662. R. G. Hawtrey to Harrod , 24 April 1937 [a]

[Replies to 638 and 644 , answered by 700 ]

18, Elm Park Gardens, [London] S.W. 10.

24 April 1937

Dear Harrod,

I have delayed a long time answering your letter of 4th March, but you must not think that that has been from any want of appreciation. I have been very busy since I finished my book, and have not had time to consider your criticisms before.

On the subject of stocks of goods and the short-term rate of interest you say that "producers usually have a standardised habit of laying in stocks two or three months in advance, from which they seldom diverge", [1] and you dwell on the various reasons why they should be reluctant to go beyond this limit. But here I think you miss my point. If all consideration of the rate of interest be excluded, it may be that the producer will settle on the purchase of two (or three) months' supply as corresponding to the maximum buying convenience, and there will never be any inducement to buy a larger stock (except by way of a speculation or precaution against an impending scarcity or rise of price). But my argument is that it is very easy to buy less, and that the sacrifice of convenience involved in a moderate reduction will be very slight. [b] It may not even mean more frequent new contracts; if a contract for a given quantity provides for more frequent and smaller deliveries, the average stock and so the average indebtedness can be kept down. To reduce the consignments below a certain size may add something to the cost of transport and handling, but the case where the three months' supply is so small that anything smaller would not be an economical consignment hardly requires consideration. In general it is safe to assume that the consignments can be reduced a long way below three months or two months' supply at a slight extra cost.

And it can hardly be maintained that a "standardised" practice of taking two or three months' supply at a time will be proof against any increase in the charge for a resulting overdraft. It is fantastic to suppose that the trader when faced with an increase of charges will take no steps at all to reduce his overdraft, and, the moment he begins to consider the matter, a reduction of his purchases of goods for stock below his standardised limit will be the line of least resistance. If he has a reserve of marketable securities he can sell some of them, but, if many traders did this, there would be serious pressure on the stock market, and the consequent fall in securities would soon become a deterrent (to say nothing of brokerage and stamp duty). He can strengthen his cash position by withholding more profits from distribution, but this is a slow and possibly painful process. He can postpone works of extension, renewal and maintenance on his plant, but that is likewise slow and may not be practicable. And the position is the same whatever the original purpose of the overdraft may have been.

You confine your arguments to the case of the manufacturer, to the exclusion of the wholesale or retail dealer. Manufacturers are likely to be less responsive than dealers because a relatively large proportion of their stocks will be primary products or crude manufactures. But even their stocks of primary products will not be wholly insensitive to credit conditions. The manufacturer will probably make forward purchases of all the materials he needs for the output he has actually contracted to produce, but he is free to arrange for deliveries of the materials bought at whatever times and in whatever quantities he chooses.

I do not know where you got your idea of the producers' "standardised habit of laying in stocks 2 or 3 months in advance." I am quite sure a detailed investigation would disclose a wide divergence of practice, and that the practice of any one concern would vary according to the circumstances. Even if the intention were to adhere to a rigid standard, an estimate of two months' or three months' requirements would often be subject to a considerable margin of uncertainty, so there would always be some discretion as to the precise amount to be ordered. I should say that even if contracts are made for two or three months' supplies, deliveries are usually for less. That does not mean that the manufacturer's average stocks would be much less than a month's or months' supply, for his minimum stocks, including material in process and stocks of intermediate products between one process and another, may be quite large.

You do not suggest that the standardised practice applies to dealers in commodities as well as to producers. And, even if it did, their estimates of three months' sales would be much more conjectural than the manufacturers' estimates of three months' output.

I have just received a letter from an American concerned in the wheat trade, who points out that big dealers eliminate the risk of price changes by hedging. "Under the protection of hedging", he says, "change in the rate of interest is particularly important to the grain dealer," though not to the speculator, who does not hedge. This shows that I understated my case, in that I assumed hedging to be unimportant except in the case of the manufacturer. He adds that "at present in the States faith in the rediscount rate and in bankers' control of borrowing stands relatively high."

With regard to public works, [2] what I have written now is entirely on the lines of what I have written more than once before. Not only have I always recognised that there are arguments for public works in certain conditions, but I believe that I am the only economist who has ever stated what they are. My fellow economists generally ignore them as completely as they ignore my arguments on the other side.

I call the French expenditure of a hundred milliards out of borrowed money in seven years pitifully small because, while it is much more than they can properly afford, it has been utterly inadequate to start revival. It represents an average of about 40 millions of francs a day. If stocks of commodities in France amounted to 100 milliards (a moderate estimate) and if an increase of 10 per cent could have been induced in a period of 100 days that would have been at the rate of 100 millions a day. And 10 per cent would not be a large increase, nor would 100 days be too short an interval for it to be completed. It is possible that 40 millions a day might have been sufficient to stave off the depression in the early stages (provided the French currency had been cut loose from the pound and the dollar and gold, for otherwise any retardation of the depression in France would have been corrected by exports of gold). But it is just in the early stages that the procedure by bank rate (and possibly open market purchases) is likely to be adequate, without any support from Government expenditure.

You say that "we are agreed in thinking the effect of the long-term rate too delayed to be very effective in averting a slump promptly," [3] and you contrast my position, "averting the vicious spiral of deflation" with yours "preventing net investment {other than in public utilities etc.} falling to zero." You proceed to say that I still have two strings to my bow, the queue and the deepening process. But of course my view is not that the deepening process and the queue are the means of averting a slump when it threatens to start, but that there is no reason why the deepening process (of which the queue is merely a manifestation) should ever fail, except when a state of exceptionally deep depression already exists, as described in the passage on my page 79 [4] to which you refer. Under any other conditions the task of the investment market is not to find capital outlay to use up its available resources, but to find resources to finance the capital outlay.

You say in your letter of 26th February that "a small gap, if not filled, would lead later to a large one." [5] But the illustrative figures on my pp. 321-2 were intended to show that the kind of gap you are supposing would make very little difference to the strain on the deepening process. If the deepening process can fill a gap of 246 millions it is not likely to break down at a gap of 256 millions, or even 286 millions. If a state of depression, arising from some extraneous cause, were so severe as to interrupt the deepening process to a serious extent, it would be very nearly as likely to fail at a gap of 246 millions as at one of 286 millions. And if the failure of the deepening process arose not from a depression but from a real glut of capital, this would be equally true; the failure of the deepening process would be almost as likely to occur when the gap is rather less than usual as when it is rather greater.

If a depression started, as you suppose, by "a recession in the capital goods industries," [6] the investment market would find the supply of new issues falling off, and would endeavour to fill the gap by stimulating the deepening process. If the market succeeded in doing so, the depression would never begin; if it failed, and the gap continued, the first symptom would be a fall in the long-term rate of interest. This is just the reverse of what happens. At the turning point the investment market is strained by an excess of new issues and the long-term rate rises. It is only when the depression is well launched that the rate begins to fall.

In your letter of 4th March you remonstrate with me for saying that you "trace trade depressions to a deficiency of demand arising from an absorption of cash." [7] I hope it will be obvious to readers that this is my phraseology and not yours, for I have given my own definitions at an earlier stage. But you now say that, whereas you do not deny the occurrence of an absorption of cash, nevertheless you "claim that to be the consequence of the depression, which is itself traced to the interaction of the relation and the multiplier."

But by what process does the shortage of investment bring about the appropriate reduction of the consumers' income so as to conform to the multiplier? The answer is in the passage I quote on my page 323 from your page 74, [8] "net investment will be above what was intended owing to an undesigned accumulation of stocks", which "will lead to action intended to rectify matters." There will be an effort to reduce stocks, which will take effect in a decline of activity and of incomes. If saving were reduced by the same amount as capital outlay, the falling off of the latter would be compensated by an equal increase in consumption, and there would be no undesigned accumulation of stocks. But the excess of saving over capital outlay is an absorption of cash. It is not necessarily an absorption of cash exclusively by the investment market (I -  , in the notation of my Chapter VI) because there may be an excess of capital raised, , over capital installed, K -  . But for your purposes this latter possibility does not arise. For in practice it will be capital raised that begins to fall off first, and capital installed will only fall off after an interval. Thus the absorption of cash by the investment market is not merely a consequence of depression but is an essential link in the causal chain whereby "the amount of saving undertaken is accommodated to the amount of net investment through changes in the level of income" (your page 74).

You demur in your letter of 26th February to my statement that if "prices begin to soar and profits to get greatly inflated," [9] there must have been an excess of capital outlay over saving. But suppose there is no such excess. If capital outlay is equal to saving, then since saving is the excess of output over consumption, output is equal to capital outlay plus consumption. There is no shortage of output, no excess of demand to be met by disinvestment of stocks of goods, and no tendency to a rise of prices.

I enclose your two letters for reference, but I should like to have them back.

Yours sincerely,

R. G. Hawtrey

  1. 1. Letter 644 , [jump to page] .

    2. Letter 644 , [jump to page] .

    3. Letter 644 , [jump to page] .

    4. Hawtrey, Capital and Employment (1937).

    5. Letter 638 , [jump to page] .

    6. Letter 617 , [jump to page] .

    7. Letter 644 , [jump to page] .

    8. Harrod, The Trade Cycle ( 1936:8 ).

    9. Letter 638 , [jump to page] .

    1. a. TLS with autograph corrections, eight pages, on eight leaves numbered from the second, in HP IV-449. The first page bears the autograph indication: "I have the draft of this", initialled "RGH"; the autograph draft is in HTRY, file 10/49.

      b. Ts: «..».


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