A Lesson in Civics
by Charles A. Beard - 1937
I am much perplexed about the copy-book axioms that I learned in Economics A-l and A-2. To what extent are they now valid in practice? Do contemporary economists check their axioms against such practices as those revealed by the Wheeler subcommittee? If so, don't they find their beautiful structure of economic logic somewhat askew just now? And how are civics teachers going to make all this plain to youngsters preparing themselves for the duties of American citizenship? One more question: are addresses on Patriotism enough?
ABOUT forty years ago I took courses in Economics in which I learned a number of propositions. Capital is wealth devoted to the production of goods. Capital comes out of savings. Interest on capital is the reward of saving, of abstinence. The function of capitalists is to furnish, directly or indirectly, the resources out of which enterprises build plants, railways, ships, and other facilities for the production of wealth. Banks act as mediators in accumulating deposits, making loans, and issuing securities for the purpose of setting productive processes in motion. Capital applied to construction and operation employs labor aids in the production of wealth. The business of a railway company is to build and run railways, and it is controlled by its stockholders who have put their money into the undertaking. Securities are floated with a view to securing capital to be applied in constructive and operative enterprises. The function of a stock exchange is to offer an open market in which securities may be bought and sold; that is, a place in which people with securities money to invest their money with some degree of assurance. All these transactions generally redound to the good of e everybody, and the duty of government is to let them alone.
To what extent these propositions are now taught in courses on civics and economics, I cannot say out of knowledge, but judging by the writings and speeches of many contemporaries they are still widely accepted as axioms.
About two months ago I began to study the galley proofs of the testimony offered at the hearings of the United States Senate sub-committee engaged in investigating railways finances under the chairmanship of Senator Burton K. Wheeler. In the testimony there presented by bankers and owners of railway securities I read about a number of things that did not square with the axioms I had learned long ago in Economics.
ECONOMICS IN PRACTICE
In this record I discovered that while capital may be wealth it is not always devoted to the production of goods. The man or company that gets possession of it may devote it to speculating on the stock exchange in the stocks of some concerneven in its own stocks. For example, a certain corporation issued through a subsidiary of a New York bank a block of gold notes" to the amount of $30,000,000. These notes were sold to investors and banks to raise capital. The managers of this corporation, on receipt of the proceeds, got in touch with a firm of stock brokers and used the money in buying and selling the stocks of another corporation which they controlled. In the investors of time the "gold notes" went sour, and the investors lost about half the amounts they had severally "invested. They ceased to receive interest, that just reward of abstinence.
The story did not end there. The managers of the corporation did not give -up the ghost. On the contrary, they went to another New York bank, one of the biggest and most celebrated in the city, and through its good offices borrowed more than $39,000,000 from a banking syndicate. Before long they defaulted on this loan, and left the bankers holding the bag, with a block of paper put up as "security." Later the bankers auctioned off this paper for a little more than one-tenth the face value of the loan.
That looked strange enough; but the story continued. One of these two enterprising managers (the other had died meanwhile) induced some friends to organize a new corporation, called the Mid-America. This new company bought the block of securities sold at the above-mentioned auction. It bought them for about $275,000 cash down, and raised the cash by borrowing from a New York bank.
Now it happened that these securities bought at auction by the Mid-America Company controlled through voting power a large number of other companies, including railway concerns controlling more than twenty thousand miles of track age. Having this huge economic empire in its hands, the owners of the Mid-America Company turned to the aforesaid enterprising manager and gave him control over its empire on an "option," by which he was to pay $8,250 sometime within the next ten years. He did not put up any money. He just took the option, and by this action recovered dominion over property once estimated to be worth $3,000,000,000. Then unfortunately for him, he died suddenly of heart disease, leaving the bewildered organizers of the Mid-America Company in possession of the three billion dollar empire. What will become of it now, no one can foretell exactly.
So it would seem that in this particular case abstinence and skimping to save did not receive its reward. Nor was all the capital raised through the mediation of banks used in productive enterprises employing labor and creating wealth. Nor indeed did the banks and their subsidiaries lend the money entirely for this purpose, for they knew that at least a large part of it was applied in stock speculation. If those who floated the thirty million dollar loan did not know that it was to be so applied, those who lent the thirty-nine odd millions knew that they were "bailing out" the speculators after things had gone wrong.
THE "FAIR AND OPEN MARKET"
Let us look next at the stock exchange axiom: the exchange furnishes a fair and open market in which supply and demand adjust the prices of stocks and bonds. The stocks in which the two speculators operated extensively were listed on the New York stock exchange. Only securities that have been "listed" can be traded in there. The exchange is controlled by a board of governors, which operates through various committees. Among the committees is one on listing. Now the exchange will not list just any stock that is offeredwildcat oil stock, for instance. Its agents inquire into the merits of the concern whose stock is offered for listingthat is, inquire with more or less care and interest.
It so happened that the stocks in which the above-mentioned speculators operated were "listed on the big board in New York." About the time one of the issues was listed, the New York bank that floated it gave several members of the governing body of the stock exchange and a number of lawyers, bankers, and politicians a quiet chance to buy the stocks at $20 a share, which was about $15 less than the price at which they were offered to the public in general. In other words, "insiders" bought their shares at a lower price than investors at large.
But it may be asked, what has government to do with all this? The answer is evident on second thought. Nearly all these transactions were made by corporations, or men in control of corporations. And corporations are creatures of governments, of state governments in this case. The two enterprising speculators, to whom reference has been made, organized a veritable pyramid of corporations under state laws, loosely drawn and loosely administered. So it might seem that if governments are to let business alone they might stop chartering corporations, artificial persons, and endowing them with vast and undefined powers. If they do not stop creating such corporations, they might at least see that such concerns do not rob the public. Or would that be a violation of natural law?
One more point deserves examination: the business of a railway company is to run a railway. So it would seem. But what about a holding company that owns a company that owns a railway? In the case of the railway empire here under consideration, one of the companies that controlled a railway organized another company, ordered it to buy some real estate, and then ordered the real estate, sold to its company. The railway company was trying to pay this bill when it blew up and stopped paying interest on its bonds in which investors had put their savings to receive their reward of prudence and abstinence. So while a railway company may operate a railway, it may be controlled by a company that does not operate a railway and be compelled to do things that are not helpful to its railway business.
Hence I am much perplexed about the copy-book axioms that I learned in Economics A-l and A-2. To what extent are they now valid in practice? Do contemporary economists check their axioms against such practices as those revealed by the Wheeler subcommittee? If so, don't they find their beautiful structure of economic logic somewhat askew just now? And how are civics teachers going to make all this plain to youngsters preparing themselves for the duties of American citizenship? One more question: are addresses on Patriotism enough?