused from its lethargy and in a fighting mood will serve to deter others from similar indiscretions. I violate no confidence when I say that henceforth the Stock Exchange will be found defending itself manfully, and I venture to remind all noisy seekers of notoriety that “thrice is he armed who hath his quarrel just.”

The Stock Exchange has felt, since the report of the Hughes Commission in 1909, that such a report, by such a body of men, would inevitably stay the hand of many of its detractors by showing them just what the Exchange is trying to do, and just how the work is done. “The committee,” says its chairman, “was in session about six months. Its expenses were paid by the members themselves, and since frugality was a necessity the services of the stenographers were dispensed with, the members taking only such notes of the testimony of witnesses as each one deemed important to the matter in hand. The officers of all the Exchanges in New York City were invited to appear before the committee and answer questions both orally and in writing, and all of them responded promptly and courteously, as often as they were asked to do so. Many volunteer witnesses, citizens of the State, were heard. None such was refused a hearing. Citizens of other States were not called, or accepted, as witnesses unless they had given evidence, by published writings or otherwise, that they had something of value to contribute to the discussion.”[50] This committee was composed of Horace White, Chairman; Charles A. Schieren, David Leventritt, Clark Williams, John B. Clark, Willard V. King, Samuel H. Ordway, Edward D. Page, Charles Sprague Smith, Maurice L. Muhleman.

Nobody who read these names doubted the independence and public spirit of its members. It was precisely the sort of committee that all fair-minded men welcomed. The high character of the members carried assurance of their good faith; their wisdom and practical experience meant a critical analysis of the subject; their independence of spirit made a whitewash impossible. Here then was the long looked for solution.[51] If there were abuses, nobody was more anxious to know of them and of the remedies for them than the members of the Exchange; if indefensible conditions existed nobody stood readier to correct them. It was felt that this was the first and greatest step toward publicity under the right conditions, and that a valuable contribution to the popular knowledge of an intricate and greatly misunderstood subject would result. There was nothing ex-parte or one-sided about the committee’s deliberations; everybody with a grievance might state it, and both sides were accorded fair play. But, mirabile dictu, the very fact of its fairness is found, three years later, to afford a reason for flouting it at the hands of counsel for a congressional sub-committee that will not hear both sides! Is there anything just or equitable in the proceedings of such a body, or in the prejudiced emanations of its precious lawyer? Is it conceivable that the law-making branch of our government will give serious heed to a report thus conceived in bias and born in inquisition? I think not.

Passing to more agreeable topics, the late Addison Cammack is said to have remarked on one occasion that publicity was ruining the business of Wall Street and the Stock Exchange and would ultimately drive it all away. Those were the days of inadequate and unreliable balance sheets, of suppressed reports of earnings and assets, of accounts that were never subjected to independent audits, and of a general atmosphere of mystery that led to financial abuses of all kinds. As a result of those conditions there was created in the public mind another vague aversion toward the Stock Exchange, and a popular prejudice which has been hard to dispel. Cammack had been brought up in the old school; he saw what was coming, but he mistook causes for effects. He would probably turn in his grave could he see the new conditions and contrast them with the old. As a matter of fact nothing could be more democratic in principle than the way the business is conducted nowadays. The rights of stockholders to information, the reports and balance sheets submitted to them, the mass of Wall Street financial material in the magazines and journals, the stock ticker, the news ticker, the printed news bulletins, the card index system, the statistical manuals and the quotation lists published in the morning and evening newspapers, together with the market letters constantly circulated by brokerage houses, these are evidences that the public is entitled to full information and that many avenues by which it may safeguard its interests are always open.[52]

It has long been known that investors and speculators in America enjoy vastly more safety in their market operations through these various avenues of publicity than do investors and speculators abroad. There are no tickers worthy of the name across the water, and the daily list of business done, as published in our newspapers, with bid and asked prices and total transactions in detail, is unheard of among all the Bourses of Europe. The eminent French economist, Paul Leroy-Beaulieu, speaks very earnestly of the superiority of our New York Stock Exchange system in this matter; he says the need for a similar method in France is “very urgent,” that the information thus spread broadcast is “very instructive,” that the pledge of publicity “is better assured in the United States than in any other country of the world,” and that an immediate reform along these lines is “absolutely necessary” in Paris in the interest of the public.[53]

This leads to another word of caution suggested by the fact that the public, despite what is done for it, does not always avail itself of these safeguards. Men buy worthless mining stocks without bothering to inquire into their bona fides. They put their savings into new and untried enterprises and they neither read the balance sheets nor attend the meetings. A thousand stockholders will attend a meeting in London and they will have their questions answered whether the majority in control likes it or not. In New York almost nobody attends these meetings. The stockholder’s right to information is absolute, but he does not go and get it, and so finally when something goes wrong he writes angry letters to the newspapers and damns both Wall Street and the Stock Exchange because he has been burned, although the fire escape and the extinguisher were always at his hand. “It is all very well” says the Wall Street Journal, “to talk about what the law, the newspaper press, and the Stock Exchange can do to protect the investor, but the investor himself can do more than all his protectors put together. His investment, however conservative and secure, carries responsibilities as well as privileges, and it is his duty to discharge the one in order to safeguard the other.”[54]

He must learn to make inquiries, to discriminate, to use his wits, to read mortgages, to study sinking funds and operating ratios. He must eschew the financial columns of questionable newspapers and confine his attention to those of established probity. He must not put all his investment eggs into one basket. The Stock Exchange cannot do all this for him, but it is always ready to help him, and the information he requires may be had for the asking.

In a recent public address the president of a great American railway sounded an encouraging note. “We railway men,” he said, “have been in a practical school, having taken a thorough course in working economics. We have learned that a railway can thrive only as a result of the prosperity of the community it serves, and that the best policy, from the viewpoint of permanent railway interests, is one of co-operative helpfulness.”[55] The New York Stock Exchange has learned the same lesson, in a similar school. As an institution it realizes that if it is to grow in prosperity the public must grow, and that as the public is attracted to investment and speculation by the soundness of the institution through which it deals so it requires and must receive full information and an assurance of fair play. “Co-operative helpfulness” is the only way. Members of the Exchange who become discouraged now and then must bear this in mind. In the face of every harassing annoyance they must never cease their work of keeping their house in order, and of inviting that portion of the public that is open-minded to lend a hand. Their labors resemble the task of Sisyphus; like him they must cultivate the spirit of “everlasting hope,” and when unworthy assailants seek to prejudice the popular mind, they must stand forth, give blow for blow, and never say die.

Pessimists may blind their eyes to the manifold evidences of material progress on every hand, but just as the workshop, the farm, the school, the hospital, and the bank, each supplies proof of continuing improvement, so also in its sphere of usefulness does the Stock Exchange. Within a few years, for example, it has rid itself of the unlisted department, and this may very properly be mentioned as a distinct progression. Under the old system a limited number of industrial corporations were permitted to obtain a market on the Exchange for their securities, although they furnished but few figures to the Listing Committee in return. This was a practice wholly at variance with the duty of the Exchange to protect the investor, since it practically assures him that corporations admitted to the Exchange have demonstrated their worth to the authorities. That character and countenance should be given to the so-called “unlisted department” was a mistake, and it has been abolished.

In this reform the Listing Committee accomplished a twofold blessing in setting the Exchange right with the public by ridding their institution of anything approaching the blind pools of early days and at the same time forcing certain wealthy corporations to abandon their policy of concealment or lose the privilege of the floor. Certainly if the country’s leading steel corporation can afford to take its 150,000 stockholders and its 250,000 employees into its confidence and treat the whole public, including its competitors, with entire frankness, there is no insuperable difficulty about the others. In any case the desire to protect the investor, which is the controlling motive of the elaborate restrictions imposed by French and English laws in new security offerings, has advanced far in this country within the last few years, and the farther it goes the more popular it becomes.

That there is still work for the Listing Committee to do goes without saying. One of the most promising improvements that comes to mind at the moment is the one employed in London, where shares of new companies are not admitted to the Board unless a sufficiently large allotment has been made to the public. This is also the rule in New York, but perhaps we may add to its effectiveness by increasing the size of the public allotments. Another praiseworthy feature of the London system is that which has to do with vendor’s shares, which are not listed until six months after the admission of the company’s securities. Under this plan if one or more individuals secure a block of stock in payment for properties in the concern, they are prevented from unloading those shares on the public until a sufficient time has elapsed to determine the merit of the property.

Another instance of progress made in recent years in the internal mechanism of the Exchange, is the abolition of fictitious transactions or “wash sales,” utterly indefensible transactions not enforceable at law. These were always prohibited under the rules, yet despite this a flagrant instance of a violation was discovered in which the guilty were made to suffer. So far as I am aware it was the only case on record in which obvious collusion between buyer and seller in a Stock Exchange transaction was shown. The broker in this instance must have known that the Committee would demand his books and that it would appear that no genuine bargain had taken place. If he did not know it, he knows it now. The example made of him will, I fancy, prevent a recurrence of the episode.

This leads to the subject of “manipulation,” as it is termed, or the uses to which the facilities of the Exchange are sometimes put to give certain stocks an appearance of activity out of proportion to their normal movement. Now we must assume as our major premise in discussing this matter that any artificial interference with the natural operation of supply and demand is pernicious; from the standpoint of economics it is harmful. The Stock Exchange has nothing to conceal, and it recognizes not only that manipulation exists, but that at times it assumes the proportions of a real evil. Therefore it is doing what it can to stop it, and it will continue to do so. Whenever unwonted activity arises nowadays in a security long dormant, as happened very recently in the stock of a certain gas company, the governors of the Exchange entrusted with such things take the matter in hand and put a stop to it if obvious manipulation can be shown after investigation. The public and the newspapers know nothing about it; the vial of their criticism is poured forth only when something escapes the watchful eye of the Exchange authorities, as must inevitably happen now and then. But if these critics could know how indignant the members of the Exchange became when the Hocking Coal episode occurred, and if they could see the resolute determination of all hands to prevent another such occurrence, they would at least give the Exchange credit for faithfully attempting to suppress manipulation of the flagrant sort.

The fact is that all forms of manipulation are by no means improper; some of it performs a useful service and is a necessary and legitimate part of the functions of the Exchange. To understand how true this is let us consider, for example, the case of a corporation that has been organized, let us say, to develop a group of recently discovered coal properties in new territory. This is legitimate endeavor as applied to American enterprise; in a broad sense it is the spirit of adventure and speculation that has made our country commercially rich and powerful.

Now, in order to develop this enterprise, it is necessary to ask the public to buy its shares or its certificates of debt and thus become partners in the undertaking. In that way our great railways were built and our Western country opened to progress. But the public will not support the new enterprise until it knows something of its merits, and accordingly the company introduces its property through the medium of that great central market-place—the Stock Exchange—furnishing the Exchange authorities with its credentials in minute detail.

At this point the so-called manipulation takes place. The securities are new, the company may wish to advertise them, attract attention to them, and solicit a public interest in the laudable enterprise that lies behind them, all of which is as right and proper as it is for any merchant to establish a market for any new article on his shelves. To accomplish his purpose the merchant must first fix an arbitrary price; if the public will not buy at that price he must “manipulate” a lower price, and in all his subsequent dealings there must be manipulation of one form or another designed to conform to the supply and demand in that particular article.

The men behind the coal company in question must do the same thing. They fix a price at which their shares are introduced in the market-place; let us say this price is $100 per share. This is manipulation. It may happen that the public will not buy at that price, in which case the price is lowered, let us say, to 80. This also is manipulation. But is it improper? Is it subversive of good morals? Is it an unhealthy interference with natural laws of supply and demand? Is it anything less than a legitimate method of attracting capital into worthy enterprises?

Critics are invited to remember that the Stock Exchange does not buy or sell anything; it merely acts as a market-place through which, among other things, capital may be directed from channels where it is least needed into those where it may be most beneficially and profitably employed. If, therefore, an oil company or a coal company or any other enterprise whose ultimate success cannot fail to enrich the community seeks to market its wares—i. e., its securities—and thereby enable itself to do business, where else is it to turn save to the Stock Exchange, and how is it to fix an attractive market price at the outset save by what is termed manipulation? Nobody is compelled to buy; as for selling, any holder of 100 shares or any other number of shares can sell them at will, and no amount of manipulation can prevent him from a free exercise of this privilege. You may depend upon it, Mr. Critic, that the Stock Exchange will take pains to suppress all forms of manipulation that are unsound and harmful, but until you or some other gifted student of economics can devise a method by which capital may be attracted to excellent channels other than through the medium of an Exchange, manipulation of the sort just described must continue or enterprise must stop. Strike out the word “manipulation,” and substitute “establishment of values” in transactions of this sort, and the practice seems to become, as it really is, in keeping with the finest traditions of the market-place.[56]

It is a difficult matter for the Stock Exchange authorities to suppress all forms of manipulation that are plainly and admittedly improper. Such things do exist; the difficulty is in devising ways and means of preventing them. Mr. Smith, a non-member of the Exchange, may be interested in a certain security to which he wishes to give an appearance of activity. He calls Brown, a stockbroker, and instructs him to buy 5000 shares “at the market.” Then he telephones Jones, another stockbroker, to sell 5000 shares. Brown and Jones are each in ignorance of the other’s order, but they meet in the crowd where this stock is dealt in, and their orders combine to give the market an appearance of animation. The governors are as determined to stop this sort of thing as the most energetic critic could wish; they send for the two brokers and the facts are revealed. But as each was entirely innocent of wrongdoing, and as no rule of the Exchange and no law of the land has been violated, what is to be done?

They may caution both brokers against accepting any more business from Smith, but Smith is not a member of the Exchange, and hence he is not amenable to its discipline. When his next orders are refused he gives them to some one else, and if the entire Stock Exchange refused to accept business from him he would and could with perfect propriety ask his bank, or a trust company, or an individual to give out the orders under their own names. Finally, if the Exchange authorities were so sagacious as to be able to close to this man every conceivable avenue by which he might approach the Stock Exchange in New York, there would still be left open to him the market in Boston, or Montreal, or London, or any other centre in which the security was listed, and the pernicious effect of his manipulation in these cities would be felt in New York just as promptly and just as harmfully as if they had originated here. I mention this case, a purely hypothetical one, to show how easy it is for manipulation of this sort to find employment, despite all that may be done to suppress it. Perhaps somewhere in the noble army of critics there may be one who can devise a means of meeting this issue. If so, let him stand forth and speak. The Stock Exchange, root, stock, and branch, will be glad to hear from him.[57]

Counsel for the Congressional Committee that is in session as these lines are written seeks to raise another dreadful ghost with which to frighten ignorant people in his alleged “discovery” that a great part of the business done on the Stock Exchange is speculation. He parades through the newspapers the fact that the number of shares bought and sold often largely exceeds the number transferred on the companies’ books. In a chapter on “The Uses and Abuses of Speculation,” I have attempted to show that the more speculators there are in a market, the better and safer the market, and I rest this dictum on the authority of every student of modern markets. In this connection let us consider the opinion of a thoughtful newspaper writer. “There is no doubt,” he says, “that the committee will find that there is speculation in Wall Street, just as there is speculation elsewhere, and in commodities other than in stocks and bonds. The instinct has always been a pronounced human characteristic, being a part of human progress, and the manifestation of it is one sign of the difference between man and the lower sorts of creatures. It is doubtful whether the general gambling impulse can be entirely wiped out, even if the mighty power of an act of Congress be called into requisition. If Mr. Pujo and his committee can abolish speculation in Wall Street (to say nothing of gambling, which is not the same thing), they may be asked to abolish every commodity market throughout the land, for there is plentiful speculation in all of them.

“What seems to bother some representatives of the Pujo Committee is that the number of shares traded in on the Stock Exchange exceeds largely the number actually transferred. It is true, for example, that the number of shares of United States Steel common sold during last year were largely in excess of the number of shares outstanding, the sales amounting to 31,266,208 shares, while the entire number outstanding was only 5,084,952. The ratio of six to one suggests healthy activity in the market for steel stocks. It is conceivable that a block of stocks may pass through many hands before it arrives at its ultimate owner, just as a crop of potatoes passes through a long chain of handlers and buyers and dealers before it reaches the ultimate consumer. Meantime, the number of potatoes has neither increased nor diminished.

“But the potato crop, which easily changes hands six times in a year, is finally eaten. The stocks go on forever. The legitimate holder is not injured if they change hands not six, but sixty times, provided he is secured by proper publicity, which the Stock Exchange assures. The free speculative market is in itself an element of value, and if it were destroyed the investor would be chiefly injured, while future capitalization for the development of the country would be paralyzed.”[58]

At the outset I began by cautioning the reader not to cry out in alarm over the utterances of newspaper statesmen bent on justifying their existence, and determined to make the punishment fit the crime. Stocks will always be bought and sold, they will pass from hand to hand just as horses are traded and lands are exchanged. The modest dollar, too, will continue to pass from pocket to pocket, having a thousand owners and performing a thousand functions many of which may alarm a timid and unsuspecting lawmaker, but which to you and me may seem natural enough.

When you read that a great Congressman is determined to put the Steel corporation into bankruptcy and throw its 250,000 employees out of business, depend upon it he is only trying to justify his job for the benefit of this constituents. When somebody else seeks to mend his fences by the noisy announcement that the Stock Exchange reeks with improper manipulation, that speculation is wrongful, and that the criminal nature of an institution is directly proportionate to its size, remember that the votes of your fellow-citizens put this man in office and that you and they must foot the bill, since it is your money that pays for all these junkets, all these investigations, and all these political excursions. More than that, you must pay your share of the $160,000,000 for pensions, of the $40,000,000 for post-offices, and of the countless millions for rivers and harbors, and these, too, are voted with amiable frugality by the gentlemen who see nightmares in banks, Clearing Houses, and Stock Exchanges.

Finally, try to investigate and study all these matters for yourself. Read the men who have spent their lives in the study of economics. Compare the results attained by our great financial institutions with those reached in similar lines abroad. In the particular application of these studies to the New York Stock Exchange, you will find that charges such as we have been considering could be brought against any institution that has stood the test of time and made the mistakes that fallible human beings must make. You will find that if changes and improvements seem to come about slowly it is not because of the unwillingness of the Exchange to remedy these conditions, but because of the gravity and deliberation with which they must be considered in the light of the future as well as the present.

The management and control of a great public business, especially one that has long survived public criticism, is no light matter. It requires more than common industry, and more than common ability. What the Stock Exchange asks of you and of every thoughtful citizen in the land is a recognition of these matters, and a patient survey of all that enters into them. The critic in “The Vicar of Wakefield” laid it down as a good rule that you should always say the picture would have been a better one if the artist had taken more time. Criticism offered in this spirit the members of the Stock Exchange can bear with good humor. What hurts them on the raw is the critic’s failure to study and investigate, or, getting back to the text of Mr. Bryce’s sermon, “the neglect to think.”

CHAPTER VI
PANICS, AND THE CRISIS OF 1907

A panic is a state of mind. It cannot be regulated by statute law nor preached down by press or pulpit. At such times, suspicion, apprehension, and alarm take possession; reflection and sobriety are crowded out; men do and say irrational and unreasoning things; incidents trifling in themselves are exaggerated into undue proportions; all kinds of difficulties are conjured into the imagination. The best that can be said of such a phenomenon is that it is of brief duration.[59]

In Wall Street, where men are accustomed to looking forward at all times, the question is ever in mind as to the next panic. The last one left its sting; we are interested now in knowing about the future. Have we learned how to avoid these difficulties? May we hope to diminish their force and mitigate their terrors? May we rely upon the superior organization of business and the greater quantity and quality of capital to soften the effect of the next shock? I think not. We may lull ourselves into a coma of fancied security as we reflect upon experience and its expensive lessons, but we deceive ourselves if we think that we shall finally arrive at a point where these convulsions shall cease.

Nothing of that sort can come about among people strong with health and vigor, confident and full of energy, and impatient for action. With such a people life is incessantly mobile; a constantly increasing volume of creative activity impels them onward. Panics are unknown in dead countries and in countries that have not yet heard the call of progress; in all other countries the violence of these shocks is directly proportionate to the enterprise of the people. The more civilization there is, the greater the creation of wealth; the more wealth there is, the greater the volume of speculation that creates wealth. In such circumstances it is idle to talk of a time when panics shall cease, because confidence and enterprise must ever push onward, speculation in material things must accompany them, supply must overtake demand, and human nature with its moods and caprices must finally pay toll.

Vast industrial, commercial, and credit expansions lie somewhere ahead, and somewhere ahead excesses and indiscretions the world over must play their part and exact their penalties. We should cease to be surprised at these vicissitudes, for, “paradoxical as it may seem, the riches of nations can be measured by the violence of the crises which they experience.”[60] Moreover, panics are rarely such unmitigated calamities as they are pictured by those who experience them. At least they serve to place automatic checks upon extravagance and inflation, restoring prices to proper levels and chastening the spirit of over-optimism. In a world of swift changes they are soon forgotten.

We may seem to be prepared for these periodic set-backs, and there may be men amongst us of sober reflection who are really wise enough to foresee the top to a normal movement, yet the accidents that have happened will happen again,—bad harvests, war, sudden failures, earthquakes,—these are not easily discerned in advance. Sanguine and ardent merchants will make the same old mistakes; good times will engender the same old hallucinations; people who see, or think they see, wealth being created all around them, will always rush in and buy at the top; there will be too much work for the dollar to do—and after that the deluge. Finally, in order that we may not become pessimists, let us remember the words of the greatest of American philosophers: “The changes that break up at short intervals the prosperity of man are but advertisements of a nature whose law is growth.”

Another phenomenon quite as curious as that of panics, and one that is similarly psychological, is the unhesitating, slam-bang zeal with which we place the responsibility for these misfortunes on the shoulders of others. We, as a people, have brought the disaster upon ourselves by reason of our indiscretions. We have lost our heads and entangled ourselves in a mesh of follies. But we do not admit such reproaches, even in our communings with self. Not at all. The fault lies elsewhere, and it is balm to our bruises to place it elsewhere with indignant energy. It will not do to preach at such times about currency systems, laws of supply and demand and kindred generalities, for these are abstract and vague to a mind inflamed by losses. What such a man wants is a head to hit; something concrete, a target for his exploding wrath. And he never hesitates. He says Wall Street did it. His fathers said the same thing, and his children will follow suit.

Now here is a strange thing. After a man has said, “Wall Street did it” over and over again, he believes it, just as he believes or takes for granted a similar tedious reiteration by the humble katydid. To such a man, the thing he wants to believe, when stated over and over again, comes by repetition to fix itself in the mind as a demonstrated truth, notwithstanding an utter absence of proof or of reasoning. He says “Wall Street,” or “the Stock Exchange,” until he can think of nothing else. It is a catch-phrase, short and sweet, which he hammers home to his own ineffable satisfaction, and he thinks it and broods over it to his heart’s content. The politician then comes along with his cures for all the ills of society, and, finding Wall Street a convenient means of perpetuating his accidental notoriety, his voice joins the harmony. The indictment is then complete.

Take the panic of 1907 as the last and most conspicuous example. The financial losses involved, and the extent of the disturbance of the machinery of credit, made it the worst panic of this generation. As it burst upon the country at a period when to the outward eye prosperity reigned throughout the land, men were at a loss to explain it. They could not understand how such appalling conditions could occur in such apparently cheerful surroundings. As everybody was affected by it in greater or less degree the whole country was full of people with a grievance. They were themselves directly to blame for it, but they looked elsewhere for the responsibility for their folly.

That sinister influences were at work was, in the popular mind, undeniable; and by that same token we are pretty close to “Wall Street” when we talk of things sinister. At about that time a member of Congress made a speech in which he asserted, with all the art of katydid repetition so dear to the heart of the true believer, that the Stock Exchange was the cause of the panic. Rich men broke the market and “held the bag,” he said, while panic-stricken owners of property poured the invested savings of a lifetime into that capacious receptacle. Nothing could be simpler. Newspapers must print such things, and the public found what it wanted on the first page. Even to-day, five years after the fact, this delightful explanation of the 1907 panic blossoms like the rose as a political campaign progresses. The voice of the hustings “knows its business.”

Mr. John Burroughs warns us that it is one thing to treat your facts with imagination, but quite another thing to imagine your facts. Sufficient time has elapsed since 1907 to soften, somewhat, the bias and prejudice created by the events of that year, and perhaps there may be among us minds open to reason. The New York Stock Exchange feels, honestly, that a great injustice was done it by the criticism and abuse so generously poured out in the first shock of that event. Far from causing the crisis, its members assert that the institution fulfilled one of its most useful functions in giving ample warning of its approach, and that, when those warnings were disregarded, it concentrated all its machinery on the task of restoring order from chaos. They speak feelingly when they say that never in its history has the Stock Exchange been called upon to deal with so great an emergency, and never has it demonstrated so admirably its fundamental purposes. When they make these statements they offer to prove them. Let us examine the proofs.

The panic of 1907 was not unlike many preceding financial disturbances. The opening months of the year had witnessed a general liquidation on the Stock Exchange, brought about naturally, and in simple, automatic compliance with economic laws and precedents. There had been over-expansion in all lines of business; careful students saw the portent; able men of power and influence heeded its warning and set corrective forces in motion months before the shock came. Total transactions in shares sold on the Stock Exchange had risen from 187 millions in 1904 to 284 millions in 1906, while the value of the securities thus sold increased from 12,061 to 23,393 millions of dollars respectively. This was too rapid growth, and the general liquidation that had been under way for months effectually corrected it, since New York City bank loans secured by Stock Exchange collateral declined, as shown by the Comptroller’s report, from $385,652,014 in August, 1905, to $251,867,158 in August, 1907—a corrective force represented by $133,784,856.

The Stock Exchange has been defined as “a barometer of future business conditions,” and never did a barometer give clearer warning. It said in effect to all the banks of the country and to business men generally: “There has been a widespread over-expansion of credit; it must stop; we are doing our share here in New York to correct it; you must do likewise.” And, in order that there might be no failure to understand what was meant, New York City bank loans were reduced with drastic emphasis, months before the panic came, by nearly 35 per cent. “Without an exception,” writes Prof. S. S. Huebner, “every business depression in this country has been discounted in our security markets from six months to two years before the depression became a reality.”[61] Senator Burton, another authority, emphasizes the point further: “In addition to other influences which promote an earlier rise and fall, there must be mentioned the more careful study and attention to the financial situation which is given by dealers in the stock markets and in great financial centres. They often forecast the grounds for a rise or fall in prices before the general public is awake to the situation.”[62] This, then, was the situation in the summer of 1907. The Stock Exchange had “cleaned house,” and had liquidated thoroughly, warning the country to go slow.

Why was not this warning heeded? I recall vividly the daily expression of surprise, on the floor of the Exchange, and throughout the financial district, in the months that elapsed between our March liquidation and the outbreak of the October panic, that the country should pay so little attention to “Wall Street’s” admonition; that it should continue its unprecedented boom despite the plain intimation that the funds to support it were exhausted, and despite the general knowledge of every tyro in business that future conditions are discounted in Wall Street as freely as promissory notes.

Had the business interests of the country so much as inquired into that warning they would have found by turning to the Comptroller’s reports of the loans of national banks for the entire country that such loans had expanded from $3,726 millions in 1904 to $4,679 millions in 1907. They would have seen that whereas the New York City banks contracted their loans by nearly $134,000,000 from August, 1905, to August, 1907, loans and discounts by the banks of the whole country in that period actually expanded $700,000,000. Surely it will not be urged that Wall Street or the Stock Exchange had anything to do with bringing about this expansion. On the contrary, it shows that speculation in commercial lines, in new enterprises, in lands and in all the various forms that “out-of-town” banks are expected to finance, went on and on in vastly increasing volume long after the danger signal had been hoisted on the Stock Exchange, and in utter disregard of the warnings those signals conveyed.[63]

As the summer of 1907 advanced, speculation throughout the country continued in rapidly increasing volume, while on the Stock Exchange there was an almost complete cessation of activity. Business men of the West and South seemed to feel that as there had been no serious failures, and as the decline in the stock market had restored values to an attractively low basis, there would be a normal recovery similar to that which followed the panic of 1893. They felt that the trouble, whatever it was, had now been corrected, and in this fancied security they went about with further expansion of their business enterprises, confident that no serious difficulties were in store. The Stock Exchange was often cynically referred to in that period as “the only blue spot on the map.” Its members were cheerfully invited by a Western newspaper to “shake off their torpor and join the Sunshine movement.”

It is only fair to say that there was some force in the buoyant if superficial viewpoint of the country at large, for in the autumn of 1907 we were blessed with all the kindly fruits of the earth in abundance. The average crop of our agricultural products gathered that year was enormous, and behind it lay large reserves of wealth that had accumulated from a series of good crops in the years just preceding. There was, moreover, a partial failure of foreign crops that brought about heavy foreign requirements, thus assuring rich returns to American producers. Our railroads, which in the previous panic of 1893 were so affected by declining traffic and by the unproductiveness of new territory into which they had ventured that bankruptcies became general, were early in 1907 in better physical condition than ever before. Their gross earnings were at a maximum; their surpluses fat with the profits of recent years; their credit high. A long accumulation of foreign-trade balances had made the inherent strength of the nation greater than ever before. Finally there was the great essential difference between 1907 and former years in that we were now, by statute law as well as in fact, on a gold-standard basis.

And yet, without one unsound basic factor visible to superficial observers, we were suddenly plunged into a grave disaster—a panic which in actual money losses surpassed any of its predecessors. It came, this cataclysm (as the Stock Exchange had vainly predicted six months earlier), at the worst time it could possibly come, just when the banks were called upon to furnish $200,000,000 to transport and market the crops. Small wonder that in the face of such an optimistic outlook men stood aghast at the violence of the panic. As they had not understood the warning, so they could not understand its swift fulfilment. In all the long processions of panic-stricken people who stood in line at the banks in those trying days, not one in a hundred could understand how an institution could be solvent and yet be forced to suspend. Later on, smarting from losses, this bewilderment gave way to distrust and suspicion, as is often the case, humanly speaking, when men look elsewhere than to their own folly for the sources of their misfortunes. They were in a receptive mood when the charge was made that “Wall Street and the Stock Exchange” had brought about all this misery; they believed it to be true, and many still believe it.

The charge was so widely circulated and was fraught with such possibilities of mischief that there was danger of ill-considered legislation directed against the Stock Exchange and supported by ill-advised public opinion. Thus it happened that Governor Hughes of New York, doubtless moved to forestall hasty law-making, appointed a committee to investigate the Stock Exchange. In another chapter we have reviewed the work of this commission; meantime, the words of its chairman are quoted, in passing, as a sort of ex post facto reply to the outcry that “Wall Street did it.”

“The immediate cause of the panic,” he says, “was a simultaneous rush to sell securities, by holders who perceived that there was trouble in the money market, and who wanted cash to meet maturing obligations. These holders were not Wall Street men merely, but people in all parts of the country who had invested some of their savings in stocks and bonds. The very raison d’être of the Stock Exchange is to supply a market where invested capital can be quickly turned into cash, and vice versa. The remoter cause of the panic was a long course of speculation in all kinds of property, real and personal, that had pervaded all parts of the country, and many parts of the Old World, and had now reached its climax.” Mr. White here adds in a footnote that it has been “shown conclusively that speculation on the Stock Exchange was not the chief contributor to the collapse of 1907, but that speculation on a much wider scale, through the length and breadth of the land, was the exciting cause.”[64]

I have said it was not surprising that the public failed to observe signs of disturbance in the happy conditions that seemed to prevail before the panic. The blindness of the mass of the people to these impending catastrophes is, indeed, a marked characteristic of all similar epochs. Let us digress for a moment and consider the history of other great disturbances. In 1825 the King’s Speech as read by the Lord Chancellor dwells on “that general and increasing prosperity ... which, by the blessing of Providence, continues to pervade every part of the Kingdom.” This was in July; in December of that year the whole country was torn by a devastating financial crisis. The London Economist, in 1873, dwelt at length on the “astounding” progress of the Austrian States, and said, “All over the rich countries of the Danube, capital and labor are vigorously at work in the discovering and turning to profit the amazing resources which have been lying unheeded for centuries.” This was written in March; the Bourse at Vienna closed its doors May 9th, and a panic of exceptional severity was followed by long and continued depression. On December 31, 1892, R. G. Dun & Company’s Weekly Review of Trade said: “The most prosperous year ever known in business closes to-day with strongly favorable indications for the future,” and yet four months later the storm burst.[65]

These instances go to show how the elect may err in estimating conditions, despite the fact that in two of these three memorable crises ample warnings of an impending catastrophe were proclaimed in the stock market long before these prophecies of continued expansion were printed. In each instance the portent was ignored; in each the ultimate penalty was paid. So it was in our own great crisis of 1907, and so it will always be.

There was a panic throughout the United Kingdom in April and October of 1847, yet the early response to changing conditions took place two years before, when stocks began to fail in July and August, 1845. In the year 1857 commerce and industry expanded throughout America in increasing volume up to the very eve of the August crisis, yet the stock market in the summer of the preceding year gave clear warning of what was to occur. One year before the panic of 1873 a similar “slump” foretold what was coming, and the same was true of the year preceding the panic of ’93.[66] Previous to the last-mentioned crisis stocks began to fall, with unmistakable emphasis, early in 1892. Of seventeen of the most active, five reached their maximum price in January, 1892, three in February, four in March, two—Lake Shore and Michigan Central—in April. And as we have seen, identical preliminary warnings developed on the Stock Exchange from one year to six months before the last great panic of 1907.[67]

The panic that hit the Paris Bourse in October, 1912, causing a disturbance not equaled in violence since 1870, was brought about by sowing the wind through an immense public speculation based on two fine harvests in Russia and a feverish revival of commercial and industrial activity all over Europe. Up to this point all the indicia of the movement—such as bank loans, building operations, public and private extravagance, and a blind infatuation for speculation by a normally prudent nation that had not speculated on a large scale since the Panama débacle of 1894—corresponds exactly with conditions in America just preceding the 1907 crisis. The similarity between the two incidents goes even farther, for early in September of 1912 the French bankers and Agents de Change, recognizing the strained condition of credit, had deliberately put in motion corrective agencies designed to stop the rise with the least possible derangement of confidence.

They would have succeeded, no doubt, and the situation would have exactly paralleled our own discounting processes of March, 1907, but for the unforeseen Balkan difficulty which, coming out of a clear sky, upset the plans of the conservative financial forces and precipitated a panic. It came, as a French banker explained, a week too soon—by which he meant that, given a little more time, the worst phases of the disturbance would have been avoided through gradual and orderly liquidation. As it stands, the panic will no doubt go down into French financial history as “the Balkan panic,” just as our disturbance of 1907 is ascribed, faute de mieux, to Wall Street wickedness; but in reality both the French and American crises had their origin in precisely similar causes. The Balkan news in Paris only precipitated what the French Bourse had planned to accomplish in an orderly manner, just as Wall Street and the Stock Exchange had done five years earlier in a similar emergency. The essential lesson of both instances is that the same causes which generate prosperity will, if pushed far, generate an equivalent adversity.

The details of the panic of 1907 are still fresh in mind, and need be but briefly referred to. Banks and trust companies closed their doors and suspended payments to depositors. Cash and credit became almost unobtainable; we were face to face with demoralization. Clearing-house certificates were resorted to at practically all banking centres throughout the country; there was a general requirement of time notices for withdrawal of savings bank deposits; all normal credit instruments were impaired. The Secretary of the Treasury was forced to exercise heroic discretion in the matter of security for government deposits and for the very necessary increase of a note circulation that was then suffering from a spasm of contraction. There was an immense hoarding of funds and a consequent drying up of fluid capital, while from one end of the country to the other, there was liquidation, business contraction, retrenchment, panic, and ruin. “Wall Street” and the Stock Exchange had foreseen that the chain was only as strong as its weakest link, and had done what it could to prepare the public for the break. To assert at this late day that it did aught but its full duty is humbug in excelsis.

I have already cited one instance, the country’s expanding bank loans as contrasted with “Wall Street’s” contraction, to show how plainly the warning was conveyed. As another instance, take the immobilization of capital tied up in the enormous real-estate speculation then prevalent. In New York City alone the increase in mortgages recorded jumped from 455 millions in 1904 to 755 millions in 1905, an increase over the previous years of 32.7 per cent, and 66 per cent, respectively.[68] The figures showing the increase in building permits are similarly significant, revealing the fact that in 1905, 1906, and the early months of 1907, money was pouring into new construction at a rate without precedent. In Greater New York alone, not including Queens County, building permits granted in 1904 amounted to $153,300,000, and in 1905 to $229,500,000, and in the face of disaster this rate of increase continued up to the very eve of the panic.[69]

Outside of New York the expansion in building operations was equally rapid and equally ominous, showing an increase in twenty-five cities alone from $201,300,000 in 1903 to $234,200,000 in 1904, to $280,400,000 in 1905 and to $307,800,000 in 1906—all this but a small part of the actual funds thus locked up throughout the whole country.[70] We thus find that one of the most important and inevitable causes of the panic was the absorption of exceptionally large amounts of capital in enterprises that required a considerable time for completion, or which, when completed, were not immediately profitable; and to them may be added factories and extensive public and private works of every kind. This form of expansion, as Senator Burton points out, when carried to extremes almost invariably brings about a disturbance.

Now let us consider. Does all this expansion of bank loans outside of New York and all this tremendous increase of building operations show that the Samsons of “Wall Street” were pulling down the temple on their own heads in order to slaughter the Philistines, as alleged, or does it show an indifference and lack of readjustment to the growing stringency of money, as revealed by the Stock Exchange in its liquidation of March and April? “As a rule,” said John Mill, “panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.”[71] There would have been no such “betrayal” had judicious reflection and a measurement of facts followed Wall Street’s warnings.

A shrewd man, one of the old school of New York City wholesale merchants, who has nothing whatever to do with Wall Street or the Stock Exchange, yet whose trade arteries extend to many parts of the country, has long governed his business by the published reports of Stock Exchange transactions. If he sees there revealed a wholesome, normal, and conservative expansion in all lines of business and a money market that betrays no uneasiness as to the future, he presses on into new lines of endeavor, confident that the immediate future is serene. If he finds an urgent liquidation on ’Change, with the coincident phenomena of impaired credit instruments, he draws in his lines and waits. It makes no difference to him who is rocking the boat, nor why; experience has taught him that if it rocks, the time has arrived to go ashore. And this steady old merchant, I have no doubt, is but one of a numerous type.

Those who ignore the economic tides that ebb and flow through the medium of the Stock Exchange as they did in 1907, do so because they do not understand that these great market movements are really but expressions of natural laws. If there is a rising tide—a boom—it is attributed by thoughtless people to speculation and gambling. If there is a bad break, it is caused by panic-stricken repentant sinners, or by the activities of the bears. The essential point that is missed here lies in the fact that, while bulls and bears alike may have their brief hour, sooner or later, regardless of them, the market responds to actual conditions and discounts the future of those conditions.

Booms are not made on the Stock Exchange; they are made in the country’s fields and forests and workshops. Panics are not created there; they have their origin in mistakes and excesses throughout the world, and in psychologic conditions which stock markets cannot hope to control. The pendulum may swing far, but it comes back. Sooner or later the movement of prices tells the exact story of future business, and of credit, and of all the economic agencies that enter into them. This was not well understood in 1907, and, as I said at the beginning, I doubt if it will ever be understood in the sense that it will avoid a recurrence of panics. All that we may hope for is that periods of depression, which are inevitable, may not be attended in future by such a loss of the reasoning faculties as that which brought about the affair of 1907.

Now let us consider another cause of the panic—the currency system, always bearing in mind the fact that the first and greatest cause of the panic was the over-expansion outside of New York that has just been described. The causes which we are now to consider were of minor importance when measured by this overshadowing matter; nevertheless they played their part and must be considered accordingly.

Not all panics, to be sure, can be prevented by a perfect currency system, yet this one could have been measurably prevented, and “Wall Street” and the Stock Exchange had labored for years so to prevent it. At the gatherings of the Chamber of Commerce, at the bank meetings, at all the meetings of merchants and manufacturers for years preceding 1907, the mischievous effects of our currency system were proclaimed and the ultimate outcome predicted. Congress was petitioned again and again to remedy those intolerable conditions, and to permit national banks to expand their circulation under proper safeguards, but without avail.

When the storm burst, a most impressive object lesson in practical finance resulted. What was at worst but a normal stringency of the circulating medium developed, when added to abnormal demands from the country at large, into conditions that created great alarm. There was no way by which the banks of the country could use the resources which they actually possessed to meet the urgent requirements of the hour. A great nation of enterprising people found itself—and still finds itself—compelled to do a banking business differing in degree, but not in kind, from the old-woman-and-her-stocking system of finance. The way our bankers got down on their knees to London and Paris in that emergency, frankly admitting their inability, under our old flint-lock laws, to handle a situation which foreign bankers meet without difficulty, is a subject at once painful and humiliating. Literally our bankers begged for help and got it. Some day we shall have to beg again.

Had the national banks of New York City enjoyed the right to expand their circulation in the manner provided by the plan of the American Bankers’ Association, at least a part of the débacle would have been avoided. “The banks and trust companies of this city have in their vaults the largest store of good credit that can be found in any city in the world,” said one of America’s foremost economists as the panic raged, “but much of it is utterly unavailable because of our currency system. One of the trust companies that closed its doors has in its possession live assets amounting to over $50,000,000. All this credit is dead. It cannot do the work of a single dollar in the paying-teller’s cage. What is wanted in a time like this is freedom to convert the credit of banks into a medium of payment that will satisfy the people.”[72]

True enough, and just what the whole financial community, including the Stock Exchange, had been repeating for years. Currency issues which do not provide for all situations, including not only ordinary demands, but also such exceptional cases of shrinkage as this one was, can never be called perfect, nor even safe. There is no health in them.[73] The most effective and the most rapid means of regulating and protecting the general credit situation is by increasing or diminishing the volume of outstanding bank-note currency not covered by a reserve of gold or other lawful money. This method is employed successfully both in France and in Germany. The Bank of France and the Imperial Bank of Germany to some extent regulate credit conditions by acting as central banks of discount; but their most effective action is by increasing or diminishing the uncovered amount of their outstanding notes. When additional currency is needed as a circulating medium they supply this currency by issuing notes. When contraction of currency, or a check upon the further expansion of bank credits is desirable, they accomplish the result by diminishing the volume of their outstanding notes and by raising the discount rate. This system is as nearly perfect as any yet devised.[74]

Whether we shall ever succeed in adopting it, or something like it, in America, is the burning question in our banking offices to-day. Until something is done, the layman who distrusts the plan of a central bank and looks upon Wall Street with abhorrence, may find satisfaction in knowing that the average New York banker is the most worried and harassed man in American business life. With millions of other people’s money in his possession subject to withdrawal by check at sight, and with millions of the best security in the world in his vaults lying absolutely idle and worthless so far as raising currency is concerned, he stands between the devil and the deep-blue sea. Anything that frightens his depositors, or even remotely suggests panic, gives him a cold chill. People who talk of manipulation by New York bankers as a cause of the panic of 1907 or any other panic are blind to the fact that any disturbance of normal conditions is the one thing that bankers would avoid as they would avoid the plague.

There was a third cause of the panic in the course pursued by the President. In some quarters it is still termed “the Roosevelt panic,” and there exists a belief that the President by his actions and speeches played a large part in bringing about the crisis. Personally, I feel that this has been exaggerated. There had been, unquestionably, wrongdoing by certain corporation managers. The President, with a characteristic vigor not unknown to politicians, seized upon it as a theme for his speeches, and the “evils,” the “malefactors,” the “corruption” and “dishonesty” with which he bruised the air, raised a suspicion in many quarters as to the status and security of the whole financial situation and undoubtedly contributed to the frightened liquidation of the day. The impression these utterances produced abroad, where American securities were popular, was painful, and led one returning tourist to remark that Europe was acquiring the idea that we were “a nation of swindlers.”

All panics are largely psychological, and this was no exception. The President’s public speeches came at a time when emotion, apprehension, and alarm filled men’s minds; and at a time when those irrational moods were most likely to exaggerate the difficulties that existed, and to conjure up difficulties that did not exist. Panics seem to come from lack of money, the real difficulty is lack of confidence, and it was to this that the President’s course directly contributed.

I am of the opinion that, judged by his public utterances, especially his October speech at Nashville, Tenn., the President had not the remotest idea that such an awful shock as the panic of 1907 was imminent. He was not a student of economic conditions; he had no familiarity with crisis-producing phenomena; he had never seen a panic at close quarters. His speeches did not cause the panic, for that disturbance was foreordained; they served, however, to hasten it, to intensify it, and to keep it alive. Perhaps I may add that the sparks beaten by him from the anvil of political expediency at that unfortunate moment threw more light upon the President himself than upon the evils he condemned. Perhaps, too, that was what the President most desired. In any case, the fact remains that just as there is too much confidence in times of excessive expansion, so there is too little in times of unreasoning depression; and that the President’s attitude aggravated the latter situations is undeniable.

But by what stretch of the imagination can the Stock Exchange be credited with playing any part in this third cause of the panic? If temporary depression results from exposure of wrongdoing among railroad, industrial, or financial institutions, nowhere in the land is execration poured forth upon the evil-doers more vigorously than within its four walls. Far from complaining, the Stock Exchange and the whole investment community welcome such exposures, despite their effect on the market, for the precise reason that their own protection and benefit, if nothing else, is promoted by it.

There was yet another reason for the panic, closely related to the attitude of the President. I refer to the predicament of the railways of the country as 1906 passed into 1907. Staggering under a load of traffic which sorely taxed their equipment, the managers of these properties cried aloud to the investing public for funds. But capital was not to be had. Tied up in real-estate speculation and in quarters whence it could not be easily recovered, the normal supply of capital was immobile and inert. What was worse, encouraged by the attitude of the President, an epidemic of radical anti-railroad legislation became manifest in the several States, new and onerous burdens of taxation were imposed, and a wave of distrust and suspicion regarding railway investments was created. Simultaneously the cost of wages and materials advanced—both characteristic phenomena indicating trouble—and, as a consequence of all this blockade, the ratio of net to gross in the matter of increased earnings fell from the normal proportion of about 40 per cent. in the first nine months of 1906, to less than 10 per cent. in the same months of 1907.

Railroads are public utilities that must continue to handle business offered them no matter what happens, and so, to meet all these abnormal demands, but one course was left open to them, and that was to raise funds by issues of new stock. This, of course, amounted practically to an assessment of stockholders; as an expedient it failed because “Wall Street” had already recognized the symptoms of disease. It was too late. Money and credit attract money and credit, and confidence attracts both. There was a shocking absence of confidence in the emergency of 1907, and the railroads suffered enormously by it.

With this matter certainly Wall Street had nothing to do; it could not in fact do more than it had just done in pointing out to the country at large, through a drastic process of liquidation, the obvious withdrawal of far-sighted investors from a situation that had become tense. Nor can the railroads be censured, because the great volume of business that confronted them was not created by them, and yet had to be transported by them. The fault lay, of course, in the wholesale and reckless expansion of all lines of industry, and in the immensely increased extravagance of public and private life.