§ 1. Credit not a creation but a Transfer of the means of Production.
Credit has a great, but not, as many people seem to suppose, a magical
power; it can not make something out of nothing. How often is an extension
of credit talked of as equivalent to a creation of capital, or as if
credit actually were capital! It seems strange that there should be any
need to point out that, credit being only permission to use the capital of
another person, the means of production can not be increased by it, but
only transferred. If the borrower’s means of production and of employing
labor are increased by the credit given him, the lender’s are as much
diminished. The same sum can not be used as capital both by the owner and
also by the person to whom it is lent; it can not supply its entire value
in wages, tools, and materials, to two sets of laborers at once. It is
true that the capital which A has borrowed from B, and makes use of in his
business, still forms a part of the wealth of B for other purposes; he can
enter into arrangements in reliance on it, and can borrow, when needful,
an equivalent sum on the security of it; so that to a superficial eye it
might seem as if both B and A had the use of it at once. But the smallest
consideration will show that, when B has parted with his capital to A, the
use of it as capital rests with A alone, and that B has no other service
from it than in so far as his ultimate claim upon it serves him to obtain
the use of another capital from a third person, C.
§ 2. In what manner it assists Production.
But, though credit is never anything more than a transfer of capital from
hand to hand, it is generally, and naturally, a transfer to hands more
competent to employ the capital efficiently in production. If there were
no such thing as credit, or if, from general insecurity and want of
confidence, it were scantily practiced, many persons who possess more or
less of capital, but who from their occupations, or for want of the
necessary skill and knowledge, can not personally superintend its
employment, would derive no benefit from it: their funds would either lie
idle, or would be, perhaps, wasted and annihilated in unskillful attempts
to make them yield a profit. All this capital is now lent at interest, and
made available for production. Capital thus circumstanced forms a large
portion of the productive resources of any commercial country, and is
naturally attracted to those producers or traders who, being in the
greatest business, have the means of employing it to most advantage,
because such are both the most desirous to obtain it and able to give the
best security. Although, therefore, the productive funds of the country
are not increased by credit, they are called into a more complete state of
productive activity. As the confidence on which credit is grounded extends
itself, means are developed by which even the smallest portions of
capital, the sums which each person keeps by him to meet contingencies,
are made available for productive uses. The principal instruments for this
purpose are banks of deposit. Where these do not exist, a prudent person
must keep a sufficient sum unemployed in his own possession to meet every
demand which he has even a slight reason for thinking himself liable to.
When the practice, however, has grown up of keeping this reserve not in
his own custody, but with a banker, many small sums, previously lying
idle, become aggregated in the banker’s hands; and the banker, being
taught by experience what proportion of the amount is likely to be wanted
in a given time, and knowing that, if one depositor happens to require
more than the average, another will require less, is able to lend the
remainder, that is, the far greater part, to producers and dealers:
thereby adding the amount, not indeed to the capital in existence, but to
that in employment, and making a corresponding addition to the aggregate
production of the community.
While credit is thus indispensable for rendering the whole capital of the
country productive, it is also a means by which the industrial talent of
the country is turned to better account for purposes of production. Many a
person who has either no capital of his own, or very little, but who has
qualifications for business which are known and appreciated by some
possessors of capital, is enabled to obtain either advances in money, or,
more frequently, goods on credit, by which his industrial capacities are
made instrumental to the increase of the public wealth.
Such are, in the most general point of view, the uses of credit to the
productive resources of the world. But these considerations only apply to
the credit given to the industrious classes—to producers and dealers.
Credit given by dealers to unproductive consumers is never an addition,
but always a detriment, to the sources of public wealth. It makes over in
temporary use, not the capital of the unproductive classes to the
productive, but that of the productive to the unproductive.
§ 3. Function of Credit in economizing the use of Money.
But a more intricate portion of the theory of Credit is its influence on
prices; the chief cause of most of the mercantile phenomena which perplex
observers. In a state of commerce in which much credit is habitually
given, _general prices at any moment depend much more upon the state of
credit than upon the quantity of money_. For credit, though it is not
productive power, is purchasing power; and a person who, having credit,
avails himself of it in the purchase of goods, creates just as much demand
for the goods, and tends quite as much to raise their price, as if he made
an equal amount of purchases with ready money.
The credit which we are now called upon to consider, as a distinct
purchasing power, independent of money, is of course not credit in its
simplest form, that of money lent by one person to another, and paid
directly into his hands; for, when the borrower expends this in purchases,
he makes the purchases with money, not credit, and exerts no purchasing
power over and above that conferred by the money. The forms of credit
which create purchasing power are those in which no money passes at the
time, and very often none passes at all, the transaction being included
with a mass of other transactions in an account, and nothing paid but a
balance. This takes place in a variety of ways, which we shall proceed to
examine, beginning, as is our custom, with the simplest.
First: Suppose A and B to be two dealers, who have transactions with each
other both as buyers and as sellers. A buys from B on credit. B does the
like with respect to A. At the end of the year, the sum of A’s debts to B
is set against the sum of B’s debts to A, and it is ascertained to which
side a balance is due. This balance, which may be less than the amount of
many of the transactions singly, and is necessarily less than the sum of
the transactions, is all that is paid in money; and perhaps even this is
not paid, but carried over in an account current to the next year. A
single payment of a hundred pounds may in this manner suffice to liquidate
a long series of transactions, some of them to the value of thousands.
But, secondly: The debts of A to B may be paid without the intervention of
money, even though there be no reciprocal debts of B to A. A may satisfy B
by making over to him a debt due to himself from a third person, C. This
is conveniently done by means of a written instrument, called a bill of
exchange, which is, in fact, a transferable order by a creditor upon his
debtor, and when _accepted_ by the debtor, that is, authenticated by his
signature, becomes an acknowledgment of debt.
§ 4. Bills of Exchange.
Bills of exchange were first introduced to save the expense and risk of
transporting the precious metals from place to place.
The trade between New York and Liverpool affords a constant illustration
of the uses of a bill of exchange. Suppose that A in New York ships a
cargo of wheat, worth $100,000, or £20,000, to B in Liverpool; also
suppose that C in Liverpool (independently of the negotiations of A and B)
ships, about the same time, a cargo of steel rails to D in New York, also
worth £20,000. Without the use of bills of exchange, B would have been
obliged to send £20,000 in gold across the Atlantic, and so would D, at
the risk of loss to both. By the device of bills of exchange the goods are
really bartered against each other, and all transmission of money saved.
[Illustration.]
A has money due to him in Liverpool, and he sells his claim to this money
to any one who wants to make a payment in Liverpool. Going to his banker
(the middle-man between exporters and importers and the one who deals in
such bills) he finds there D, inquiring for some one who has a claim to
money in Liverpool, since D owes C in Liverpool for his cargo of steel
rails. A makes out a paper title to the £20,000 which B owes him (i.e., a
bill of exchange) and by selling it to D gets immediately his £20,000
there in New York. The form in which this is done is as follows:
NEW YORK, _January 1, 1884_.
At sight [or sixty days after date] of this first bill of exchange
(second and third unpaid), pay to the order of D [the importer of
steel rails] £20,000, value received, and charge the same to the
account of
[Signed] A [exporter of wheat].
To B [buyer of wheat],
Liverpool, Eng.
D has now paid $100,000, or £20,000, to A for a title to money across the
Atlantic in Liverpool, and with this title he can pay his debt to C for
the rails. D indorses the bill of exchange, as follows:
Pay to the order of C [the seller of steel rails], Liverpool,
value in account. D [importer of steel rails].
To B [the buyer of wheat].
By this means D transfers his title to the £20,000 to C, sends the bill
across by mail (“first” in one steamer, “second” in another, to insure
certain transmission) to C, who then calls upon B to pay him the £20,000
instead of B sending it across the Atlantic to A; and all four persons
have made their payments the more safely by the use of this convenient
device. This is the simplest form of the transaction, and it does not
change the principle on which it is based, when, as is the case, a banker
buys the bills of A, and sells the bills to D—since A typifies all
exporters and D all importers.
Bills of exchange having been found convenient as means of paying debts at
distant places without the expense of transporting the precious metals,
their use was afterward greatly extended from another motive. It is usual
in every trade to give a certain length of credit for goods bought: three
months, six months, a year, even two years, according to the convenience
or custom of the particular trade. A dealer who has sold goods, for which
he is to be paid in six months, but who desires to receive payment sooner,
draws a bill on his debtor payable in six months, and gets the bill
discounted by a banker or other money-lender, that is, transfers the bill
to him, receiving the amount, minus interest for the time it has still to
run. It has become one of the chief functions of bills of exchange to
serve as a means by which a debt due from one person can thus be made
available for obtaining credit from another.
Bills of exchange are drawn between the various cities of the
United States. In the West, the factor who is purchasing grain or
wool for a New York firm draws on his New York correspondents, and
this bill (usually certified to by the bill of lading) is
presented for discount at the Western banks; and, if there are
many bills, funds are possibly sent westward to meet these
demands. But the purchases of the West in New York will serve,
even if a little later in time, somewhat to offset this drain; and
the funds will again move eastward, as goods move westward,
practically bartered against each other by the use of bills. There
is, however, less movement of funds of late, now that Western
cities have accumulated more capital of their own.
The notes given in consequence of a real sale of goods can not be
considered as on that account _certainly_ representing any actual
property. Suppose that A sells £100 worth of goods to B at six months’
credit, and takes a bill at six months for it; and that B, within a month
after, sells the same goods, at a like credit, to C, taking a like bill;
and again, that C, after another month, sells them to D, taking a like
bill, and so on. There may then, at the end of six months, be six bills of
£100 each existing at the same time, and every one of these may possibly
have been discounted. Of all these bills, then, only one represents any
actual property.
The extent of a man’s actual sales forms some limit to the amount of his
real notes; and, as it is highly desirable in commerce that credit should
be dealt out to all persons in some sort of regular and due proportion,
the measure of a man’s actual sales, certified by the appearance of his
bills drawn in virtue of those sales, is some rule in the case, though a
very imperfect one in many respects. When a bill drawn upon one person is
paid to another (or even to the same person) in discharge of a debt or a
pecuniary claim, it does something for which, if the bill did not exist,
money would be required: it performs the functions of currency. This is a
use to which bills of exchange are often applied.
Many bills, both domestic and foreign, are at last presented for payment
quite covered with indorsements, each of which represents either a fresh
discounting, or a pecuniary transaction in which the bill has performed
the functions of money.
§ 5. Promissory Notes.
A third form in which credit is employed as a substitute for currency is
that of promissory notes.
The difference between a bill of exchange and a promissory note
is, that the former is an order for the payment of money, while
the latter is a promise to pay money. In a note the promissor is
primarily liable; in a bill the drawer becomes liable only after
an ineffectual resort to the drawee.
In the United States a Western merchant who buys $1,000 worth of
cotton goods, for instance, of a Boston commission-house on
credit, customarily gives his note for the amount, and this note
is put upon the market, or presented at a bank for discount. This
plan, however, puts all risk upon the one who discounted the note.
In the United States such promissory notes are the forms of credit
most used between merchants and buyers. The custom, however, is
quite different in England and Germany (and generally, it is
stated, on the Continent), where bills of exchange are employed in
cases where we use a promissory note. A house in London sells
$1,000 worth of cotton goods to A, in Carlisle, on a credit of
sixty days, draws a bill of exchange on A, which is a demand upon
A to pay in a given time (e.g., sixty days), and if “accepted” by
him is a legal obligation. The London house takes this bill
(perhaps adding its own firm name as indorsers to the paper), and
presents it for discount at a London bank. This now explains why
it is that, when a particular industry is prosperous and many
goods are sold, there is more “paper” offered for discount at the
banks (cf. p. 222), and why capital flows readily in that
direction.
It is chiefly in the latter form [promissory notes] that it has become, in
commercial countries, an express occupation to issue such substitutes for
money. Dealers in money wish to lend, not their capital merely, but their
credit, and not only such portion of their credit as consists of funds
actually deposited with them, but their power of obtaining credit from the
public generally, so far as they think they can safely employ it. This is
done in a very convenient manner by lending their own promissory notes
payable to bearer on demand—the borrower being willing to accept these as
so much money, because the credit of the lender makes other people
willingly receive them on the same footing, in purchases or other
payments. These notes, therefore, perform all the functions of currency,
and render an equivalent amount of money, which was previously in
circulation, unnecessary. As, however, being payable on demand, they may
be at any time returned on the issuer, and money demanded for them, he
must, on pain of bankruptcy, keep by him as much money as will enable him
to meet any claims of that sort which can be expected to occur within the
time necessary for providing himself with more; and prudence also requires
that he should not attempt to issue notes beyond the amount which
experience shows can remain in circulation without being presented for
payment.
The convenience of this mode of (as it were) coining credit having once
been discovered, governments have availed themselves of the same
expedient, and have issued their own promissory notes in payment of their
expenses; a resource the more useful, because it is the only mode in which
they are able to borrow money without paying interest.
§ 6. Deposits and Checks.
A fourth mode of making credit answer the purposes of money, by which,
when carried far enough, money may be very completely superseded, consists
in making payments by checks. The custom of keeping the spare cash
reserved for immediate use, or against contingent demands, in the hands of
a banker, and making all payments, except small ones, by orders on
bankers, is in this country spreading to a continually larger portion of
the public. If the person making the payment and the person receiving it
keep their money with the same banker, the payment takes place without any
intervention of money, by the mere transfer of its amount in the banker’s
books from the credit of the payer to that of the receiver. If all persons
in [New York] kept their cash at the same banker’s, and made all their
payments by means of checks, no money would be required or used for any
transactions beginning and terminating in [New York]. This ideal limit is
almost attained, in fact, so far as regards transactions between
[wholesale] dealers. It is chiefly in the retail transactions between
dealers and consumers, and in the payment of wages, that money or
bank-notes now pass, and then only when the amounts are small. As for the
merchants and larger dealers, they habitually make all payments in the
course of their business by checks. They do not, however, all deal with
the same banker, and, when A gives a check to B, B usually pays it not
into the same but into some other bank. But the convenience of business
has given birth to an arrangement which makes all the banking-houses of
[a] city, for certain purposes, virtually one establishment. A banker does
not send the checks which are paid into his banking-house to the banks on
which they are drawn, and demand money for them. There is a building
called the Clearing-House, to which every [member of the association]
sends, each afternoon, all the checks on other bankers which he has
received during the day, and they are there exchanged for the checks on
him which have come into the hands of other bankers, the balances only
being paid in money; or even these not in money, but in checks.
A clearing-house is simply a circular railing containing as many
openings as there are banks in the association; a clerk from each
bank presents, in the form of a bundle of checks, at his opening,
all the claims of his bank against all others, and notes the total
amount; a clerk inside takes the checks, distributes each check to
the clerk of the bank against whom it is drawn, and all that are
left at his opening constitute the total demands of all the other
banks against itself; and this sum total is set off against the
given bank’s demands upon the others. The difference, for or
against the bank, as the case may be, may then be settled by a
check.(241)
The total amount of exchanges made through the New York
Clearing-House in 1883 was $40,293,165,258 (or about twenty-five
times the total of our national debt in that year), and the
balances paid in money were only 3.9 per cent of the
exchanges.(242) For valuable explanations on this subject, consult
Jevons, “Money and the Mechanism of Exchange,” Chapters XIX-XXIII.
The explanation of the functions of a bank, Chapter XX, is very
good.