Money Rates, Bond Yields, and Security Prices

Abstract

TN this REVIEW for January I926 we brought together some of the results of our studies of the relationship between money rates and speculation in the business cycle. There we stated our general conclusion that substantial quantitative changes in money rates, regardless of the length of time during which those changes take place, have been, in general, highly significant for security markets.' This general conclusion resulted from our statistical studies of the cyclical fluctuations of monthly average rates on prime commercial paper, duly adjusted for seasonal variation, on the one hand, and of monthly average industrial stock prices, monthly average railroad stock prices, monthly average prime railroad bond prices, and monthly average miscellaneous bond prices, on the other hand. The periods studied were I884-I925 for money rates and stock prices, and I890-I925 for money rates and bond prices. For these periods both the magnitude of fluctuations of the series, and their sequence in time were examined to ascertain whether systematic and simple relation between the money market and the securities could be proven to exist. In making this examination it was found convenient to divide the periods into the following four sub-periods: i884-i896, a period characterized by declining commodity prices, agitation for free silver, and difficulty in maintaining the gold redemption fund for greenbacks; I897-I9I3, a period of rising commodity prices, unquestioned maintenance of the gold standard, and comparative freedom from nonbusiness disturbances; I9I4-I8, a war period of large gold imports and abnormally low money rates followed in I9I7, after the entry of the United States into the war, by a money market controlled with reference to the exigencies of war finance; I919-25, a period characterized by, first, continued control of money rates with reference to the government's post-war financing, second, the withdrawal of control, for government purposes, of the money market and, third, paper inflation and deflation in Europe, unprecedented gold imports into the United States, and abnormally low money rates in this country. When we undertook the search to find some systematic and simple relation between the money market and the securities markets we did not expect to discover, nor did we in fact discover, a constant mathematical relation between money rates and security prices holding invariably in war as well as in peace, in times when the gold standard was threatened (such as I895-96) as well as in times when its permanence was not questioned, and in times of abnormal international gold movements (such as I92225) resulting from non-business influences as well as in times of movements resulting from fluctuations in trade. No one with the slightest familiarity with business and economic affairs would expect to find that security prices were in constant mathematical relation to money rates certainly not for such a long and varied period as I884-I925. Although an unvarying function was neither expected nor discovered our studies had led us to expect that a systematic and simple relation between money rates and security prices might be found to hold during the normal cyclical fluctuations of business from depression to prosperity and back to depression. Disturbances of a non-business nature were fewer and less pronounced during the interval of I7 years from I897 to I9I3 than during any other interval of equal length in the last 40 years. In fact the Spanish War was the only momentous non-business disturbance during these i 7 years, so far as money rates in the United States are concerned. Consequently, the investigation began with a study of the period I897-I9I3. For this test period the conclusion was reached that the simplest and most unvarying relationship of any discovered, between changes of money rates and subsequent levels of stock prices was given by the table showing (i) the rise (or fall) of I4 per cent and (2) the level of stock prices for the month immediately following the rise (or fall) mentioned.2 For the levels of bond prices,