Sec. 10. #Capitalization theory of crises#.  Here we verge upon a different type of explanation of the financial crisis—­one of a psychological nature.  The quantity of money, we have seen, affects prices more or less according as credit is more or less used in connection with it.  Money plus confidence has a larger power of sustaining prices, than money without, or with less, confidence.  And throughout the business cycle the amount of confidence, expressed in such ways as the readiness to grant credits and in the easy extension of the time of collection, is constantly changing.  Over-confidence at one time is suddenly followed by widespread lack of confidence.  This has led some to say that lack of confidence is the cause of crises.  This is a truism, but it does not explain what is the real cause of this lack of confidence, which, when the crisis comes, is not mere unreasoning fear that needs only to ignore the danger to banish it.  Might it not just as truly, if not more truly, be said that the cause is over-confidence in the period preceding the crisis?

The essential characteristic of a crisis is the forcible and sudden movement of readjustment in the mistaken capitalization of productive agents.  Capitalization runs through all industry.  The value of everything that lasts for more than a moment is built in part upon incomes that are not actual, but expectative, whose amount, therefore, is a matter of guesswork, or “speculation."[10] Many unknown factors enter into the estimate of future incomes.  The universal tendency to rhythm in motion (material or psychic) manifests itself in an overestimate or underestimate of incomes and of every other factor in value.  This is emphasized by a psychological factor called sometimes the “hypnotism of the crowd,” and sometimes, the “mob mind.”  Most men follow a leader in investment as in other things.  The spirit of speculation grows till often it becomes almost a frenzy, and people rush toward this or that investment, throwing capitalization in some industries far out of equilibrium with that in others.

The cause of crises immediately back of the maladjusted capitalization thus is seen to be a psychological factor; it is the rhythmic miscalculation of incomes and of capital value, occurring to some degree throughout industry, but particularly in certain lines.  This subjective cause in men is given an opportunity for action only when certain favoring objective conditions are present.

Sec. 11. #The use of credit.# Most noteworthy of these objective conditions is the general use of credit.  The credit system greatly enhances the rhythm of price.  If the value of a thing that is fully paid for falls, the owner alone loses; but if the value of a thing only partly paid for falls so much that the owner is forced to default in his payment, the loss may be transmitted along the line of credit to every one in a long series of transactions.  A credit system, highly developed, is a house of cards at a time of