Wesley Clair Mitchell: The Advent of U.S. And NBER Business Cycle Research

Abstract

Business cycles often begin with the work of Mr. Wesley Clair Mitchell, the first Director of Research at the National Bureau of Economic Research, NBER. Mr. Mitchell was elected the NBER

Business cycles often begin with the work of Mr. Wesley Clair Mitchell, the first Director of Research at the National Bureau of Economic Research, NBER. Mr. Mitchell was elected the NBER Director of Research on February 2, 1920, shortly after its chartering.¹ He held that position for over 25 years. In that capacity, Mr. Mitchell produced the first two NBER volumes of research on Business Cycles. In fact, prior to his NBER appointment, Mr. Mitchell had conducted extensive research on the history of the greenbacks, currency issued during the U.S. Civil War, and business cycles, producing several large monographs on these topics.²

Let us begin with Part III of Mr. Mitchell’s Business Cycles (1913) and review prosperity, crises, and depressions, his stages of economic activity. Mr. Mitchell wrote his book with an intended audience of businessmen. In this monograph, we stress money profits by business enterprises, as did Mr, Mitchell when he stated, “Since the quest of money profits is the controlling factor among the economic activities of men who live in a money economy, the whole discussion must center about the prospects of profits.”³

2.1 Mitchell’s Early Business Cycles Analysis: What Investors Needs to Know About the Cumulation of Prosperity

Mr. Mitchell began his discussion of business cycles with the revival of business activities between 1890 and 1910.⁴ U.S. revivals began with highly profitable grain harvests in 1891 and 1897 and a successful defense of the gold reserve standard in 1895. Depressions eventually create conditions for recovery, such as falling prime and supplemental costs of manufacturing commodities (inputs) and in inventory of wholesale and retail merchants, low rates of interest, and a liquidation of business debts. Falling costs and lower interest rates tend to widen profit margins and facilitate bank borrowing. Once started, a revival of economic activity spreads across most, if not all, of the business world. The industries producing the raw materials and supplemental supplies are the first industries stimulated. Transportation, railroads, and banking industries start to boom. Employees earn higher salaries and proprietors earn higher profits, enabling workers and owners to pay off debts incurred in depressions and expand their purchases. Better quality food is substituted for lesser quality eaten during depressions and clothing demand increases. Furniture, entertainment, and luxury items are purchased. Industries are stimulated as the revival expands across the economy. Optimism endues and loans are provided for business enterprise expansion. Optimism is reenforced by an increase in the volume of goods ordered.

Prices begin to rise, but tend to lag in the revival, and rising prices create a stronger incentive for obtaining larger supplies to sell at wider profit margins. Eager bidding allows suppliers to exact higher prices. Mr. Mitchell observed that (1) retail prices rose less than wholesale prices of the same commodities; (2) wholesale prices of finished goods lag behind the prices of partially manufactured goods in the same commodities; (3) wholesale consumer goods prices rose less than wholesale producers’ goods prices; and (4) wholesale prices of raw materials responded to changes in business conditions with greater accuracy and certainty than whole prices of raw farm or forest products⁵ Men control more completely the production of coal, iron, copper, and zinc more than the production of beef, pork, mutton, and wool to meet the increasing demand.

Workers traditionally think of making a living, rather than making money. The prices of labor rise less in a revival than wholesale commodity prices. Mitchell attributes some of the lag in wages to nonexistent or weak trade unions.⁶ Despite a lagging wage, working-class members are better off as business conditions improve. Interest rates lag in a revival. In fact, discount rates are usually lower in the first year of a revival than the rates were in the last year of a business depression. Bank loans increase in a revival and bankers often have liberal reserves. During a recovery from a depression, the ratio of capital liabilities to total liabilities falls due to depositors’ inflows.

The net effect of rising prices and lagging wages and interest costs are increased profits.⁷ Supplemental costs rise slowly with the physical volume of business. Wages, freight costs, prices of prime and supplemental rise slower than prices such that net profits rise with business volume. Profitability increases vary greatly across industries, due to relative differences in industry prime, supplemental, labor, and transportation cost ratios. Mitchell turns his attention to the stock market, and states plainly that the market price of a business enterprise rests primarily on the capitalized value of its current and prospective profits. That is, stock prices “vary roughly” with the rate of profits.⁸ In 1913, as Mitchell wrote his Business Cycles monograph, railroads were the one group of business enterprises with data existed on stock prices and profits.⁹ “Dividend smoothing” was noted in 1913 as Mr. Mitchell noted that dividends had been kept more stable than net income. Interest rates at which stock prices are capitalized are subject to variations. Further complications, known in 1913, included stock manipulation, speculation, and contests for control. Mr. Mitchell’s further observations included that low-priced stocks rose more than high-priced stocks; common stocks rose more than preferred stocks; and irregular dividend-paying stocks rose more rapidly than stable dividend-paying stocks.¹⁰ Business revival conditions lead to increases to business expansion in size and the creation of new enterprises. New investment never ceases entirely, but falls to very low level in a depression, and becomes large again after the recovery is well established. The creation of new enterprises increases demand for buildings, machinery, and furnishings, which further increases the demand for materials, labor, equipment, and loans. Increases in prices, volume of trade, and profits make optimists of entrepreneurs and every convert to optimism makes new converts, further favoring business expansion and further price increases. Workers now demand, and employers conceded to higher wages, resulting in higher family income that widens the market for consumer goods. Higher wages increase labor costs of retail and wholesale commodities. Interest rates rise for similar reasons and increase the cost of production. The increases in wages and interest rates are why prosperity does not continue indefinitely. Mr. Mitchell refers to prosperity as “The Business Equilibrium.”¹¹ It is the increasing costs of business that disrupt business equilibrium.

2.1.1 Mitchell’s Early Business Cycles Analysis: Prosperity Breeding Crisis

Prosperity is not maintained because of the slow but sure increases in business costs. Once firms reach full capacity of existing mines, factories, stores, and railroads, then new enterprises are built to accommodate additional orders. Rent, interest, depreciation, insurance, and office salaries, supplemental charges, increase. New construction of plants carries high interest costs. Businesses often close unprofitable goods production and rid themselves of unskillful management, antiquated equipment, and weak financial backers. The return of prosperity leads owners to reopen these enterprises and these reopening bid up the prices of labor and materials, which lessens the profitability of all well-equipped, located, financed, and managed firms. Prime costs increase in revival activities, labor, and materials. Full prosperity forces enterprises to hire more marginal talent, men too old, boys too young, or “trouble makers,” which reduce the efficiency of the work force (Mitchell, 1941, p. 32). Prosperity leads to the employment of the relatively inefficient reserve of labor and increased overtime of existing, and potentially tired labor, working from 8 to 12 hours a day. The quality of output declines and the quantity of damaged goods increases. Material costs rise and materials in 1900 constituted two-thirds of all total costs. Bank loan costs increased with the interest rate. The increasing labor, materials, and interest costs lessen profits.

The rising interest rates in prosperity create tension in the money market because the demand for short-term loans rises at a rapid rate. Prosperity and the quantity of gold in monetary use have an interesting relationship. The factors lessening the quantity of gold in prosperity include increases in the cost of gold mining supplies and lessens the efficiency of labor. More gold is used in jewelry than for coinage in prosperity. If prosperity increases imports more than exports, then gold may be exported to trading partners. The factors increasing the quantity of gold in prosperity include investors want speculative securities promising higher rates of returns and it is easier to raise cash for developing new mines. Prosperity encourages the sale of securities to foreign capitalists, which can offset the increase of imports on the balance of payments.¹² Mr. Mitchell notes only a slight correspondence between the average quantity of bank notes and fluctuations in business activity in the 1890 to 1910 time period.¹³ Selling prices cannot advance indefinitely because of an inadequate quantity of money.¹⁴ An increase in business initially causes a rise in profits which tax the productive capacity of existing industrial equipment. The expectations of future profits induce bidding for materials, labor, and loans, increasing business costs. The decrease in bank reserves makes banks less interested in expanding loans. Increases in costs lead to the diminished expectations of prospective profits, even as realized profits may be reaching their maximum level, and diminished profit expectations can turn prosperity into a crisis.¹⁵ An aggressive businessman may borrow on credit and use leverage (other people’s money) to engage in greater production and trade in prosperity. Rising profits enable greater use of credit. The increased interest rate reduced the capitalized value of current and future profits. Increasing interest rates reduce both bond and stock prices. Prosperity eventually turns to liquidation as expectations of future profits are reduced. When the demand for outstanding credit becomes the general phase of business, then prosperity turns into crisis.

2.1.2 Mitchell’s Early Business Cycles Analysis: Crisis

The conditions that created prosperity will lead to a downward revision of credits, creating a crisis, which begins liquidation. External events, such as wars, political disorders, the collapse of a large financial institution engaged in speculative behavior, crop failures, crisis in foreign countries, or uncertainty regarding the monetary standard can start the process of liquidation. Mr. Mitchell says that while there is no general rule concerning the conditions on which debtors are forced to pay off their debts begin, violent price fluctuations of important materials can threaten losses to merchants or manufacturers, and these trades are often the first trades to lose credit.¹⁶ Contractors providing industrial equipment are likely to be victims of debt payment demands as interest rates rise as the bond market becomes stringent. Banks may give notice to enterprises that their maturing debt will not be renewed or extended. The debtor must then raise funds, by seeking payment from his debtors or offer liberal inducements to settle accounts now yet due. The debtor may have to offer goods at “sale prices” or sell securities to raise the necessary cash. The debtor who successfully raises cash to pay off his debt and avoid bankruptcy may have forced his debtors, who paid him, into similar cash problems, injuring the market for other enterprises. An apprehensive creditor can be sufficient with a debtor in trouble may strengthen the movement toward liquidation. The start of liquidation can be difficult to stop. The demands for bank loans are increased not only by debtors being pushed for payments but also by enterprises to seek to build cash positions to meet future demands for their repayments of loans.

Banks may be reluctant to increase loans because their reserves were reduced by the preceding prosperity. Large reserves are maintained by banks for their prestige.¹⁷ The risk of bad debts increases with the demand for loans and banks holding the paper of bankrupt firms will suffer delays or loss on collections of these loans. The rising interest rates of prosperity give rise to possible liquidations as prospective profits fall and enterprise creditworthiness is questioned. The leading banks play a major role in whether rising interest rates that turn prosperity in a crisis will turn the crisis into a panic. Can banks maintain their reserves and mitigate the crisis by effective means of relief? The Panic of 1907 is a typical bank panic, brought on by bank failures. The U.S. had endured panics, indeed depressions, in 1893 and 1897. In months leading up to the panic of 1907, interest rates and uncertainty in the investment market caused a slackening of new construction. The demand for copper fell and its price fell from 26 cents a pound to only 20 cents a pound in July 1907. Subsequent price drops to the price of copper to 12 cents in October. Cooper mining stock prices fell substantially as a result of the copper price decline.¹⁸ A prominent capitalist, Mr. F.A. Heinze, organized a pool to bolster the price of the United Copper Company. Mr. Heinze was one of many large owners of copper stocks who used the securities as collateral for bank loans. On October 14th, the copper pool of investors drove the price of United Copper Company stock from 37 to 60, but the price increase was only temporary. By October 16th, the price of United Copper Company had fallen to 10. Gross & Kleeberg failed, alleging that Mr. Heinze’s brother did not take the stock purchased for his account. On October 17th, Otto, Heinze & Company trading was suspended.¹⁹ Mr. Heinze was President of the Mercantile National Bank, and he was thought to exercise “control” over its operations. He was suspected to have taken advantage of the price decline of copper to obtain large loans upon the security of the stocks that had fallen so great in value. Bank depositors became alarmed and began to withdraw their accounts. Close business associates of Mr. Heinze controlled seven other banks and suspicion spread to these banks. These eight banks had $71.4 million dollars of deposits and $21.8 million dollars of capital and surplus on October 12th.²⁰ These eight banks believed that they could have difficulties in meeting depositor demands for cash and they appealed to the clearing house for support. The clearing house pledged its aid but required that Mr. Heinze and Messrs. C.W. Morse, E.R., and O.P. Thomas, his alleged associates, withdraw from control of the banks. By October 20th, it appeared that the panic had been averted.²¹

On October 21st, the President of the Knickerbocker Trust Company was interested in certain Morse enterprises. There were issues with unfavorable clearing house balances and shortly thereafter the National Bank of Commerce announced that it would no longer act as the clearing agent for the Knickerbocker Trust Company. On October 22, 1907, there was a run on the Knickerbocker Trust Company such that after three hours, it suspended operations after paying out $8 million of accounts. The Knickerbocker Trust Company was the third largest trust company in the U.S., with deposits of $62 million. Its failure caused widespread panic and led to runs on the Trust Company of America and the Lincoln Trust Company, with deposits of $64 million and $22.4 million, respectively. Several Westinghouse companies failed that same week and the Pittsburgh Stock Exchange closed. On October 24th, several runs began on banks and trust companies in Manhattan, Brooklyn, and Providence.²² The New York bank run led out of state banks to call in loans outstanding with stockbrokers and timid depositors sought to withdraw their accounts. Businessmen prepared to maintain as large a cash balance as possible for possible emergencies and to take advantage of opportunistic buying at bargain prices. The Secretary of the Treasury deposited $35 million in national banks, with a larger share being placed in New York, to the threatened trust companies. To prevent further collapse of stock prices on the New York Stock Exchange, the NYSE, a pool was formed to lend $25 million on call on October 24th and $10 million on the 25th. The clearing house began to issue clearing-house loan certificates on October 26th. The money of the Treasury and the pool to help the NYSE was a mere fraction of the money ultimately used to prevent a collapse of the U.S. financial system.

The panic spread from New York such that two-thirds of all U.S. cities with more than 25,000 inhabitants had their banks suspend cash payments.²³ The amount of money in The Treasury went from $329 million on September 30, 1907, to $272 million on October 31, 1907, to $261 million on November 30, 1907, to $270 million on December 31, 1907.²⁴ The corresponding average of 40 common stock prices on the NYSE were 197, 171.5, 159, and 167%, respectively. The “grand average” of common stock prices fell 15.6% over the four months, or 45.69% annualized.²⁵ Mr. Mitchell’s statement that the “panic wrought” seems obvious. Business failures exceeded 3100 firms quarterly during the 1907–1908 time period, rising from 3138 firms failed in the first quarter of 1907 to 3635 failed firms in the fourth quarter of 1907 to 4909 failed firms in the first quarter of 1908 to 3524 failed firms in the fourth quarter of 1908. Business failures had quarterly average liabilities of $10,228 in the first quarter of 1907, to $22,379 in the fourth quarter of 1907, to $12,099 in the fourth quarter of 1908 (Mitchell, 1941, p. 98).²⁶ Wholesale prices fell from 127 in January 1907 to 121 in December 1908 during the panic of 1907. Mr, Mitchell noted that it was very difficult to data when the crisis of 1907 began, with money markets having severe stringency in 1906, stock prices falling in January 1907, crashing in March 1907, and prices of raw materials falling in February 1907. The Panic of 1907 can be dated from October 22, 1907, with the collapse of the Knickerbocker Trust Company.²⁷ Failures of large business enterprises ushered in the panics of 1893 and 1907. Mr. Mitchell stated that the “Elasticity of lending power is more needed than the elasticity of currency.”²⁸ Mr. Mitchell further stated that small, independent banks had no adequate means for putting available funds where they were most needed.²⁹

2.1.3 Mitchell’s Early Business Cycles Analysis: Business Depression

The Depressions of 1893 and 1907 were followed by increases in business activity. The impaired confidence that caused the preceding crises was replaced by optimism. The bursts of business activity following the panics passed quickly and renewed discouragement reigned. The decline in new orders began several months before the crisis. The lack of new orders will limit expansion. In 1894 and 1908, new orders were not sufficient to support the reopening of business enterprises, many of them mills. The lack of new orders blights the hope of a quick restoration of a prosperity following a severe crisis. The confidence of the return of expectations of profitable prices and profits, and a large volume of business activity is not restored.³⁰ Workingmen are discharged during a crisis and consumer demand fell. Food expenditures are seriously reduced and even more sharply reduced are expenditures for clothing, furniture, fuel, and amusements. Accumulated savings are drawn down and personal property may be pawned off. Mr. Mitchell stated that in general, current business conditions lessen demand for raw materials and partially finished goods.³¹ Manufacturers try to maintain as much employment as possible within a skeleton organization. The first lull in business activity allows an opportunity to overhaul plants and bring equipment back to the highest levels of efficiency. In the early stages of depression, very few new construction contracts are started. As more workers are discharged, consumer demands fall more, and there is less demand for raw materials. The lowest point in the physical volume of industrial behind raw production usually comes in the first or second year after a severe crisis.³² As the crisis continues, prices continue to fall. Wholesale prices fell for four years after the crisis of 1893. The lowest point of commodity prices is reached toward the close of the subsequent depression, not during the crisis. Retail prices lag wholesale prices of the same goods. Manufactured commodities prices lag the raw materials from which they were made. Prices of labor fall less than wholesale commodity prices. Interest rates on long-term loans fall at a slow pace but for a longer period of time than wages. High-grade bond prices rise because of the fall of long-term interest rates whereas common stocks fall because of diminished (current) earnings and dull prospects of future earnings.³³ Preferred sticks fall, but less than common stocks.

Mr. Mitchell pointed out in his business depression chapter that the quantity of money did not contract consistently in the months of depression during the 1890 to 1910 time period. The gold currency rose in early 1897, late 1908, mid 1910–1911, and 1903–1904. The belief that gold currency contracts regularly with the volume of trade is not supported by the data.³⁴ Similar monetary patterns were reported in England, France, and Germany. The failure of the money supply to contract promptly when crisis turns to depression results in monetary redundancy, or idle cash residing in banks.³⁵ The closest statement of Mr. Mitchell regarding the Quantity Theory of Money is found in the business depression chapter.

In so far, the quantity of money is a factor in accelerating the adjustment of costs to selling prices that ultimately restores the prospects of profits and ushers in a period of expanding trade and rising prices. Hence such an increase in the world’s production of gold as has been going in recent years tends to cut short and to mitigate depressions as well as to prolong and intensify prosperity. By thus altering both the intensity and the relative duration of these two phases of business cycles, it tends to give an upward direction to those long-period movements of the price curve in which the years if depression and prosperity are averaged. ³⁶

The decline in orders in depressions and the accompanying decline in selling prices put severe pressure on managers in business enterprises to cut expenses. Wholesale prices fell faster than retail prices; producer goods prices fell faster than consumer goods prices; and raw materials prices fell faster than manufacturing goods prices. Interest rates fell faster than wholesale prices and loan costs fell in proportion to prices of products. Wages decline in periods of severe depression. Mr. Mitchell pointed out that there was strong evidence that the efficiency of labor becomes much greater in depression than in prosperity.³⁷ The weeding out of less desirable workers instills the threat of layoffs in other workers and drives men to do his best. In depressions, the surviving business enterprises are those that achieve lower production costs on average during the period.³⁸ Supplemental costs are irrelevant in depressions as selling prices do not cover total costs in depressions. Although Mr. Mitchell does not explicitly make the statement at this point, profits become negative in depressions. Depressions eliminate small wastes in business enterprises. Business volume reaches its lowest point in the first or second year of depression. The quantity of goods produced starts to rise in the second or third year of depression. Goods increase and are transported by railroads and sold by merchants. First, the accumulated stocks of goods of the preceding prosperity are eventually sold. Manufacturers reduce their stocks of raw materials and fill orders with goods on hand. Once their current inventory is substantially reduced, then current purchases and production increase. Second, consumer demand eventually picks up as clothing and furniture is worn out and must be replaced.³⁹ Third, the population increases in depressions at about the same rate as other phases of the business cycle, further increasing demand. Mitchell uses German data to support the population statement as the U.S. data is uncertain.⁴⁰ Finally, and most importantly, demand for new construction in the latter stages of depression. Savings continue and the money-seeking fresh investments often goes to the purchase of property that the “embarrassed” owners are forced to sell.⁴¹ Liquid cash creates investments that represent a redistribution of ownership. Small and large capitalists can take advantage of very low interest rates to borrow long term and the more enterprising spirits can build for themselves. Building is more efficient because materials are cheap, and labor is efficient. Technical improvements occur as the depression wears on and there is an incentive to invest in new equipment. When new orders begin to increase, business enterprises begin improvements in existing facilities and there are organizers of new ventures. Both sets of investments use cheaper construction costs to have their plants ready for operation by the time a revival of activity is recognized.⁴² The physical volume of business reaches higher levels than those reached at the close of the preceding prosperity. Liquidations cease. Depression eventually breeds revival with prime cost, labor, materials, and interest, reductions. Expected profits increase and in the money economy, prospective profits are the great incentive to activity.⁴³ Prices and trade volume continue to fall even as the physical volume of business has begun to rise. Prices fall at a slower rate in the latter stages of depression than in the earlier stages. As business enterprises sell off their inventory and their heavy fixed charges are paid off, enterprises can live within their incomes. Mr. Mitchell summarizes his theory of business cycles as prosperity breeds crisis, which evolves to depression, and depression eventually paves the way to a return to prosperity.⁴⁴

2.1.4 Mitchell’s Early Business Cycles Analysis: Wider Aspects of Business Cycles

The revival of economic activity starts from depression and a low level of process compared to prosperity. Drastic business cost reductions, narrow profit margins, and liberal bank reserves are accompanied by an expansion in the physical volume of trade. Exceptional harvests and heavy government purchases of supplies may further increase demand in the home market. Active enterprises purchase more materials from other firms and employ more labor, use more borrowed money, and make higher profits. Prices lag the recovery. Newly employed labor, machinery, and starting old equipment and prices start to rise. Prices of raw materials rise first, and retail prices, which lag behind wholesale prices, eventually rise. Wages and interest rates often rise more than proportionally. Large profits often result from divergent price fluctuations and larger sales. Business optimism and the increase in profits leads to a marked expansion of investment, further driving up prices.

Business costs are driven up in business revivals and higher interest rates, rent, and salaries and the lessening efficiency of labor serve to drive costs higher than selling prices. The supply of funds fails to keep up with demand and there is a “scarcity of capital.” Businessmen face the prospect of declining profits. Rising interest rates reduce the capitalized values of business enterprises. Profits start to fall. Prosperity starts a liquidation, which ultimately turns into crisis.⁴⁵

Liquidation increases rapidly as businesses settle their maturing obligations. Liquidation generates a crisis. Making profits gives way to maintaining solvency. The volume of new orders falls dramatically, and expansion becomes contraction. If banks can meet credit needs and some business enterprise bankruptcy issues, then there is no panic. However, if businesses cannot borrow funds, and depositors are refused payment in full, then the alarm turns into a panic.⁴⁶

Falling consumer demand, employee layoffs, the gradual exhaustion of savings, and reductions in family incomes, combined with a fall in trade and prices lead to a depression. Profits and prospective profits are reduced. Depression is overcome with the subsequent reduction in business costs that eventually spurs a business revival.⁴⁷

The practitioner reader of Mr. Mitchell’s Business Cycles (1913) must understand the business cycle movements from prosperity to crisis to business depression. One notes Mr, Mitchell’s emphasis on the entrepreneur’s seeking of corporate profits and the role of expectations and hard work in their achievement. Mr, Milton Friedman, a student of Mr, Mitchell at Columbia University, while appreciating the smooth, casual-sounding exposition of Mr. Mitchell’s business cycle phases, nevertheless thought numerous significant theoretical insights underlie the text.⁴⁸

2.2 Mr. Mitchell and His Business Cycles and Unemployment

It is an interesting note to Mr. Mitchell that the first NBER Studies in Business Cycles volume was Business Cycles and Unemployment (NBER, 1923), which addressed a public policy issue that brought together the titans of industry, including Owen Young, Chairman of the Board of the General Electric Company, Joseph Defrees, former President of the U.S. Chamber of Commerce, Mathew Moll, Vice President of the American Federation of Labor, and Clarence Wolley, President of The American Radiator Company, with Mr. Mitchell, and Mr. Herbert Hoover, the Secretary of Commerce. The President’s Conference on Unemployment in September 1921 addressed relief to the four to five million unemployed Americans from the business slump of 1920–1921. Secretary Hoover wrote the Foreword for the volume. Hoover’s Foreword stressed that unemployment was the greatest national waste and that the commission acknowledged the suffering associated with the inability of jobseekers to obtain employment. Some firms showed progress during the period of national recession, “the recent period of national disaster,” in Secretary Hoover’s words, and successfully achieved stability, whereas the ignorance of determinable facts accounted for disasters to many other firms. Mr. Mitchell and the Committee defined business cycles as changes in business conditions that were characterized by an upward movement to a boom, followed by a downward movement into depression.”⁴⁹ As in his Business Cycles (1913), Mr. Mitchell began his business cycle analysis when business is recovering from a recession or depression. Characterized by an increasing manufacturing volume, rising stock exchange prices, business expansion, and increased demand for credit. Commodity prices rise as do interest rates, and credit becomes strained. Stock prices fall and general business conditions increase unevenly. Speculative buying overwhelms transportation and credit, which shakes public confidence. A widespread cancellation of orders is followed by a liquidation of inventories and an irregular fall in prices. During the period of depression, there is a widespread period of depression, there is widespread unemployment. The business cycle which ended in the depression of 1921 was unusual in its amount of preceding expansion and in its severity of unemployment and amount of unemployment. Thus, business cycles and fluctuations must be examined.⁵⁰ Mr. Mitchell discussed a tale of two businessmen in December 1919, who go to see their bank. The two manufacturers of silk had different perspectives of the post-war boom. The first businessman decided that the current boom was beginning to appear to be unsafe and he decided not to expand his operations and told his banker that he would sell his goods as quickly as possible. The second silk manufacturer decided that brisk business led to a scarcity of raw materials and that he should expand his inventory to maintain his trade. The second businessman asked the bank to grant him a loan given that his firm was in good financial shape, as characterized by the “two to one ratio” of quick assets, defined as total current assets less inventory, exceeded twice his current liabilities. Mr. Mitchell tells the reader that almost immediately following the bank visits, prosperity turned to depression in the silk industry and raw silk and finished produce prices fell significantly. The second silk manufacturer had a reduced value of his inventory that made him unable to liquidate his loan and his business was virtually bankrupt.⁵¹ Silk wholesale prices increased until 1920 and in February 1920, silk manufacturers discussed its great demand and its shortage of raw goods, expecting prices to rise. Insurance companies discovered that the silk that they had insured was beyond safe limits and announced an excess supply of silk, which led to all prices of silk falling at once, and manufacturers could not liquidate their inventories. Mr. Mitchell and the Committee used the silk industry as a striking example of incomplete information as to inventory goods in transit, and speculative buying that is duplicated in many industries and leads to great problems for bankers.⁵²

Mr. Mitchell stressed the need for facts regarding general business conditions, and probable future trends of general business conditions. The businessman must know current facts about his industry and his relative position within the industry; enough information about his firm to render proper policy judgment, including the attitude of his banker to loan extensions.⁵³ The Committee further discussed remedies for control of bank credit, control of inflation by the Federal Reserve System, control of businessmen and business expansion, construction of public works in depressing unemployment, creating unemployment reserve funds, and Federal and state unemployment bureaus.⁵⁴ Information was to be increased in the Survey of Current Business, published by the Department of Commerce, where the series and services were to be maintained and expanded. Information must be increased to the Department of Commerce and bankers regarding inventory, shipments, prices, and sales volumes. Second, the Committee recommended that statistical analysis be increased and standardized by the Bureau of Labor Statistics. Greater analysis was possible in five-year, rather than two-year, statistical collection of data in the Census of Manufacturers, by the Department of Commerce. Third, general research into economic forces and trends must be expanded, with more integration with businesses. Fourth, control of bank credit expansion requires a large fund of knowledge of business activities.⁵⁵ Borrowing of banks from the Federal Reserve System is a last resort and was a new business activity in the depression of 1921. Fifth, the Federal Reserve System must control inflation by preventing excessive expansion of credit in upward periods. The automatic check on expansion is the legal minimum bank reserve against current liabilities, but bankers must realize their responsibilities in issuing additional credits to the community. The accumulation of U.S. gold in the First World War led to “excess gold” which could become the basis of a disastrous expansion of domestic credit. Prosperity should be maintained by credit, not destroyed by inflation.⁵⁶ Businessmen must control the expansions of their businesses, such that a strong financial condition allows the business to maintain steady employment of workers. Public and private construction must be controlled in boom periods, by postponing or ceasing construction work and reserves built up for construction during periods of depression. Here Mr. Mitchell and the Presidential Commission discuss public goods. Businessmen must have sufficient data for construction activities.⁵⁷ Public utilities must be regulated such that utilities and railroads finance new construction or improvements in times of depression, when costs are low. The Committee’s ninth recommendation was for sufficient unemployment reserves to be created to stabilize employment and spending in time of depression. The Committee, in 1921, found that the cooperative unemployment reserve fund lacking, confined by trade unions and efforts of few individual firms. The tenth, and final recommendation was for a national system of employment bureaus to be created. The employment bureaus’ reports will provide reports on the demand for labor and become another measure of business conditions.⁵⁸

2.3 Mitchell’s Business Cycles Analysis at the NBER: Volume 1

Mr. Mitchell became the Director of Research at the National Bureau of Economic Research (NBER) in 1920. In 1927, Mr. Mitchell published the first of many NBER Studies in Business Cycles, entitled Business Cycles: The Problem and Its Setting.⁵⁹ The initial studies of commercial crises were made up of divergent fluctuations in many processes, leading every investigator to find evidence to support the hypothesis he favored.⁶⁰ Statistics has confirmed many of the theories of business cycles. Data on fluctuations in pig iron production, clearing bank checks, transporting freight, declaring dividends, and creating “general business conditions,” in addition to wholesale prices, the volume of trade, and physical production “indexes” have been published. An inquiry into business cycles should begin with the individual series being studied objectively, seeking to find what these processes are, how they effect and interact with each other, and what whole story they make up. Mr. Mitchell stated that the best way to learn about the processes is to profit by the earlier work on business cycles; most researchers find clues in some single economic process. Mitchell starts with the Mississippi Bubble and the South Seas Scheme in France and England in 1720. Commercial crises emerged in 1763, 1772, 1783, and 1793. By 1815, progressive changes in economic organizations were better equipping men to deal with crises, and Adam Smith and Ricardo were developing political economy. Smith, J.S. Mill, and A. Marshall wrote of principles which hold “in the long run” or create a “normal state.”⁶¹ Mitchell wrote of Simonde de Sismondi, a Swiss, who observed economic fluctuations in England around the Napoleonic Wars; 1816 being depressed; 1817–1818 being great in industrial activity and 1820 seeing a return to depression. Sismondi noted that businessmen only observed prices (not knowing customers’ purchasing power or tastes and consumption) and price expectations determine whether he expands or reduces prices.⁶² “The needs of laboring men are limited of necessity.” When production methods improve, economic institutions keep men busy and increase the volume of products offered for sale. Luxury goods are often made in foreign lands, and everyone would be better off if workers had sufficient incomes to provide a base for home demand.⁶³ Modern machinery growth has “over-produced” the capacity of society to consume; hence, the under-consumption theory of cycles was developed. When profits fall to a very low level, business failures rise and there is a loss of confidence. If workers lack the wages to buy goods, then over-stocking creates low expectations of profits, leading to a crisis.⁶⁴ J.S. Mill sought the fundamental cause of commercial fluctuations in psychology, fair trade breeds optimism, then recklessness, then disaster. Such disasters breed pessimism and stagnation. Depression ends when men's spirits recover, finding out that things are not as bad as they feared (Mitchell, 1927, p. 9).⁶⁵ Jevons sought weather and its control over crips and harvests. Mill and Walker discussed the “periodicity of crises.” Juglar’s 1899 book was a “book of facts on fluctuations.”

Mitchell listed the current theories of business cycles:

• 1. Weather

W.S. Jevons studied the 1721–1878 time period, finding 16 crises in 157 years; 10.466 years for an average business cycle which was very similar to the 10.45 years for sunspots. Henry Moore’s analysis of rainfall amounts shows 33-year and 8-year cycles of crop yields and business cycles, The eight-year cycle is confirmed by the time that Venus comes into the path of solar radiations to the Earth. Hunting observed that a low death rate breeds prosperity and health depended on the weather.

• 2. Uncertainty

C. Hardy builds on price expectations for production. Speculative purchases that producers hold when they are ready to sell goods.

• 3. Emotions in Business Decisions

Pigou held that business fluctuations are caused by businessmen's confidence. Optimism breeds prosperity but errors in expectations create a day of judgment.

• 4. Innovation, Promotion, and Progress

Schumpeter championed the concepts that business conditions are based on errors created by uncertainty and nourished by mass psychology. Scientific discoveries by a few men create innovation and their new forms of economic organization enhances the development of new products, seeking to new markets, exploiting new resources, and shifting trade routes. As innovation slows and enterprises cannot get capital, then depression develops. Depression eventually gives way to men regaining confidence. They borrow for new projects, raising interest rates, prices of industrial equipment, and payrolls. General activity increases until goods flood the market and creates a new crisis. Few men can innovate, and these highly endowed individuals achieve success.

• 5. Savings and Investment

Depressions lead to falling savings of entrepreneurs and wages decrease; landlords are unaffected, as are salaried workers and their savings are enhanced by a lower cost of living during a depression. Savings decline less than investing, and increases loan capital. Consumption rises in a prosperity. Goods eventually flood the market.

• 6. Construction Work

George Hull advanced the theory that enterprises build and equip houses, stores, factories, docks, and railroads. Construction accounts for 77% of industrial product.

• 7. Generalized Over-Production

Demand rises during depression, increasing employment and stimulating consumer demand, and encouraging newer orders for equipment. Prosperity cannot continue indefinitely.

• 8. Banking Operations.

Alvin Hansen, I. Fisher, and Hawtrey held an expansionary monetary policy lowers the interest rate and expands trade. Dealers give large orders to producers, increasing output and incomes. Rising incomes raise prices, retail demand, and prices. Businesses borrow more freely, and interest rates rise until interest rates equal the profit rate, and the inducement to increase goods is reduced.

• 9. Promotion and the Flow of Income

Emil Lederer held that depression begins with a decline in physical trade and prices, the cost of living falls faster than wage cuts. Consumers can buy more. Business profits fall because wages, rents, and interest charges lag behind falling selling prices. A business revival reverses prices, raising the volume of trade, quickening the circulation of money and credit. The gold supply increases, disproportionally of production and income. Over-production and prosperity turns into depression.

• 10. The Role of Profit-Making

Veblen held that prosperity has rising prices and profits, caused by an increased supply of gold or government purchases. Increased investment to exploit profits pushes up prices, confirmed by J.M. Clark.

Mr. Mitchell listed the theories of business cycles that prevailed before 1927.⁶⁶

The emergence of joint-stock companies in England in 1600, with the establishment of the East Indian Company (EIC), known also as “The Company,” with the consent of Queen Elizabeth, to trade in the Indian Ocean region and later China, England rose to dominant world trade. It is estimated that The Company accounted for one-half of world trade in the 1750–1815 time period. Financial crises were recorded in England during the 1558 to 1720 time period by Mr. William Scott, of St. Andrews.⁶⁷ These financial crises occurred every 5.5 years, but only 5 of the 29 crises were considered depressions during the 163 years. Mr. Scott associated twelve of the crises as being proceeded by “depressed trade,” not prosperity. With the emergence of the Quant—Stock companies in England in 1600, with the date of the establishment of the East Indian Company (EIC) known also as “The Company” by decree of Queen Elizabeth to trade in the Indian Ocean region and later China, England rose to dominate world trade. It is estimated that the Company accounted for one-half of World trade in the 1750–1815 period.

Financial crises were recorded in England during the 1558–1720 time period, by Dr. William Scott (of St. Andrews pp. 76–77). Scott's financial crisis occurs with famines, plague, wars, civil wars, or large governmental actions. Financial crises occur about every 5.5 years. Scott reports only 5 depressions followed the 29 crises during the 163 years. Scott listed 12 of 30 crises preceded by “depressed trade,” not prosperity.⁶⁸

Mitchell makes the point that Scott's British crises did not follow the pattern of modern business cycles (Mitchell, 1927, p. 80). England suffered financial crisis in 1745, 1972, and 1783 following military conflicts with “The Pretender and his Highlanders” the end of the Seven Year War, and the end of the American Revolution.⁶⁹ Mitchell addressed the issue of the labor force in the U.S., in 1920, Some 39.4% of the approximate 100-million-person population, made up of 72% men, 12% teenagers, aged 15–19, and 16% adult women. Employment during depressions was most reduced in manufacturing, railroads, mining construction and secondary in finance, wholesale trade, and transportation. In 1920, corporations owned 32% of American manufacturing establishments that employed 87% of wage earners and produced 88% of value-produced. In the Census of 1920, 345, 600 corporations filed tax returns reporting $126,000,000,000 of aggregate gross income.⁷⁰ Mitchell pointed out that parent, or holding, companies owned all or large parts of corporations, noting the growing power of financial alliances (mergers), involving the exchange of common stocks.

Mitchell noted that an investor could reduce his risks by spreading his stock holdings among numerous enterprises.⁷¹ “A business enterprise can serve the community by making goods only on condition that, over a number of years, its operations yield a profit. Issues of social and business reforms and legislature add little to understanding business cycles (p. 105). Finally, in Chapter 2 Mr. Mitchell dismisses the Irving Fisher (restatement of the Quantity Theory of Money with regard to business cycles stating that we need a far more discriminating statement of the relations among prices, volume of trade, the quantity and velocity of money and circulating medium, taking into account the relations produced by depression revival, prosperity and recession.⁷² Corporate profits are the most volatile type of income.⁷³ To prosper, and survive, business enterprises must make profits on average. Profit making is the central process among the activities of a business economy.⁷⁴ Business cycles are among the unplanned results of business enterprises.

In Chapter 3, Mr. Mitchell discusses the time series modeling of U.S. data and the logistic (or Gompertz) trend curves of Simon Kuznets. The logistic curves are on a secondary business cycle nature, not the long-run Kondratieff (analysis) curve of British wholesale prices that rise from 1789 to 1814, fall to 1849, rise to 1873, fall to 1896, and rise to 1920. The first curve began in the late 1780s crested 1810–1817, troughed in 1844–1851, and lasted 50–60 years. The second long-run curve began in 1844–1851, crested in 1870 1875, troughed in 1890–1896, and lasted 40–50 years. The half-curve started in 1890–1896, and crested in 1914 - 1920 (Mitchell, 1927, p. 298).⁷⁵ The Kondratieff curves are statistically probable, but the author offers no economic explanation or hypothesis to account for them (p. 228) The Juglar 22–24 year secondary curves exist.

In Chapter 3, Mr. Mitchell further discussed efforts to estimate a business barometer. Much of this effort has been led by Warren Persons, of Harvard. Professor Persons had been modeling time series and constructing a business barometer for the Harvard Economic Service, during the 1916–1928 time period. Mr. Persons was one of the first economic forecasters and he also served as founding editor of the Review of Economic Statistics, which became the Review of Economics and Statistics. We will discuss the general business conditions index of Mr. Persons in Chapter 3. Persons was concerned that many of the economic time series in this modeling work had standard deviations such as bank cleanings and call-loan rates, several times as large as the standard deviation of bank reserves, the wholesale price index, and National Bank reserves. Mr. Mitchell suggested that the plotting of time series, with secular and seasonal trends removed, reveals that the time series will not reach peaks and throughs at the same time, but the peaks and throughs are distributed over several months, and perhaps as long as a year.⁷⁶ Cyclical changes in certain economic processes lead or lag the corresponding changes in other economic time series. The time intervals of the leads and lags that were constant.

Mitchell reminds his readers that a leading aim of statistical research is to determine the time sequence in which economic time series pass through business cycles and identify the average time periods by which the series lead or lag other time series.⁷⁷ Correlation Coefficients are estimated to identify the lead and lag periods of the economic variables. Mitchell’s statement that the correlation coefficients of the time series may be relatively unchanged with its various lags is consistent with the estimated autocorrelation functions and cross correlation functions of many time series. Mitchell asks the reader to consider causal relations of variable leads and lags. Moreover, Mr. Mitchell argues that the theorist should not only consider one-way, or one direction, causality.⁷⁸ Mitchell quotes the Irving Fisher modeling results that the highest correlation coefficient between monthly change in the wholesale price index of the Bureau of Labor Statistics with the Persons’ index of physical volume of trade was 0.727 for a seven-month lag in the volume of trade. Fisher conceived that the hypothesis that a given price change in one month upon the volume of trade is distributed in accordance with a probability curve. When professor Fisher produced his best fit, the monthly volume of trade lagged. Monthly price changes have a logarithmic time axis by 9.5 months, and probably error points between 5 and 18 months. Thus, Fisher held that monthly price changes and the Persons’ Index of physical volume of trade had a correlation coefficient of 0.941 from August 1915 to March 1923 period. Mitchell further states that if a significant relationship is shown to exist between price changes and the volume of trade, but also a be between changes in volume of trade and subsequent changes in prices. Now known as “feedback,” then the statistician would come closer to presenting the complicated relations in economic theory.⁷⁹ Mitchell stated the separate coefficients should be computed for periods of revival, recession, prosperity, and depression.⁸⁰

Mitchell proceeds in Chapter 3 to discuss the estimation of “Indexes of Business Conditions” discussing works of Beveridge (1910), who modeled the U.K. economy, 1856–1907, and its bank rate, employment, foreign trade, marriage ratio, industrial production and consumption of beer. Beveridge could not trace the “pulse of the nation to a single significant factor or cause.⁸¹ The second business conditions index that Mr. Mitchell addresses is the Persons’ “Index of General Business Conditions” in which professor Persons reduced series fluctuations relative to their respective standard deviations. Mr. Persons estimated correlation coefficient to access concurrent and lagged relationships among time series and the period of lags during 1875–1913 time period. Finally, Mr. Persons created three indexes of time series by averaging 13-time series. These indexes were “an index of speculation,” composed work of railroad bond yield, industrial and railroad stock prices, and New York bank clearings; “an index of physical productivity and commodity prices combined, composed of pig iron production non-New York bank clearing, the Bradstreet price index, and New York bank reserves and “an index of the new financial; situation in New York” composed of 2–3 month, 4–6 month paper rates and loan and bank deposits of New York banks (p. 293) The Persons’ index was created to forecast business changes. The index of speculation preceded the index of physical productivity and commodity prices, which preceded the index of financial conditions.⁸² AT&T, the American Telephone and Telegraph Company, developed a variation of the Persons’ model.

Mr. Mitchell reviewed 11 economic/ forecasting models in Chapter 3 and concluded that none of the indexes give an adequate picture of business cycles.⁸³ Business cycles are composed of a large number of time series that differ widely in amplitude and timing. Mitchell reminds the reader that index numbers are an indispensable tool in studying the arrays of price changes condensed into a single set of averages.⁸⁴ Mitchell suggested that rather than start with a single purpose and criticizing the existing indexes in their ill-adapted use, it is probably more useful to start with the methods and data (time series) employed, and consider what the results mean and how the results might be used.⁸⁵ Mr. Mitchell proceeds to “pop the hood” of the Persons’ “General Business Index” and states that a forecasting sequence or model cannot be expected to properly use all available information to consider it a “general” model. lt is difficult to find many economic time series with “regular” leads and lags to forecast reliably. The only relevant criteria are the forecasting results, Curve C variables, money rates, lagged Carve B variables, business variables, by four months, on average during the 1903–1914 time period. Curve B variables lagged Curve A variables, speculative variables, by an average of eight months. Curve C variables, rates, lagged Curve A variables, speculation, by an average of 12 months. To complete the analysis Mr. Mitchell recommends that it is necessary to find the average period that speculative variables (A) in one cycle lag behind the money rates variables (C) in the preceding cycle.⁸⁶ Moreover, Mr. Mitchell stated that the irregular nature of the business indexes makes it difficult to count the number of business cycles in a given time period. All the business indexes correctly identified major crises in 1882, 1893, 1907, 1917, and 1920. However, minor business crises are not easily identified in all indexes nor are their durations consistent. The business indexes do not agree on the crest or trough of a given cycle nor agree on turning periods, not points, Mitchell reported that the Snyder’s Clearing Index was more accurate than Fickey's, AT&T, and Persons’ index of trade, ranks in order of accuracy. Lags lasted longer at crest than troughs.⁸⁷ The business cycles, crest to crest averaged 42–43 months (p. 341).⁸⁸ Mitchell noted that the general business indexes had differences in amplitude, but saw no reason to question the relative severity of the “deepest depressions.”⁸⁹ The general business indexes identify troughs better than crests.⁹⁰ Finally, Mr. Mitchell commented that the National Bureau of Economic Research collected economic statistical data for the U.S., France, Germany, and Great Britain. The best U.S. data are wholesale prices, foreign trade, banking railroads, and money and securities markets data.⁹¹

Is there a “normal state of trade”? Mr. Mitchell says no. The economic histories of England, China, Sweden, Australia, and most other nations, from 1790 to 1925, show incessant business fluctuations .⁹² Mitchell lists 32 recessions in the U.S. between 1790 and 1925 and 13 of these are considered severe enough to be business depressions.⁹³ The average term of the cycle is about 3 years in the U.S., and 4 years in England. There have 1.5 years of prosperity per year of depression in the U.S., as opposed to 1.11 years in England in the 1790–1925 period, and 1.18 in France and Germany in the mid 1850s-1860s to 1925.

In conclusion, Mr. Mitchell noted that counting from crisis to crisis widened the times of cycles relative to counting from recession to recession. Mr. Mitchell could not confirm that long holes are multipliers of shorter cycles. There appears to be no periodicity of crises. There is no regularity in length to business cycles. The average duration of business cycles was 5.2 years in 1796–1822, 3.5 years in 1822–1960, 5.5 years in 1860–1888, and 3.2 years in 1888–1923. Mr. Mitchell concludes that business cycles are fluctuations in the economic activities of organized communities where business restricts activities to be of a commercial nature.⁹⁴ Cycles do not occur with regularity.⁹⁵ Business cycles may be confused with changes in business condition occurring between dates of “crises.” Business cycles affect major activities of the business community, not minor parts of the community. Cycles do not include recurring fluctuations every year and “long waves” and the less established secondary trends. Mr. Mitchell's tentative working plan was to identify features characteristic of all or most cycles, minimizing particular cycles, and develop the “normal” features of business cycles.⁹⁶

2.4 Summary and Conclusions of Mr. Mitchell and His Business Cycles and His Business Cycles

Mr. Mitchell in writing his Business Cycles (1913) and Business Cycles: The Problems and its Settings (1927) put forth the phases of the business cycle and laid the groundwork on how the NBER would conduct much of its business cycle research from its inception in 1920 until 1992. Mr. Mitchell was trained in traditional (classical) economics. His emphasis on empiricism and economic description and analysis of business conditions and cycles from 1862 to 1927 were discussed in this chapter. In later chapters, we review the analysis of Mr. Burns and Mr. Mitchell in 1938 and 1946 of real-world business cycles. In fact, the Leading Economic Indicators, LEI, the signaling indicator of economic conditions, created by continues to be widely followed to the current period. Why should investors and participants in the labor force examine the LEI? The LEI time series is highly statistically significant in the forecasting of real GDP growth and employment in the U.S., 1959–2021.