Chapter V:
Can We Reorganize Under the Present System?

WE now take up the fourth and last of the main questions set for discussion as a part of our attack on the larger question whether the present system is workable. In one chapter we reached the conclusion that a return to the 19th century, pioneer, frontier, expansion pattern is out of the question, mainly because we have not the requisite starting point. In the next chapter we were forced to dismiss, as highly improbable of realization and wholly undesirable to undertake, any large scale resumption of consumption financing on credit along the lines followed between 1915-1929. And in the last chapter we estimated the chances to be about fifty-fifty that this system can go on financing the costs of the depression until the outbreak of the next war, which seems likely to start within the next five years.

In this and the next chapter we are closing out the attack on the workability problem with a discussion of the chances or possibilities of reorganization within the framework of the fundamental principles and institutions of the present system. It is, of course, one of the premises of fascism that reorganization under the present system is impossible. And it is a proposition about which all sound exponents of capitalism must find themselves in agreement with the fascists — that the present system can only operate successfully (assuming, as the defenders of the system assume and as the fascists deny, that the requisite conditions for operation still exist) if reorganization and readjustment can be effected. The issue is not whether reorganization is necessary, for that is universally conceded, but whether reorganization is possible. So far, the affirmative rests more on hope and prediction than on achievement since the War.

The weakness of capitalism is not the occurrence of mistakes and maladjustments. Nor is freedom from such misfortunes to be claimed as a merit of any social planning so far achieved. The weakness of liberal capitalism in the period since 1914, or really the period which includes not only the War and its sequels but also the irreconcilable conflicts of interest which had to culminate in the outbreak of the War, is that, in this final phase of capitalist decline, capitalism cannot reorganize and readjust in ways essential for its continued operation as a social system. The system has developed organic inflexibilities in the debt structure, the price structure and the volumes of supply and demand. A planned economy can readjust its maladjustments almost as easily as it can make them. It is ever making adjustments and maladjustments at the same time.

A planned economy can be, and probably will be, responsible for expenditures of human effort quite as foolish, harmful and objectionable from almost any rational viewpoint as the construction under free capitalism of several billion dollars worth of office buildings and apartment hotels for which there is no adequate market. But a planned economy does not have to put up with large-scale unemployment as a result of having been responsible for bad investments. War, for instance, can be considered a bad expenditure of effort and resources for one or both belligerents. But France with its devastated regions, the victor, and Germany, with a war tribute to pay, the loser, did not have to suffer depression or unemployment for many years after the War. Why? Because, in both countries, the state intervened to insure after the disaster or blunder of war the benefits of maximum activity. The state can reorganize and readjust after the greatest of social calamities, war, with attending benefits and prosperity for all. As soon, however, as the regime of sound liberalism or capitalism once more becomes fully and normally effective, that is, as soon as the State retires from the enterprises of war and reconstruction, the maladjustments produced by a business boom must persist unless the corrective forces of a frontier expansion can operate to dissipate them in another boom.

At the outset of any discussion about economic reorganization let it be clearly stated that the system is supposed to effect its own reorganizations or readjustments automatically through the orderly legal and economic initiatives of private individuals, each acting in his own supposed self-interest. If it does not so happen, that fact, and that fact alone, suffices to prove the unworkability of liberal capitalism, exactly as the failure of a physical organism to eliminate its own poisons is proof that it is not working and that a condition exists which, if not promptly corrected, results in the death of the organism. This obvious consideration is persistently disregarded by a numerous school of facile liberal writers, of whom men like Sir Arthur Salter are typical examples. Probably, their best defense is to say that they hope to do for the liberal economic system what the doctors do with insulin for a diabetic system, namely, keep it alive by helping artificially to eliminate its poisons which it would otherwise be powerless to prevent from proving fatal.

The problem of reorganization and readjustment can really be thought of as one of getting rid promptly of poisons in the economic system which the system is supposed automatically to eliminate and which it is not eliminating. After unemployment, the chiefest of these poisons, it will generally be admitted, is debt, of which there is incontrovertibly in this country several score billion unpaid, uncanceled, and unrepudiated, but clearly unpayable. Within the scope of this generalization is to be included our two score billions of public debt. The capitalist system everywhere got terribly into debt through the War and its sequels, and, as I pointed out in my Is Capitalism Doomed? written in 1931, capitalism during the depression is suffering, not from War losses which have been more than replaced, but from the paralyzing effects on world trade caused by lingering War debts, both national and international. Now that the leading nations of the world are cynically refusing to honor their obligations to our government, now that our government with equal cynicism has repudiated its obligation on its gold bonds, and now that so many slightly less important debtors are in difficulties with their debts, it hardly needs to be argued that debt is one of the major maladjustments of the moment.

The following facts make this clear. The study entitled The Internal Debts of the United States, page 10, published in 11933 by the Twentieth Century Fund, gives a fairly good picture of the debt situation:

Amounts in Millions of Dollars. Latest

Class Available Year Pre-war Year

Farm mortgage debts......... $ 8,500 $ 3,310

Urban mortgage debts........ 17,554 5,151

Railroad debts............... 14,164 11,186

Public utility debts........... 11,115 3194

Industrial debts.............. 10,450 3,738

Financial debts............. 11,919 4,040

State and local debts......... 18,685 4,751

Federal debt................. 14,137 (30,000 in 1935) 968 

Total reported debt........ 116,834 36,448

Total estimated debt....... 134,180 37,989

In addition to this total for so-called long term, or funded debt, there is short term debt to be considered. The difference between what is commonly called long and short term debt is purely nominal, for most of the short term debts are really long term debts. Most short term debt is not paid off at maturity but renewed, if not with the same bank, lender or credit grantor, then through borrowing or obtaining credit from another. A short term loan from a bank is paid off with the proceeds of a new loan from another bank. For the purpose of drawing conclusions about the effects of interest and inflexible money obligations, long and short term debt are practically the same. The Twentieth Century Fund investigators computed our total short term debts as follows: (The Internal Debts of the United States, page 301):


Kind of Debt End of 1913 End of 1932

Short term business debt.............. $47 X89

Short term personal and household debt 4 314.4

Total short term debt................ 51 1o3.6 Total long term debt................. 37.9 134.2.

Total debt........................... 88.9 2-37.8

Unfortunately, there are no reliable figures showing by how much the total debt structure of the country has changed during the depression, or between 1929 and 1935. Bank loans have decreased during this period by about twenty billions, and it is a reasonable guess that long term debts have been reduced by about ten billions through the processes of bankruptcies, mortgage foreclosures and corporate reorganizations. The amount of net total reduction of debts is smaller than may be imagined, for the deflationary processes have been considerably modified by government action and voluntary agreement between creditors and debtors. And the net reduction of private debts has been offset by the net increase in public debt, aggregating for the first six depression years about fifteen billion for federal debts, and at least two or three billions for state and city debts. So it seems a fair guess that the net total of fixed obligations, bearing interest, has not been reduced by more than ten billions, or five percent, for both long and short term, during the first six years of the depression. The most significant statistical, or numerical, fact about the debt burden, perhaps, is that while the total national income in 1933 was only fifty-seven percent of what it was in 1929, dividends thirty-six percent, rents and royalties fifty-two percent, wages and salaries, fifty-six percent, the money lender’s portion, or interest, was ninety-five percent in 1933 of what it was in 1929. This is the feature of loans or interest, inflexibility, which contributes most to producing general maladjustment. Obviously, a five percent reduction in debts or a five percent reduction in interest charges, does not correspond to a fifty percent reduction in production or paid income of the nation.

It is, however, appropriate to mention a certain line of apology for the debt structure, the best statement of which, perhaps, has been formulated by Carl Snyder, an economist of the New York Federal Reserve Bank. This apology is based largely on an analysis of figures showing the rates of growth of debts, total productive wealth and total production for fifty or more years prior to the World War. This analysis will disclose that, leaving out war debts, other forms of debt, including that to banks, did not rise relatively to total wealth or current production any faster during or since the World War than during any other correspondingly long period in the past. That is to say, our productive capital increased as rapidly as our total debts, if war debts be eliminated.

This defense seems impressive if one considers only the statistics given, and if one disregards certain other relevant statistics and considerations. It has two fatal weaknesses: In the first place, any attempt to exclude war debts from the debt picture for a comparison, the avowed purpose of which is to show that the debt increase since 1914 has not been dangerous, is unworthy of serious consideration. United States Government debt contracted during the War lays an interest charge on the people like any other class of debt, and as a credit item it plays a more important role in the holdings of banks and institutions than any other class of debt or credit.

In the second place, the main weakness of the apology is the failure to recognize that if it be true that most of the post-War creation of debt has been as well matched by the creation of a counter-value in productive capital as were the debts created in any previous period, there is this vital difference to be noted, which Mr. Snyder does not note: New productive capital created in the 19th century, while smaller in quantity and less efficient in operation, found a larger and surer market for its output than new productive capital created since the War. To be more concrete, it may be true that a twenty-five million dollar block of new mortgage bonds in 1929 was matched by twenty-five or even thirty-five million dollars worth of Fifth Avenue office building, or luxury hotel-at the then cost of construction, which was fifty percent higher than it would be at present. And, consequently, it may be true that this new debt was as fully covered or secured by a physical asset as was a million dollar block of mortgages used to finance the building of New York City tenements in the eighties or nineties.

But there is this difference to note: Due to heavy immigration, the tenements found a market or tenants at rentals which quickly amortized the construction costs, while many a Fifth Avenue office building or hotel constructed during the boom never had a chance of finding tenants at rentals to carry overhead and amortize construction costs. The same difference holds good in reference to debt incurred to develop the productive plants of basic industries like mining, textiles, farming, and the many steel companies launched in the 19th century, and the debt incurred to finance during the 1920’s expansion of production in steel, copper, petroleum or raw and fabricated foodstuffs. In a word, the market for the product is the thing that secures any business debt and not the physical or productive asset created with the proceeds of the borrowing.

To point out the inconsistencies between the usual statement of the productivity theory of debt and a large part of current business practice (leaving out of account entirely consumption loans or war debts) would involve a voluminous analysis of modern business. We may look briefly at some of the facts which are inconsistent with the theory as propounded by the apologists of money-lending. Thus we shall see what fascism has to do to make a system of private ownership and management workable, so far as arrangements involving capital income or reward are concerned. The ruling principle must be that capital and management reward must be kept in continuous and flexible adjustment with economic possibilities, and that legal and institutional arrangements-like loan contracts, bonds, legal concepts of just compensation, due process of law, and confiscation-must not obstruct executive action of government to maintain this adjustment otherwise than by the present devices of bankruptcy, foreclosures, reorganization, and cycles of booms and depressions.

In other words, we know the supposedly automatic correctives or self-adjustments of capitalism for bad debts, and we don’t like them. Of this medicine, we may say, We can’t take it. Mr. Hoover, in erect, said this when he launched the National Credit Corporation and the Reconstruction Finance Corporation.

A simple, typical and important example of the inconsistency of debt practice with the productivity theory for justifying debt is furnished by the railroads. According to the best debt theory, the productivity theory, a railroad should incur debt only for the original investment which creates or expands earnings. Replacements and betterments which do not increase traffic or which do not increase earnings by lowering operating costs while traffic remains constant, ought not to be financed by new borrowing but out of income, whether such income be made available by reducing interest, dividends or costs, or whether it be made available by increasing charges. New and more comfortable cars do not necessarily or even ordinarily increase railroad travel. New and more comfortable or speedier transportation may be necessary to meet bus competition. But it is obvious that outlay to enable the railroad to hold its own is not an investment which increases traffic or earnings. Money so spent on new equipment is like money lost by reason of a reduction in rates to meet competition or to increase traffic.

A twenty or thirty million dollar passenger terminal for a large city may add to the beauty of the city and the comfort of passengers, as well as to the facilities of operation, but contributes little or nothing to gross traffic or net earnings. The same number of people will travel, whether the station be a dingy affair or an architectural monument, for the decision to take a train is not influenced by the artistic qualities of the terminal. If a million or two dollars a year of interest charges on the new terminal be added to railroad operating costs, it goes without saying that net earnings will be diminished rather than increased by the terminal. The terminal doubtless should be built, but it is in no sense a capitalistic investment on the productivity theory of loans. The new terminal is as much a socialist investment as a new public library or city hall. It should not be financed by bond issues but out of income or surplus. It is an operation cost and not a capital investment. It is a civic adornment.

Now it is largely as a result of financing replacements and betterments, whether grander stations or more commodious and serviceable equipment, with an increase in railroad debt, that we today have a railroad debt of some fifteen billion dollars and an available net income to serve these capital charges, even if all common and preferred stock were extinguished, which does not allow two percent on the total railroad debt.

Why were these replacements and betterments so generously made? Answer: Because the managing or controlling bankers were in a position to profit personally on the building and purchasing contracts. Why were these replacements and betterments financed by such large issues of new bonds and equipment trust certificates? Answer: Because the bankers controlling the railroads are merchants of securities. They are, therefore, interested in having the railroads sell as many bonds and the investors buy as many bonds as possible, regardless of how unsound the bond issues may be.

The average college professor teaching economics will tell his students, out of the depth of his ignorance of business as it is, that the bankers have an interest in selling good bonds, for, if they sell bad bonds, it will react against them, all of which is largely nonsense, for the following two reasons: When bankers sell bad bonds, they make money on the sale of the bonds, and then collect inordinate fees and commissions on the receivership, reorganization and refinancing of the railroad which they have wrecked. Almost every important investment banking house has wrecked and reorganized railroads with more profit on the wrecking and reorganizing than on the original financing. Moreover, no matter how many bad bonds the bankers sell their clients, the latter must go to the same bankers again for further investments when they have funds to invest. To whom else can they go for investment securities but the bankers?

Why were necessary replacements and betterments not paid for out of earnings since the War, especially during the boom years, instead of by new financing? Answer: Because the controlling bankers were not only interested as merchants in the security traffic, but they were also making large speculative profits through the ownership and manipulation of railroad stocks, wherefore they had the roads borrow as much as possible so as to provide a favorable dividend and propaganda picture for the common stocks.

Why did government regulation through the Interstate Commerce Commission, and the state commissions, not prevent the bankers from getting railroad finances into their present mess? Answer: Because of the doctrines, self-contradictory, metaphysical and wholly irrelevant to modern economic problems, which the Supreme Court is allowed to apply to government regulation of railroads and utilities.

There is not space in this book to analyze cases and point out in detail the incompatibility of Supreme Court decisions with the development of any government regulation adequate to insure sound railroad or utility financing and management. Briefly, it can be stated that, in respect of the creation of debt and accompanying capital charges, some totalitarian economic theory has to be followed. And it is of the essence of our judicial and political system that no such theory can be made explicit or effective. The chief purpose of our institutions, so far as law and government administration are concerned, would seem to be that of making explicit and effective a political theory developed in the 17th and 18th centuries and appropriate only to the conditions of those days. About the only economic theory which our courts can be said to follow is that they have the right to pass on each and every specific act of government affecting a property right for the purpose of deciding whether that act involves confiscation without just compensation or is an arbitrary, unreasonable or unconstitutional exercise of governmental power.

This amounts to saying that the only governing economic theory, if economic and theory it can be called, revolves not around present day social means and ends but around the court’s definition of the terms confiscation, just compensation, arbitrary, unreasonable, and unconstitutional, as well as around the court’s interpretation of a voluminous set of facts in each case, the complexities of which the judges usually have neither the time nor the technical competence to master. The average American judge, including the average of those on the Supreme Court, having no adequate training in advanced accounting, is no more able to find his way through the books of account of a modern railroad or utility linked up with an involved system of holding companies and banker relationships, assuming he ever tried to do so, than he would be to find his way through the African jungle. To suppose that a judge who could not possibly give a clear statement of the complicated financial arrangements, practices, and interlocking relationships of one of these modern corporate set-ups can determine equity in a given case involving these arrangements, practices, and relationships, is one of the fictions of liberal jurisprudence.

It would be a comparatively easy matter for a corps of business executives, accountants and economists, assuming they were subjected to adequate superior political dictation, to draft a body of theory, and administer a set of rules of practice, to realize any set of feasible social results. One of these results might be keeping capital charges or debt in a constantly workable relation to earnings or to the part of income safely available for meeting capital charges. Such administration could not guarantee any rate of earnings or return to capital, but neither can the present system of the bankers and lawyers. Such an administration, however, if freed from the 17th century inhibitions and imperatives of the present American legal system, could insure continuous adjustment without the processes of bankruptcy, foreclosure, boom and depression, inflation and deflation, on which the bankers and the lawyers now fatten at the expense of social order and welfare. To maintain such constant adjustment is one of the major tasks of fascism. The services of the financial expert and the legal expert can be used as instruments of a national plan, but not as instruments of individual greed playing an essentially anti-social and economically wasteful game.

But no such financial and economic control or regulation could possibly be devised to square with the doctrines laid down by our Courts, or with the principle of judicial review of final decisions and policies of government. The Supreme Court has even gone so far as to hold a regulatory measure confiscatory because it did not allow seven percent on an investment. This does not mean that seven percent is the Supreme Court’s official rate for a fair return on utility investments. It merely means that no regulatory agency of government can possibly tell what rate of return the Supreme Court will hold just or what rate it will hold confiscatory, in a given case, until that case has been tried by the Court. Nor is it to be understood that the courts prevent all government regulation. On the contrary, the courts leave a comparatively large area of regulation free from judicial interference or review. No; the courts only intervene, as a rule, where regulation is fraught with important social consequences.

To take, at random, one more important field in which debt abuses have been rampant and on a large scale — guaranteed mortgages — it may be said that the most obvious considerations of public interest would have caused government to prevent these abuses had we a government empowered to deal with such practices. I select this example mainly because it is easy to state briefly and simply the ruling considerations. A company with a capital of twenty million odd dollars would assume obligations to guarantee over a billion dollars of mortgages. Now, to forbid a racket of that sort, it should be enough to show that if the guarantee has any value, the defaults in any given year must be so few, and the amounts so small, as to constitute a risk not worth the premium paid by the assured. And if the defaults in a year ever exceed two percent, the guarantee will prove worthless for defaults in excess of two percent. To charge one-half to one percent a year for years and years for insurance which can only be good for two percent of the risk assumed is obviously the next thing to robbery. Human mortality risks are calculable on the basis of past experience, and we are authorized to expect that never more than a certain percentage of the insured will die in any one year. Mortality risks on loans cannot be so calculated, because no one can fairly assume that any given percentage of defaults, certainly not the maximum of two percent, will never be exceeded in any given year. The phenomenon of a business depression may inflict twenty-five or even a hundred percent loss on loans. No one can set aside a reserve for depressions which will constitute any real insurance, since no one can tell, as this depression demonstrates, what the percentage of economic losses of a depression will be until the depression occurs.

A simple way to illustrate the fraud inherent in the insurance of loans or mortgages is to suppose that a company were to offer insurance of United States Government bonds against loss of purchasing power. Such insurance would be a palpable fraud, or collecting something for nothing, for the following reasons: The Government can, as has happened in varying degrees in most countries, including our own, reduce the purchasing power of its money and, consequently, of its bonds. If the government does not do this, the insurance will not be needed. If the government does this to any considerable extent, or, say, to the extent of more than a ten percent devaluation, the insurance will be worthless.

No insurance company could operate profitably and carry much more than a ten percent reserve against total risks.

Considerations like these are obvious enough, but they cannot usually be made to sustain regulatory measures of government under our juridical system, in which the courts undertake to fix the limits of government interference with private conduct according to no theory of social welfare relevant to the complex pattern of today but according to theories appropriate only to a 17th century social situation. Our courts can prevent a governmental undertaking to solve a problem, but they cannot initiate or guide the initiation of another and better undertaking to solve that problem. On the contrary, the Supreme Court, as in the case of the N.I.R.A., may for two years contemplate the drafting, enactment, popularizing and enforcing of a law which they know perfectly well they are going to repeal with the judicial veto. The courts can never be constituted to rule, but only to function as an instrument or tool of government. If they function as a check on government, the results are certain to be bad, for government finds enough checks in the difficulties of maintaining order and promoting welfare. Government obviously needs the counsels and loyal cooperation of all its agencies, not their purely destructive criticism and obstruction.

One can multiply indefinitely examples showing the impossibility, under the present system, either of preventing or correcting maladjustments in property arrangements once the dynamics of the frontier do not take care automatically of such readjustments.