The Financial Situation

Leaves from An Observer's Notebook

MERRYLE STANLEY RUKEYSER

WALLL STREET is a little better and a trifle worse than the lay public believes.

Like any community, from Sodom to Gopher Prairie or Zenith, the financial district is composed of good folk and bad. The great flareup of insolvent bucketeers last year dramatically warned each investor to make sure that his broker was honest

Virtue in finance is perhaps an elusive thing, but for pragmatic purposes, the unethical are those who do not perform their promises. In the final analysis, the difference between the good and the bad security vender simmers down to this: the legitimate broker intends to help his customer in the pursuit of making his money bear fruit, whereas the illegitimate speaks the language of helpful aid, while secretly knowing that his advice will inevitably lead to partial or complete loss.

This distinction seems too elementary to require articulation, yet in the world where stocks and bonds dwell there is unending confusion regarding this point. The undiscriminating speculator who acts on the suggestion of a well meaning broker and buys a stock which obstinately declines and effaces his margin when he hoped for a rise and facile gains, becomes irreconcilably angered at his financial advisor and agent. He considers the unwise broker who gave advice about a highly speculative matter, where the element of risk was high, quite as reprehensible, in a moral and an economic sense, as the swindler who knowingly sells absolutely worthless securities. The cautious broker will not give advice about future price movements indiscriminately and some never will, but where a prediction is made in good faith, however unwisely', the broker meant well at any rate.

Hell and the backdoor steps of Wall Street, may be paved with good intentions, yet the law recognizes intent as a factor in the determination of fraud.

Many ill meaning promoters, who take from the unknowing laymen from $500,000,000 to $1,000,000,000 every twelfth month, according to scientific guessers, cleverly avoid statutory fraud.

To protect the babes in the woods, some forty' states have passed so-called blue sky laws to bridge the gap between old fashioned swindles and new fangled promotions that elude the criminal law yet end in failure. Such laws are rather heavy handed attempts to remove the tonsils with a woodman's axe, yet they have accomplished some good, especially in forcing the withering light of publicity on enterprises that flourish only in the darkness.

Such legal experiments, which have developed within the last decade, have been supplemented by the voluntary efforts of intelligent business men who recognize that the public confidence in all men of finance would be impaired if the Robin Hoods of the investment world remain unchecked in their brigandage. This consciousness has resulted in the formation of so-called Better Business Bureaus throughout the country, whose efforts are co-ordinated by the Vigilance Committee of the Associated Advertising Clubs of the World. Moreover, Chambers of Commerce and Rotary Clubs, as every reader of Babbitt knows, have particularly within recent months, added their voice to the great national swell of protest and warning which has risen up against the fakir in finance.

Where the business man, either individually or in associations, undertakes to set up standards of conduct, he imposes on himself and his colleagues the obligation to make their own methods above reproach. There is a danger of cultivating an attitude of smugness and a "better than thou" feeling in the present movement, which, however, can render immeasurable public service in raising the red flag before the new investor unfamiliar with the pitfalls.

For the layman it is unwise to take calomel without a physician's prescription and equally hazardous to convert cash into securities without competent advice. And with bankers, trade associations and periodicals ready and able to advise him, the investor can readily safeguard his interests. Attaining safety of principal and regularity of income, which are the two-fold purposes of an investment, is feasible. A more difficult activity is waxing rich through the speculative process of correctly gauging price fluctuations, which depends on long range foresight concerning the ebb and flow of trade.

Speculation, in which the motive is large gains rather than a secure income, involves the assumption of risk, and is a necessary' part of the economic life under the present organization of society. If Socialism prevailed, the State itself would have to become a monopolist speculator, absorbing the shocks of trade fluctuations and assuming the risks growing out of the probable size of the wheat crop and the taste of middle aged women in hats during the following season. Speculation cannot be abolished by law, and to do so, if feasible, would be most undesirable. If those endowed with enough capital and intelligence to undertake the hazards refrained from speculating, some means of compelling them to do so would have to be invented. For industrial progress depends on incessant experimentation and the eternal will to pioneer, both of which involve great risks for capital. Speculation should be shunned like a plague by those financially and temperamentally unable to stand losses and to make independent decisions, but as a luxurious pursuit by the favored classes it is an essential part of the present day game, which the academically inclined dub economics.

PREJUDICE, emotion, and superstition play a part in the great marketplaces of the world where prices of securities are determined. If pure reason were the only factor, future quotations could be forecast with greater certainty. The price of a security which can be bought at an organized public market ought to be a reflection of what many individuals in all parts of the country or possibly of the world think it is worth. The relative yield is an excellent rough index to the relative intrinsic value of securities. But sometimes the low yielding bond, in which the public confidence has been high, will falter and eventually default, whereas occasionally the high yielding share or bond, about which public uncertainty had been marked, will perform the letter and the spirit of the indenture. If these surprises and anomalies were non-existent, the job of acquisition and investment would be automatic and devoid of interest.

As a class, foreign bonds arc at this writing quoted at prices that give a larger return to the investor than domestic bonds. In this mass judgment of security buyers, there is a large element of sane thinking and practical realization of the political risk involved in many securities of alien governments. Yet unquestionably', that most ancient of folkways, suspicion of the foreigner, is also a factor.

In spite of the fears stirred by the collapse of Central and Eastern European countries, there is no good reason for anticipating that all the world outside the borders of the United States will cease to function and stop meeting their obligations. Obviously, the financial breakdown of Germany has a profound effect on a country such as France, which had been counting heavily on reparations as a means of making her budget balance, and upon Belgium and Italy. Yet even those countries, whose likelihood of repaying their loans from the United States Treasury in the near future may have passed, are facing no substantial difficulty, present or prospective, in meeting their interest payments to individual investors in the United States and elsewhere who hold their external obligations. There has recently been something of a flight from such bonds, in which of course there has been some risk.

There are external bonds of other countries, which are not affected directly by the reparations tangle and, if affected at all, only remotely. Bonds of Canada, the provinces of Australia, particularly Queensland, Great Britain and Ireland, Argentine, Switzerland, the Netherlands, Denmark, and Sweden are among the better of the alien issues, d he obligations of Bolivia, Brazil, and Chile are little swayed by the financial status of Germany, but their market price reveals a degree of reservation regarding them on the part of the pursuers of safety. There are indications of improving credit in South America, where the ability to pay seems ample. Willingness to pay in certain of the Latin American countries has been less manifest than in Europe, but the economic desirability of a good credit rating is an expanding factor making for safety. Holding a foreign bond involves the necessity of keeping in touch in at least a general way with changing economic and political conditions, but there is ample justification in the larger return offered for including a proportion —perhaps one fifth—of one's investable funds in the more substantial foreign issues.

Continued on page16

Continued from page 14

DAY to day commentators have for many months been pointing to the imminent collapse in Germany. The breakdown is unlikely to come on any particular day, but is a gradual process of financial deterioration. National bankruptcy is feared, yet technical bankruptcy for a nation is perhaps a contradiction in terms.

Germany needs to free itself from the chaos of a currency fast dashing towards worthlessness. Theoretically, the mark can decline until it reaches a phase when storekeepers will no longer exchange meat, and vegetables, and clothing for the present paper marks. Money is expected to serve as a standard of value and a medium of exchange. The mark, because of its excessive fluctuations—it has lost as much as fifty per cent of its value in a week—has already ceased to be an effective standard of value. It seems to be approaching the stage where it will no longer serve as a medium of exchange, If such a condition should arise in Germany, foreign currency—sterling, dollars, or any more staple foreign currency—is likely to serve as a temporary standard until a new Teuton unit is invented.

Unscrupulous brokers helped Germany to finance itself for nearly four years by urging foreigners to buy marks or mark bonds and hold them until their return to par. There is nothing in historical precedent or in the present facts to warrant such an absurd expectation. Recently more marks have been issued in a week than in a generation before the war. The new mark is similar to the pre-war mark only in name. It no longer bears any rational relation to the productive power or to the gold holdings of Germany. Inflation—the unrestricted printing of irredeemable currency—has kept the nation alive during these transitional years, but its continuance as an effective means of national economy cannot be expected much longer.

If an effective moratorium on reparation payments can be obtained, Germany will be "free to set out upon the precarious task of devising a new unit of currency, Countries in the past have survived the collapse of their currency, but the case of Germany is complicated by the excessive speculation in marks by foreigners. More or less deliberately, whether of necessity or not, Germany has been pouring out unlimited quantities of marks, liquidating national good will and credit. It will be interesting to observe how long it will be before capital, always timid, will regain confidence in Germany's future promises, as revealed in currency and securities. The United States escaped from the odium of the worthless currency of the colonies; France from the valueless assignats toward the end of the eighteenth century and the beginning of the nineteenth; and the South from worthless Confederate currency. A financial collapse does not necessarily involve lasting economic ruin.

NINETEEN twenty-two was a year of rising commodity prices, and there is no reason to believe at this writing that the peak has yet been attained, Bradstreet's index, which gives an average picture, reveals that prices of things in general rose 21.2 per cent during the first eleven months of 1922, and 29.7 per cent from the low level reached during the downward reaction culminating about the middle of 1921. This story is corroborated by the other statistical devices for measuring price shifts. Gains in the nation's gold holdings, which increased $1,000,000,000 in the last two years, have no doubt been a factor in the upward tendency of prices, which has been an expression of the recovery in trade. The situation is further reflected in expanding bank loans, extraordinarily heavy freight traffic, increasing productivity and fuller employment of human workers.

Despite the prospects for minor price reactions during the winter, some of the financial soothsayers, such as the Standard Statistics Company, are predicting distinctly higher wholesale and retail prices for nineteen twenty-three.

The speculator in securities will watch the trend of commodity prices closely, for a moderate further rise will foreshadow prosperity. A precipitate rise up to the fantastic heights reached during the post-armistice boom ending in June 1920 would, however, mean a secondary inflation, whose ultimate results would be equally as disappointing as the previous bubble-like period, which was followed by the swiftest price decline in history. Stable prices an equilibrium would mark a new normal, on which enterprises could base their calculations with a greater degree of certainty. Falling! prices, on the other hand, would involve the repetition of the earlier depression, in which tremendous losses in inventories would have to be written off and trade would become stagnant as the various factors in business would wait timidly for further declines and cheaper prices.