Wall Street And Money
( Originally Published 1939 )
To understand the stock market, it would seem necessary to understand that money and credit are the primary pillars upon which the stock market rests. It thus seems appropo that the subject, both domestic and foreign, should be treated in a manner which should be fully comprehensive to the student and investor alike, before we turn our attention to such things as the selection of stocks, their analyzation, market trends and attempts at fore-casting. For to understand the function of money and credit throughout the world, is to gaze behind the scenes and penetrate what many people call the blinding fabric of finance.
According to the Encyclopedia Brittanica, the word "money" is believed to be derived from Moneta, an attribute of the Roman goddess Juno, because the ancient Roman Mint was established in the Temple of Juno Moneta. It is possible, however, that the goddess's attribute, Moneta, was itself derived from the use of the Temple as a mint.
Everyone will unquestionably agree that money is good for only one thing, and that is, as a medium of exchange. If people work and exchange their work for money, and then exchange their money for food and clothing, it is obvious then, that they are ex-changing their work for food and clothing. The money they receive is merely like a receipt, to be parted with again for food and clothing.
In order that one person's money or receipt will buy as much as his neighbors, we have what are known as exchanges, or organized markets. Let's make this clear by an example: A man lives in a primitive state of society. His chattels consist principally of goats. He wishes to take unto himself a wife and he wishes to present her with a string of beads. He is willing to exchange one goat for the string of beads. The owner of the beads wants the goat, so their mutual wants are sufficient to bring about the exchange.
Now, in organized markets, the man with the goats can make a comparison of what people have to offer for his goats. It may be possible that he can find someone who will give him two strings of beads for his goat, or, conversely, the man who wants the goat may get a better offer. He won't exchange his beads for one goat, if someone else offers him three goats. It may be that his beads are very valuable, and someone offers one cow, two dogs and a cat. How is he to decide among all of these offers?
He cannot decide, unless he has at hand a common basis for comparison of the others. How can he get this common basis? Only by having one of the articles in which they are exchanging, act as a medium. If everything which is brought to a market was exchanged for a certain or stipulated amount of the article agreed upon, then the desired comparison becomes possible. This being so, no one will offer more for a certain product than his neighbour. Thus when you have an organized market, the terms on which, at any one time or place where exchanges are made, are equalized.
In such markets every goat has his price, the quantity of the article for which his owner will exchange him. In simple definition, we will say that price is a definite quantity at a given time and place; because, in virtue of the equalizing effect of the market, similar things do not exchange for different quantities of the medium. In other words, two goats of similar quality and weight would exchange for the same number of beads, not one goat for one string, and the other goat for two strings.
The comparison by the owners of the goats, which were exchanged, is a comparison of prices. Once the exchange has been made it then ceases to play any part in the competition of the market.
In all markets of the world, to quote a price is to make an offer. When any one accepts the offer it creates an obligation on the part of the one who made it to deliver the goods. It also creates a debt, from the man who accepts the offer, to the man who made it. How is this debt to be paid?
Down through the ages, precious stones, metals and then money came into existence as the ideal medium of exchange. Through this medium the debt between the two men making and accepting the offer is discharged. It is the unit in which the price is reckoned; the ultimate measure of value.
But different markets have different kinds of money you say, and how can this be reconciled? It can only be reconciled when the qualities used, in the medium called money, are the same. If it is to function well it must be so uniform and perfectly graded that it can be counted or measured without individual scrutiny.
If you are dealing in small things in the market, and there are small differences of values between the things dealt in, then the medium, money, must be subdivided. If goats were the only money, then nothing less than a whole goat could be bought or sold, and, on bargain day, you would have to raise or lower the price by a whole goat at the time.
So the medium had to be something which everyone could carry back and forth, educated and ignorant alike, for not all could hope to be specialists in the medium for which they were exchanging their wares. Again, the medium had to be something which was portable, and could be distinguished from imitations. If a man sold his entire herd of goats, possibly he needed nothing else at the moment, hence the medium must be something which would keep until he was ready to exchange it for his wants. To find some-thing which would keep, necessitated finding something which was not only durable, but would not be subject to decay or destruction.
Down through the ages, first one thing and then another was tried, and it was finally and almost universally decided upon, that the qualities demanded in the medium could best be combined in gold and silver.
This medium was used for hundreds of years, and as trade in-creased, the demand became evident that a substitute was needed which carried with it the same maximun of safety, and yet, would not be so bulky. Thus paper money came into existence, and made legal tender for a specified amount of the money of account, in varied denominations. The paper itself is merely a token or tickets which entitles the bearer to pay debts to the amount of their specified denominations. Some are issued in large denominations, be-cause it is obvious that coins would be entirely too bulky, and others in low denominations, for coins would be inconveniently small. In other words, one hundred dollars worth of silver compressed into one coin would be inconvenient, as would twenty dollars worth of quarters.
With paper money, as well as gold and silver, a common de-nominator was needed. What might be a silver dollar in Mexico might be worth only fifty cents in the United States. So each nation sets up what is known as a monetary unit. That is, a pre-scribed weight of gold or silver is equated to a certain coin. Gold and silver is dealt in, in every market, hence the prices of other commodities simply represent the terms on which they can be exchanged for gold or silver. Paper money, itself, may be so regulated that the monetary unit is the equivalent of a fixed quantity of gold or silver. For example, it may be made convertible, on demand, into coin.
At the moment, many countries, including our own, are off of the gold standard, but, as a rule, all countries using paper money have always endeavoured to maintain its convertibility into metal. From time to time some of them have lapsed, but they have always aimed at reestablishment. A metallic standard is the universally accepted monetary policy, and departures from it only occur during times of emergency.
We know, however, that some of them have departed, and it has taken years before the theoretically normal standard has been restored. In such times, when the monetary unit is represented by nothing more substantial than a printing press, what is the significance of price? In what terms does price measure value? This question is fundamental in the theory of money. Germany itself was an outstanding example of paper money, when, according to one eminent authority, the entire German national debt of fourteen billions, in 1913, could have been paid with one American penny in 1921.
If it was possible that every exchange, in all markets, could be settled every day, that is, where there would be no outstanding debts until the following day, then it would make very little difference as to the absolute value of the unit. Prices would correspond daily to the things exchanged. But this is not possible. In our modern life, not only are debts left outstanding every day, but also balances of money are kept on hand for indefinite periods. If the value of the unit changed from day to day, there could be no such things as mortgages, stocks and bonds, savings accounts and life insurance policies.
So every creditor, and every man who possesses money, irrespective of how little, is primarily concerned with the value of the unit in which he must pay his debts, or collect debts owed to him. Essentially this unit represents purchasing power.
Purchasing power naturally varies with the price level. What is this price level, you ask? Personally, I think it admits of no exact definition or theoretically perfect solution. Technically, the price level of all products is settled in the same way as the price of any one of them. Prices are determined in the market. A man who finds the sale of his product increasing and his supply de-creasing, raises his prices. If he finds his sales falling off and his supply increasing, he lowers prices. The higher the price level, then the lower the purchasing power of the monetary unit. The lower the price level, then the higher the purchasing power.
We can accept it as almost infallible that the relation between the price level and the monetary unit, is the relation between the supply and demand of the monetary unit, money. If money is plentiful the price level rises, if money is scarce the price level falls. For it is obvious that the price level is determined by the amount of the consumers outlay.
Remembering the influence that the price level has on the value or the wealth of the monetary unit, expressed in purchasing power, and that the value of the unit can be fixed in definite terms of gold and silver, how are we to reconcile these two almost paraxodical processes? Naturally, payment by weight automatically equates the monetary unit to a specified amount of money.
However, there is another side of the picture. Vast quantities of gold and silver are used in the industrial and commercial world, and how can this be reconciled with money? The answer is, that the quantity of metal, gold or silver, used in the coining of money, will automatically adjust itself with the market value of the monetary unit.
At times, coin or money is diverted from monetary use to industrial use, and vice versa, that is, from industrial to monetary. If, in the latter case, the monetary, the market price of the metal must fall to the coinage price, and if in the former case, the market price must rise to the melting point of the coin. I mean by this, that if the metal in the coin is worth more than the value for which the coin will pass, then it is said to be at the melting point. On the other hand, if an article which you have contains a full ounce of gold, such as a gold plate, and the ounce of gold is worth $35.00, and the plate only $25.00, hence we can see that the plate is at the melting point for monetary use.
Many coins are imperfect and this also effects the coinage price at the melting point. However, if the coins in circulation are imperfect, it doesn't mean that one melting point is applicable to all coins. Quite naturally the bullion taken from the most perfect coins would command the highest price, and thus, when coins reach the melting point, it can be expected that the most perfect coins will disappear first.
Any issue of debased or light coins, that is, coins containing less than the prescribed amount of the standard metal, when added to the existing stock of money, has the effect of depreciating the unit.
We can assume that the monetary unit in terms of gold and silver is constant, but that does not necessarily mean that its value in terms of wealth in general is always constant. Like any other commodity, the standard metal may be exposed to variations of price, not in accordance with the general trend of the price level. More than this, it is also exposed to special influences on account of the very fact that it is used as money. Every country which uses gold or silver as its monetary standard, provides a market for the metal at the coinage price, and holds a stock of it, in the form of bullion, coins in circulation, or reserves against paper currency.
In modern times a metallic standard has come practically to mean a gold standard. To any one country, a gold standard means stable rates of exchange in others. There are three different methods of securing this end: First, a standard based on the free coin-age of gold, which is called a specie standard. Second, one based on the convertibility of paper money into bullion, which is known as a gold-bullion standard; and Third, the one which is known as a gold-exchange standard.
The last, which seems to be the most desirable, is the principle of converting currency not into gold but into foreign currencies. For this standard presupposes the existence somewhere of a gold-bullion or a gold-specie standard.
People do not want gold for itself, but in the present day and time, with people trading with each other in every part of the globe, they need gold to sell abroad, so that they can get foreign currencies. It is obvious that if they can get foreign currencies without gold, they do not require or demand it. Thus a country which has the gold-exchange standard not only has the advantage of practically interchanging currencies, but also the advantage of holding interest-bearing assets in place of idle gold.
Many countries have temporarily abandoned the gold standard, through economic pressure, but the line of demarcation is somewhat different than in countries having had to leave it because their currencies were debased.
Our present Administration felt that the big factor contributing to a low level of commodity prices was the existing monetary system. As you will recall, it was a campaign promise that commodity prices would be raised, and President Roosevelt sought to accomplish this by depreciating the value of the dollar.
How was this to be done?
First, you will recall that all gold, and all gold certificates, held by anybody in the country, were called for delivery to the Secretary of the Treasury, by the Emergency Banking Relief Act of March 9, 1933.
Second, the gold clause in all Federal and private banking obligations were cancelled, and obligations were made payable in legal tender by the Gold Repeal Joint Resolution of June 5, 1933. All coins and currencies of the United States, including Federal Re-serve and National bank notes, are now legal tender.
Third, the President was authorized by the Gold Dollar Reserve Act of January 30, 1934, to revalue the dollar at fifty to sixty percent of its existing statutory gold equivalent. The Act declared an end to the coinage of gold. Henceforth the metal is to be held in bullion form in the Treasury, as backing for paper currency.
In accordance with the provisions of the Gold Reserve Act, the President announced on January 31, 1934, the devaluation of the dollar to 15 5/21 grains, 9/10 fine, which was a devaluation of approximately forty-one percent. The official price of gold was set at $35.00 per ounce, as against the old coinage parity of $20.67. The President still has power to further devaluate the dollar.
It is now possible, to see with greater clarity, why the gold plate with its ounce of gold rapidly rose to the melting point, with gold worth $35.00 an ounce, against an old parity of $20.67.
When discredit has brought depreciation of the unit beyond a certain point, a restoration of the former gold value becomes impossible. The gold standard can only be restored by devaluation, the adoption of a new parity, not differing by much from the existing gold value of the currency in the market.
In the Middle Ages devaluation was common, especially when the imperfection or debasement of the coin led to a depreciation of the unit, and a restoration was deemed impractical or undesirable.
In this day and time, however, it is sometimes denounced as being something like a fraud which robs the creditors of their just dues. This is a misapprehension of the real nature of the monetary standard.
The fact remains that the equivalence of the monetary unit, as to a specified weight of gold or silver, was established by law, and hence it can be altered by law. Nevertheless, when the depreciation is not so great as to make a return to the old parity impracticable, there are many advantages in reestablishing it. The old parity commands a confidence in a way that no new parity can do.
The process by which a currency is raised in value, either to its former gold parity, or to a new parity, above its existing value, is called deflation. Deflation requires a dimunition of the consumers income and the consumers outlay, and this is usually effected by means of a contraction of credit or similiar measures.
The shrinkage of demand, and the consequent fall of prices, have a paralyzing effect on business, causing trade depression, unemployment and bankruptcies. It is on account of these injurious consequences that the value of a currency unit can only be raised to a very limited extent.
With money occupying such a vital part in our social and economic structure, it naturally finds its expression in a market the same as any other commodity, This market is known as the "money market", and is sometimes used to include the whole machinery of finance, from the Stock Exchange to the instruments of company promotion. In the technical sense of the word, however, it is usually confined to organizations which provide credit of short duration. These include banks which make advances for short periods of time; discount houses which buy and sell bills of exchange; accepting houses, or, better known as merchant bankers, which operate with banks in providing the trade with first-class bills, by endorsing or guaranteeing them for a small commission.
The undisputed headquarters for the American money-market is New York City, and while there are subsidiary centers, such as Chicago, St. Louis, and San Francisco, they are secondary markets, and are not sufficiently large enough to attract any large sums of funds. The principle requisite of a money-market is based not only upon the opportunities for the profitable employment of capital, but the facility with which it can release funds when the occasion demands.
New York City seems to be the focal point which provides both the opportunity for employment of funds and the facility to re-lease them. Security operations in New York requires stupendous sums of money, inasmuch as all large-scale governmental and private business corporations use the New York market to float their securities. The annual offering of new securities amounts to nearly ten thousand millions of dollars.
Between the time, or during the interim, when the securities first appear, until they are absorbed by the investing public, large sums of money are needed, and these sums are normally borrowed. For instance, a corporation contracts with an underwriting group to market its five million dollar bond issue. The corporation is usually paid a specific price for its bonds, and until the underwriters resell these bonds they borrow the money with which to pay the corporations. The aggregate of these sums run into hundreds of millions of dollars each year. Speculative operations in the stock and bond markets, especially when they are conducted on a marginal basis, likewise require billions of dollars.
Leaving the security field, we turn to commercial paper, and, once more, we find New York the headquarters for the nation. The largest dealers in bank acceptances have their quarters there. Nationally-known firms who manufacture various articles, ranging from mouse-traps to automobiles, sell their paper as fast as it is created to acceptance dealers. The dealers buy these acceptances, pay for them with borrowed funds, and then turn them over to any bank, firm or individual, who has money to invest. It's something like skinning the cat to get its fur, feeding the carcass to the catfish, and then feeding the catfish to the kittens.
The American Foreign-Exchange market is also in New York. Interior banks do not. have enough business to justify their own foreign department organizations, hence they rely on New York houses. The aggregate of this business from all over America constitutes a mighty stream.
There is nothing particularly complicated about foreign ex-change, nevertheless, few investors of my acquaintance seem to be initiated in its function. I believe, therefore, that more than passing mention should be made about this subject.