Charles H. Schmidt

Ralph A. Young

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the
National Bureau of Economic Research
Volume Title: The Effect of War on Business Financing: Manufacturing
and Trade, World War I
Volume Author/Editor: Charles H. Schmidt and Ralph A. Young
Volume Publisher: UMI
Volume ISBN: 0-87014-325-5
Volume URL: http://www.nber.org/books/unkn43-3
Publication Date: 1943
Chapter Title: III. Postwar Liquidation
Chapter Author: Charles H. Schmidt, Ralph A. Young
Chapter URL: http://www.nber.org/chapters/c5863
Chapter pages in book: (p. 75 - 82):. POSTWAR LIQUIDATION
ne .of the strategic factors influencing the course of business ac-
vity is corporate asset investment. The average rate of dollar
[vestment in new assets —especiallyinventory and fixed prop-
'ty —ofour several samples was exceptionally high, during the
Torid War I expansions. The dollar volume of corporate asset
ivestrnent was greater for manufacturing and trade companies in
)20 than in any other war expansion year; yet by the middle of
J20 business recession had set in, and by the end of the year a
quidatIon bordering on panic was in process.
Six factors appear to have been vitally important in the financial
tuation ofi 920 —commodityprices, inventory, short-term busi-
ess debt, foreign trade, stringency in the money market, and corn-
Litments and cancellations. During the spring of that year, the
rst three were carried to levels substantially higher than those of
[ovember 1918 by what the Federal Reserve Board described as
an unprecedented orgy of extravagances, a mania for speculation,
verextended business in every part of the country, and general
emoralization of the agencies of production and distribution."6'
Legarding foreign trade, the dollar volume of exports and the bal-
nce of foreign trade attained record levels for the entire period
the two World Wars. The dollar value of manufactured
xports in many industrial lines, e. g., automobiles, textiles, ma-
hinery, and the like, was twice as great as it had been in igi8.
Stringency in the money market, the fifth factor, was partly at-
ributable to the sustained outflow of gold that followed the re-
aoval, in June 1919, of the wartime embargo on gold exports, and
ontributed to the sharp reduction in reserve ratios of Federal Re-
erve Banks; the stringency was accentuated by heavy demands for
redit to carry speculative positions in primary commodities and
ri securities. The last factor, commitments to buy and sell and can-
ellatiori of orders, was a phenomenon associated with the postwar
)rice advance, speculative inventory buying, transportation bottle-
tecks and the unprecedented expansion of foreign trade.62
While confidence in continued prosperity dominated the public
tatements of business leaders at the opening of 1920, there were
ome in high financial and business circles who ,viewed the entire
1 Federal Reserve Board, Annual Report for 1920, p.
2Seeabove, p. 40.
75national situation apprehensively, a fact attested by the increase i
the discount rate on commercial paper of the New York Federa
Reserve Bank on January 22 from 4.75 to 6 percent. In a numbe1
of important lines of activity there were signs of extreme tension
and misgivings over business prospects were openly
Confidence received a setback in April, when a sensational collaps
of prices took place in Japanese markets; again on May 3, whet
John Wanamaker offered $20 million of "best merchandise" at
20 percent markdown; and again on May 29, when the New Yorl
Federal Reserve Bank rediscount rate was raised to 7 percent, thi
highest in its entire history. Price recession spread from one
to another, and with price recession there developed a glut of inven
tory, an extensive cancellation of orders, a scramble to liquidat4
current assets; and pressure from short-term creditors for repaymen
of debt. Speculative excesses had been widespread, and in certair
indus&ies —automobiles,textiles, rubber, paper, retailing am
wholesaling, for example —financialoverextensions were numet
ous and in some cases conspicuous.
While profitable operations and asset expansion were the rule fo:
the majority of manufacturing and trade corporations in 1920
widespread losses and contraction characterized 192 i, when the ful'
effect of deflation was recorded in business accounts. The financia
history of the year was written large in total asset shrinkage, inven
tory liquidation and write-downs, bad debt write-offs, short-tern
debt retirement, and operating losses. Industrial production was i
percent lower in 1921 than in 1920.64 The index of wholesale com
modity prices, which averaged 222 for 1920 as a whole (1915=100)
ended the year at 174 in 1921 it averaged 140 and stood at 134 a
the year end.
Not only did the drastic fall in prices bring direct
losses; responsible concerns assumed additional losses by
excessive commitments to buy and by accepting cancellations o
orders (too often dupliéates of orders placed with other companies
rather than enforce contracts and run the risk of converting order
to sell into bad debts.65 Cancellation of orders from abroad, and un
collectible foreign debts, were damaging. One con
63 For an interesting account of the strains characterizing this period see Payne, op.cii
64Babson's index of the physical volume of business activity.
65 See above, p. 40.
76emporary commentator estimated the floating debt of Europe to
rivate American creditors at $3.5 billion.06
The charts previously presented indicate the main features of
'he i 92 0-2 i financial contraction.
nventory Liquidation and Write-down
ust as the increase in business assets resulting from the inflation of
nventory was greater in the wartime expansions for large conceits
han for medium and small corporations, so the decrease in assets
rom inventory liquidation in the postwar collapse was greater for
arge companies, and greater for those in trade than for those in
anufacturing. For three of our industry-size groups, funds ob-
ained through the sale of inventory represented a larger propor-
ion of total assets in 1921 than in either of the subsequent peace-
ime contractions (Table 8); the exception was the medium and
manufacturing group, for which the contraction of 1930-32
as the most severe in its effects on inventory. These funds from
of inventory, and others obtained from the liquidation of
assets, were applied to the financing of losses and the retirement of
current debt. Also the total inventory shrinkage through sale and
write-down, in relation to beginning-of-year inventory, was higher
ini 921 than in either of the later peacetime contractions,°7 the
smaller manufacturing corporations again constituting an excep-
tion. The 192 i reduction in inventory was especially violent for
the large trade companies; in this group the book value of inven-
tory was almost cut in half during that year.
The then prevailing methods of pricing inventory —methodsap-
proximatinig the first-in, first-out procedure in manufacturing and
the retail method in trade —hadgiven rise to substantial book
profits while prices were rising. When prices collapsed these
B6 B. M. Anderson, "Three and a Half Billion Dollar Floating Debt of Europe to
Private Creditors in America," Chase Economic Bulletin (October 5, 1920).
B7 Reduction in the book value of inventory was not only substantial in total amount
butalso widespreadamong the individual companies in our samples, both in 1921
md 1922. For 1921 such reductions were reported by 65 out of 82 large manufacturing
corporations; by 51 out of 72 medium. and small manufacturing corporations; by 7
out of 8 large trade corporations; and by 23 out of go medium and small trade cor-
porations. For 1922 the figures are: large manufacturing,out of Si; medium and
small manufacturing, 40 out oflarge trade, 2 out of 8; medium and small trade,
17 out of go.
77TABLE 8—PERCENTAGE DECREASE IN BOOK VALUE OF
INVENTORY, AND INVENTORY REDUCTION THROUGH SALE
IN PERCENT OF BEGINNING-OF-YEAR TOTAL ASSETS a
. World War! Peacetime
Industry-Size Group
,Contraction Contraction
1930-32 1 1921
MANUFACTURING SAMPLES .
Large companies
Percentage decrease in bookvalue 22% 13% 1
Reduction through sale, .
in percent of total assets 5 2
Medium and small cos. (Wisc.)
Percentage decrease in bookvalue 4 15
Reduction through sale,
in percent of total assets 1 2
TRADE SAMPLES
Large companies .
Percentage decrease in bookvalue 43 13
Reduction. through sale, .
in percent of total assets 18 4
Medium and small cos. (Wisc.) .
Percentage decrease in bookvalue 14 10 1
. Reduction through sale,
in percent of total assets 7 4
a Seetext footnote 27. Percentage decrease in book value, here computed by the cc
pound interest rule, refers to decreases due to sale of inventory plus those due
writedowns. The figures for 1930-32 represent annual averages. For description
the samples see Appendix A.
methods brought about book losses, whether the decline in bo
value was recognized separately as a charge to incohie or surpi
or was buried in the cost of goods sold.
In the 1921 deflation inventory write-downs, treated asasepara
charge to surplus or to current earnings, were more common amoi
large than among small companies. Only 2 out of the 103 mediu
and small manufacturing and trade concerns in the Wiscons
sample reported revaluations in 1921, and only 3 during t]
entire three-year period While information on the wril
downs of large corporations is available only from scattered sourc
and for a small number of companies, it is known that of 64 lar
68 Whether these small proportions resulted from an absence of inventory specu
tion, from a conservative policy of inventory valuation, or from sheer ignorance
proper accounting practice, cannot be ascertained from the record. There is
to believe, however, that the third factor was more operative than the first two.
78ompanies of them included in our sample) 49 wrote off $187
illion in inventory book value during i 921.69 This huge write-off
imounted to 13 percent of the inventory book value of these corn:
anies at the begiflning of the year, and accounted for nearly one-
ialf of their total 1921 reduction in inventory book value. Not all
nventory write-offs incident to the postwar price deflation were
aken in i 921, however; 33 of thecompanies had taken a total
f $122 million in the preceding year, and 9 companies marked off
nother $35 million in 1922.
etirement of Short-Term Debt
he crisis in the commodity markets made business creditors anx-
ous to collect debts and debtors anxious about their retirement.
Within the single year, 1921, billions of dollars of short-term busi-
ness debt owed to banks and trade creditors were repaid. The
Jebtor-creditor tension prevailing in that year is evident from
Table 9, which shows the short-term debt repayments by our sam-
ples ini 921, in comparison with repayments in the two major
:bntractions of the postwar era.
Only one group, medium and small manufacturing companies,
[ailed to repay short-term debt to any significant extent in 1921.
Their repayments, however, were merely deferred one year: in 1922
their current debt was reduced by 25 percent, a reduction amount-
ing to 4 percent of total assets. Among the large manufacturing and
;maller trade companies the greater part of the short-term debt
retirement took place in 1921, but these companies too made fur-
ther reductions —17percent and 4 percent respectively —in1922.
The debt retirement of large trade companies was high in both
years —39 percent in 1921 and 29 percent in 1922.
There are three principal sources of funds for the retirement of
short-term business debt: first, cash "throw-off" or funds from cur-
rent operations, that is, net income before depreciation, depletion
and other non-cash charges; second, the liquidation of assets; and
third, the sale of stocks and bonds. Operating losses in 1921 greatly
reduced the volume of funds from operations: for two of our
industry-size groups —mediumand small manufacturing compa-
9 This information was obtained from investment manuals, through direct inquiry
to companies covered in our large corporation samples, and from the Hearings
before the Ways and Means Committee of the House of Representatives on the Reve-
nue Revision of 1941(77thCongress) Vol. 2,p.1150.
79TABLE 9—PERCENTAGE DECREASE IN BooK VALUE OF SHORT-
TERM DEBT, AND SHORT-TERM DEBT LIQUIDATION IN PERCENT
OF BEGINNING-OF-YEAR TOTAL ASSETS a
Industry-Size Group
World War I
Contraction .
Peacetime
Contractions
1930-32 19; 1921
MANUFACTURING SAMPLES .
Large companies
Percentage decrease in book value 39% 22% 20
Liquidation in percent of total assets 4 2 2
Medium and small cos.(Wisc.)
Percentage decrease in book value b 7 7
Liquidation in percent of total assets b 1 1
TRADE SAMPLES
Large companies
Percentage decrease iii book value 39 10 C
Liquidation in percent of total assets 8 2 b
Medium and small cos. (Wisc.)
Percentage decrease in book value 17 12 5
Liquidation in percent of total assets 6 3 1
a Seetext footnote 27.Percentage decrease in book value is here computed by ti
compound interest rule. The figures for 1930-32 represent annual averages. For d
scription of the samples see Appendix A.
b Increase of 1 percent or less.
cIncreaseof 4 percent.
flies and large trade companies —funds,from operations were
tive in that year. Even among the companies that reported ni
profitsc not all of the funds from operations were available for del
retirement, since corporate managements continued, for one reaso
or another, to pay cash dividends to stockholders; after the pa
ment of such dividends even the large manufacturing and smalh
trade groups had little or nothing left for debt retirement. Ti
burden of debt retirement fell largely upo
asset liquidation and new security sales. And since capital mark
conditions were not favorable to the sale of corporate investmen
and fixed property, or to security sales except by companies of ti
highest investment standing, most debt retirement came from liqu
dation of current assets. All our groups of concerns liquidated suc
assets in order to repay debt, a necessary procedure in the circur
stances, but one that somewhat depleted working capital.
The process of debt retirement in the World War I liquidatic
is detailed in Table io, which also gives comparable data for ii
8°ABLE 10—SouRcEs OF FUNDS FOR THE RETIREMENT OF
HORT-TERM DEBT, IN PERCENT OF BEGINNING-OF-YEAR
['OTAL ASSETS a
Industry-SizeGroup
World War I
Contraction
Peacetime
Contractions
1930-32b 1988 1921
h4ANurAaunNc SAMPLES
Large companies
I Fundsfrom operations 5% 6% 7%
Less: Cash dividends 3 4 3
Retained funds 2 2 4
Current asset liquidation 6 4
Security sales 2 c 2
Medium and small cos. (Wisc.)
Funds from operations —1 1 3
Less: Cash dividends 2 3 2
Retained funds —3 —2 1
Current asset liquidation V 4 2
Security sales c c —1
SAMPLES
Large
Funds from operations —1 8 11
Less: Cash dividends 2 5 6
Retainedfunds —s 3 5
-Currentasset liquidation —5 —5 —2
Securitysales 16 0 C
Mediumand small cos. (Wisc.)
Fundsfrom operations 5 2 1
Less: Cash dividends 4 2 2
Retained funds —1 —1
Current asset liquidation 7 5 4
Security sales 1 C —2
a. See text footflote 27. For description of the samples see Appendix A.
Li Annual average.
Less than 0.5 percent.
two peacetime contractions of the '305. The table highlights the
part played by current asset liquidation in the 1921 debt retire-
ment. En 1921 (and also, on the whole, in the later contractions)
more funds were made available from this and other sources than
were actually used for the reduction of short-term debt shown in
Table g. This suggests that before the contractions set in, our sam-
ple companies had made commitments for fixed property outlays;
also, it may be that even during the contraction periods invest-
8iments and other assets were acquired by the more aggressive anc
farsighted concerns.
The acuteness of the short-term 4ebt problem that confrontec
manufacturing and trade enterprise during 1921, and the need ix
solve it by liquidating current assets, are further illustrated by th
fact that at the end of 1920 about of the concerns representec
in our samples had short-term indebtedness that exceeded, in som
cases very substantially, the highest amount of "cash throw-off'
from operations of any single year during the entire perioc
This condition, it should be emphasized, refers to sur
viving companies, for all but one of these concerns weathered nol
only the liquidation of 1921 but also the prolonged depression ol
1930-32 and the sharp contraction of 1938.Sincethese concerm
were among the more conservatively financed, the current debi
position of the less conservatively financed companies, with smallei
or less consistent earning capacity, must have been critical indeed!
Apparently many business debtors had depended on future
transactions at inflated price levels, rather than on cash funds from
earnings and other operating sources, to liquidate current debt.
When these expectations could not be realized, debtors had prac
tically no choice but to dispose of inventory, accelerate the collec-
tion of receivables, sell marketable securities, and draw down cash
balances. The necessity in some cases, and the desirability in others,
of liquidating current assets in order to retire current debt, in all
likelihood contributed greatly to the demoralization of commodity
markets and to the sharp deflation of prices that occurred between
mid-i92o and mid-1921.
70 In the large corporation sample, 39 out of 82 manufacturing and 4 out of 8 tradc
companies had outstanding current debt commitments at the end of 1920 that ex-
ceeded the highest amount of cash funds provided through tperations in any out
year, 1915-20, and in some cases the excess was as much as three or four hundred
percent. For the medium and small corporation samples, the proportions of such
companies wereout of 71 and 20 out of 29 respectively for the period 1917-20.
82

The Effect of War on Business Financing: Manufacturing and Trade, World War I

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