Part 4

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

V

Political Influences, Crops, Etc.

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

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

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

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