The fact of free coinage means, substantially, that the state has made

the money form a free good. How much value is thereby destroyed we may

best see if we ask precisely how much the money form could mean _at the

limit_. Initially, the money form means simply the certification of

weight and fineness by a trusted authority. It saves, therefore, the

delay and expense of testing the weight and fineness by assay, etc. It

saves the trouble and delay of subdivision of a formless metal. It

averts many difficulties. For small retail transactions, indeed for

retail transactions in general, the conveniences of coined over uncoined

metal are very great. Small transactions do not justify the trouble and

expense of assaying and weighing and subdividing gold! In a country,

therefore, where the bulk of the money work is in effecting small

transactions, we might expect a considerable agio for coined over

uncoined metal. This would be especially true if that country had few

facilities for credit substitutes for the coin, particularly for small

transactions. In a country like the United States, however, where checks

are often drawn for amounts less than a dollar, and where the bulk of

the gold, or standard money, is to be found, not in circulation but in

reserves, one need not anticipate that the medium of exchange function

would give a big agio to gold coin, even if free coinage ceased. So long

as coinage means merely a certification of weight and fineness, this

conclusion will hold. For purposes of large transactions, the item of

weighing and assaying would not be serious. Indeed, American banks are

accustomed to weigh even gold coin, in quantity. It goes by weight,

rather than by tale, and if light-weight, it counts for less than its

nominal value. The writer knows a bank which has a considerable store of

light-weight gold coin that has been in its vaults for over twenty

years. Such coin may be counted at par in reports by the bank to the

Government.[494] It might be paid out through the window to customers,

who would not weigh it, in case of a "run" on the bank. But it cannot be

used in dealings with other banks without loss.

Does the legal tender aspect of coin count for more? Under a smoothly

working system of free coinage, where moreover, all forms of money are

kept at a parity by ready redemption, we have seen that the legal tender

feature makes no difference. Would it make a difference where coinage is

restricted? If we assume that the use of checks for small payments, and

the use of bullion in reserves, in a given case, prevents the existence

of an agio growing out of the other functions of money, I think it clear

that the legal tender feature alone will not create one. But suppose

that there is an agio from other causes, will not the legal tender

aspect of money tend to increase it? Will not men demand coin, which

bears an agio, rather than bullion, when they have the right to demand

either? And will not the agio then, in a way, grow out of itself, a

bigger agio appearing, because an agio has already appeared? It does not

seem to me that this need follow. If there be an agio, then creditors

will demand either coin, or bullion _on a different basis from coin_.

But so long as they get the benefit of the agio, either in the form of

coin, or of a larger amount of bullion, particular circumstances, rather

than a general rule, will determine which they will demand. The banker

might well prefer bullion. The international banker would prefer

bullion. The man who wishes money for retail transactions will take

coin. Men will use the legal tender quality of money as a means of

getting the benefit of what agio there is (though contract right, where

the contract calls for coin, would accomplish all that a legal tender

law would accomplish), but whether they take 23.22 grains of coined

gold, or 25.5 grains of gold bullion, will depend on which they prefer

in the circumstances. I do not see that the legal tender feature adds

anything to the case of restricted coinage that it does not add to the

case of free coinage.[495] In either case, there will be temporary

emergencies, when panics arise, when legal tender money gets an agio

over any possible substitute. Solvency may depend on it. This might

arise under free coinage, if the panic were acute, and if settlements

had to be made immediately. But as long as there is time for men to

work things out, I should not expect the legal tender feature, _per se_,

to add to the agio of coined metal even under restricted coinage.

In general, the possibility of an agio for coined metal, under

restricted coinage, rests on the extent to which coin has a unique

function. In so far as substitution is possible, there is no room for an

agio. For many purposes, bullion may be substituted. To the extent that

credit is developed, and is flexible, various other substitutes are

possible. To the extent that barter can be used, still other substitutes

are possible.

Among an ignorant people, little accustomed to developing new

expedients, having an economic life that is not flexible, having an

economy based on petty economic units, having little development of

credit, accustomed to the use of money in most transactions, money might

well be, in many connections, highly important if not indispensable. In

England, before the War, where no bank-notes under five pounds were in

circulation, and where small checks were little used, an agio on coin

might appear if coin got so scarce as to be inadequate for retail trade,

but for bank reserves bullion would have served virtually as well as

coin, and with the stock of coin she had at the time England could have

gone on for a long time indeed with no more agio than just enough to

prevent the melting down of the coin. In the United States, where checks

can be used for very small transactions, and where a high percentage

(very conservatively estimated by Kinley at from 50 to 60%) of retail

business is done with checks, the agio on coins of a dollar or over

growing out of retail trade might be expected to be very slight. On the

other hand, the legal requirements for reserves in specified types[496]

of money might, in time, lead to some agio. I do not think that the

reserve function in England would ever do so. If we could combine our

use of checks in retail trade with England's absence of legal reserve

requirements, I should think that the agio would have little chance

indeed of growing great! If to this could be added Canada's extensive

use of small elastic bank-notes, the chance would be still less. If

bank-notes of one dollar could be issued, the agio would be less still.

It is in the case of coins of very small denomination that the agio

might appear most readily. Such coins, if limited in amount, and if

given the usual restricted legal tender,[497] do not need redemption to

circulate at face value, even when made of baser metals. It is quite

thinkable that such coins should, even when redeemable, circulate at an

agio over the redemption money. In small retail transactions the need

for money to do business is most imperative. Even here, however, there

is large flexibility. The present writer, during the period of money

stringency in the Panic of 1907, made much larger use of checks in very

small payments than was his usual practice, and the same was true of

various of his acquaintances.

I think that the quantity theorist, with his doctrine of an unlimited

agio through the restriction of coinage proportionate to the

restriction, is best understood if we say that he has taken an

exaggerated estimate of the imperativeness of the need for formed money

in the smallest retail transactions as typical of the whole

situation.[498] I have elsewhere shown, however, that, in so far as

Kinley's figures for 1909 give us a clue,[499] the total retail trade of

the United States is less than one-eleventh of the total of all

transactions calling for the use of money and checks. Of that total

retail trade, the part in which money is actually used is, on Kinley's

high estimate, between 40 and 50%,[500] and the part in which money is

imperative is much lower still. Small retail transactions do not give

the type for the pecuniary transactions in the United States! They more

nearly do so in India, and the possibility of agio is, doubtless,

greater there. For our larger transactions, there is an almost

indefinite possibility of substitutes for coined money, if profits can

be made by making the substitutions. Beating the agio would be a source

of profits.

I repeat what was said in the chapter on "Dodo-Bones" differentiating

this doctrine of the agio from the quantity theory doctrine: (1) This

doctrine presupposes value for the money article from some non-monetary

source. It relates only to a differential portion of the value of money.

(2) This doctrine denies the law of proportionality even for this

differential portion. (3) This doctrine is concerned, not with the

general level of prices, but with the absolute value of money measured

in the ratio of coin to bullion.

Under the system of free and gratuitous coinage, no agio of coined over

uncoined bullion is possible. Where small brassage charges are made, as

in France (or as in England, where the interest lost during the period

of coinage is charged to the man who exchanges bullion for coin at the

Bank of England) there may be an agio of this amount, though it often

happens that this agio disappears, particularly in England. So perfectly

is bullion a substitute for coin in England, that the Bank of England

will often forego its privilege of taking the slight toll in interest,

and will credit men depositing bullion with as much as if they had

deposited coin. From what has gone before, as to the possibility of an

agio, I conclude that the United States, England, Canada, and possibly

France, would be unable to make large brassage charges. If the brassage

charge were much larger than the charges made by reputable and

well-known jewelers for assaying and weighing, etc., there would be a

large substitution of bars for coins, and the mints would have little to

do. However, it needs no arguing that with free coinage, and either very

low or no brassage charges, the value of bullion and of coin will,

quality for quality and weight for weight, be virtually identical,

within a narrow range of variation.

What, then, shall we say of the way in which the forces drawing gold

from the arts into money manifest themselves?

How describe the equilibrium between the value of gold as money and the

value of gold in the arts? How construct intersecting curves, presenting

a marginal equilibrium? The problem is baffling, and I frankly confess

that what I shall have to say does not satisfy me. I hope that some

critic may solve the problem better. I can point out the difficulties of

the situation, and can indicate reasons why the sort of solution which

the economist's training in marginal analysis leads him to desire are

not easily found. But I fear that I shall fail to satisfy the demand

for an application of curves to the problem!

The first difficulty is that we are barred from the use of our

yardstick. Money is the measure of all things in economic theory--except

money and gold bullion! Of course there are economic values other than

those of gold which do not actually come into the market, but even there

we can commonly, by the accountant's methods, make use of the money

measure. In very high degree, our conventional curves of all sorts run

in money terms, and assume a fixed value of money. Clearly the money

curve of diminishing value for gold would tell us nothing. The value of

gold might sink as its quantity increased, but then the value of the

money-unit would sink _pari passu_, and so the curve, with ordinates

expressed in numbers of dollars per ounce, would not sink. The

value-curve of gold, expressed in money, is a straight line, parallel to

the X axis. Possible substitutes in the form of abstract units of

value,[501] or of composite units of goods, of an assumed fixed value,

will have to be used if anything is used, but they are less satisfactory

in the application, and leave the analysis a good deal less realistic.

If this were all, the problem would be easy! But there is a second

difficulty. We find the factors requiring gold as money, if summed up in

a curve, presenting themselves as a call for the temporary rental of the

gold. The money functions are performed, in general, not by keeping

gold, and getting an endless series of uses from it, as in the arts, but

by passing it on, sooner or later. Even in the case of the reserve

function, the bearer of options function, and the store of value

functions, it is not expected to hold the gold indefinitely--always

there is the anticipation of some time when it will be passed on again.

A curve for gold in the monetary employments, therefore, would be a

curve showing the diminishing values of rents, or particular services

rather than a curve for capital values. The curve for gold in the arts,

however, would be a curve showing the diminishing _capital values_ of

units of gold, as the supply in the arts is increased. The two curves do

not run in common terms. But another and more fundamental difficulty. In

the case of wheat, we may construct our curve free from complications,

in idea, at least. On the base line, we lay out quantities of wheat. For

each quantity of wheat, we erect an ordinate, a sum of money, or a

number of abstract units of value, as the case may be. Connecting these

ordinates, we have a curve, showing how the value (or the money-price)

of wheat descends as the quantity of wheat increases. Given the shape of

the curve, and given the number of bushels of wheat, the marginal value

of the wheat is given. In idea, at least, it does not matter, for the

shape of the curve, whether the amount of the wheat is great or small,

whether the marginal value of the wheat is low or high. If there are ten

thousand bushels only in the market, wheat will be worth $5 per bushel.

With 100,000 bushels, it is worth 40c. The fact that there are 100,000

bushels does not lessen the magnitudes on the higher portions of the

curve. The nature of the services which wheat performs is not affected

by its value. This is _not true of gold_, either in the arts or as

money. In the arts, I have already shown that one function of gold is as

a means of conspicuously displaying wealth. Gold is like diamonds in

this. _Because gold is a valuable_, it gets an additional valuable

service. This additional valuable service enhances its value. The thing

is checked, however, before an endless circle is created, by the fact

that as gold rises in value a smaller amount of gold will display a

given amount of wealth. The value-curve for gold in the arts,

therefore, is not a simple thing like the curve for wheat. It turns upon

itself, in ways that I see no graphic device for presenting. This is

even truer for money. Men wish to have, when they seek money, a quantum

of _value_ in highly saleable form.[502] The curve for the value of the

services of money presupposes a fixed capital value of money. It is the

capital value of money which does the money work. Given a value of

money, and given the values of goods, we may see how much money is

required to effect a given exchange or perform some other money service.

Then, knowing how much value will be created by each exchange, or other

money service, we may arrange the services in a series, a scale of

descending importance, and get a curve. This curve is, in fact, the

curve which presents itself in the money market. There we find a curve,

running in terms of money itself, so much money for the use of money for

such a length of time. But this is a curve of demand for money funds,

rather than for gold as such. The "supply" that corresponds to this

"demand" is, not gold, but all manner of credit instruments, chiefly

bank-deposits, expressed in terms of gold. Such a curve is clearly not

to be put into equilibrium with the value-curve for gold in the arts,

(1) because it assumes a fixed value for money (2) because it is

concerned with temporary rentals, and not capital values, and (3)

because the demand it expresses is not for the use of gold alone.

We may get some aid in reducing these complexities to familiar terms if

we employ the device of assuming an equilibrium between gold in money

and gold in the arts, without trying to explain in quantitative terms

how that equilibrium is arrived at, and then see what causes will lead

that equilibrium to shift. In getting the laws of _change_, we may get

closer to the causes of the phenomenon itself. The effort to reduce the

thing to precise mathematical form requires a degree of simplification

which seems to me likely to rob an answer of much significance.

Assuming that the equilibrium is reached, we may see what factors would

tend to cause gold to go into the money-use, and what factors would tend

to draw gold into the arts use. We may also see how these changes from

one side or the other would modify the value of gold.

Assume that a manufacturing jeweler has extra demand for his products.

His products, of course, are composites of gold, labor, and other raw

materials, etc., but part of the extra value that comes to his products

attaches itself to the gold that is in them. He now has an incentive,

which was lacking before, to melt down full weight gold coin in his

possession, or to buy gold bars which might otherwise have been coined.

To buy the gold bars, however, probably means that he must have

accommodation at the bank. He borrows from the bank the amount he needs,

giving a short-time note, since he expects to make up his gold and

market it in a fairly short time. The paper of manufacturers of gold

will commonly stand well in the "money market," and this is especially

true of those in whose hands the gold is not worked up into such

specialized forms that the value of the bullion is a minor matter. (I

find it necessary to refer frequently to the money market, though a full

analysis of money-market phenomena cannot come till after our discussion

of credit.) If he must borrow to get the gold, _then the money-rates

will come into comparison with the profits he expects to make from

working up the gold_. This will usually be true even if he melts down

gold coin already in his possession. He might deposit that gold, and so

reduce his expenses at the bank, either buying back his own discounted

paper, or getting interest on daily checking account. If he has to

borrow to get the gold, he may get it either by drawing gold from the

bank directly, or by giving a check on the bank to a bullion dealer,

which may ultimately lead to a diminution in the bank's supply of gold.

However he gets the gold, there is bound to be some reaction, (1) on the

bank's supply of gold, (2) on the supply of loanable funds in the money

market, and hence (3) on the money-rates themselves. If he borrows from

the money market, he affects the money-rates directly (even though

probably, in a given case, not noticeably); if he melts down coin,

instead of depositing it (or paying it out to others who may ultimately

deposit it) there tends also to be less gold in the bank's vaults; if he

buys gold with his own funds in the bullion market, the supply of

current bullion for which the banks also compete is reduced. In any of

these cases, the banks have less gold than would otherwise be the case.

The relation between gold reserves and the supply of money-funds has

been partly discussed already. We have seen that there is no

proportional relation, as Fisher, and other quantity theorists contend.

Loanable funds, on a given gold reserve, are highly elastic. But the

elasticity calls for higher money-rates, and higher money-rates tend to

reduce the volume of trading, and check the demand. Borrowings from the

money market by workers in gold, therefore, are much more significant

than borrowings by other manufacturers or merchants, because the latter

are content with credit devices, for the most part, while the workers in

gold withdraw gold itself from the money market. It is, moreover, harder

for the money market to resist extra demand from the jewelers than from

many other interests. The assets of the jewelers, especially from those

who do not work the gold up in highly specialized forms, are exceedingly

liquid. Their paper, therefore, is exceptionally good in the discount

market. Usually, too, the larger jewelry houses have specially good

general credit and high reputation. There is, then, less disposition for

the market to look askance at an unusual supply of their paper than

would be the case with many other sorts of paper. They tend to get about

as low rates as anyone else in the market. A money market under

centralized control seeking to protect its gold, might tend to raise

discount rates on jewelers' paper, but a competitive money market is

very unlikely to do so.

An increase in the value of gold in the arts would, thus, reflect itself

pretty quickly in the money market, first in the form of added value for

the services of money, and then, secondly, in an increase in the capital

value of money. Indeed, an increase in the value of a single rental is

an increase in the capital value also, since the value of the single

rental is one portion of the capital value. Not only does it mean a

higher capital value for gold, but it consequently tends to mean a

higher "price." It does mean a higher "price" for present money as

compared with future money. It tends, also, to mean a higher "price" of

money in terms of other goods. Meeting higher money-rates, all borrowers

tend to borrow less, and to buy less, to offer less money for goods. It

need not follow, however, that the rising value of gold reduces prices.

The rise in the value of gold in the arts may well be a manifestation of

a general rise of values. General prosperity, rather than causes

affecting the value of gold in the arts alone, may have occasioned the

increasing demand for gold in the arts. This would mean rising values

for goods at large. It might well be, therefore, that the rise in the

values of goods would offset the rise in the value of money, and that

prices of goods would rise at the same time that gold is being withdrawn

from the money market to the arts.

Business in general, as well as the jewelers, may be making increased

demands on the money market. This would tend still further to raise the

money-rates. It would also, however, tend to increase the supply of

money-funds. Commercial and industrial paper, in a time of buoyancy and

expansion, is particularly acceptable to the banks, and they are likely

to expand their loans despite the failure of gold reserves to keep pace.

They simply get along with smaller reserves. Higher money-rates in such

a case tend to reduce the volume of business, but need not actually

reduce it, if there are bigger profits than before anticipated in

business transactions. Not absolute money-rates, but money-rates in

relation to anticipated profits from the use of money, are significant.

There is large room here for flexibility, elasticity, etc. There is much

slack to be taken up by the money-rates, much slack in the fluid

substitutes for money in various functions, and much slack to be taken

up by the volume of trade. But all this will best appear after our

discussion of the money market.

I have said enough to indicate the character of the factors immediately

determining the equilibrium between gold in the arts and gold in the

money employments. In the preceding discussion, also, I have discussed

the more fundamental factors governing the value of gold in both

employments. The problem of translating the fundamental theory of value

into money market terms, and of translating the phenomena of the money

market into terms of fundamental values is not easy. Most of our value

theory in the past has been concerned with individual psychology, Crusoe

economics, trading in small markets with a few buyers, barter

transactions, etc. It has been abstract and unrealistic. The practical

students of the money market, who are immersed in the facts of modern

money, have got little help from it, and have often been scornful of it.

I hope to be able to contribute something to bringing the two methods

of approach to common terms. They are correlative aspects of the same

problem. Each gives highly important clues to the understanding of the

other. Neither can be understood without some understanding of the

other. A theory of value which cannot be applied in the money market,

the stock exchange, and the great field of modern business generally,

has small _raison d'etre_.

In the next chapter I shall take up the problems of credit, and the

money market.

CHAPTER XXIII

CREDIT

Analysis and description are much more important than definition.

Definition at the beginning of a study is frequently a fetter, rather

than an aid to thought. This is especially true in a field where

phenomena overlap and interlace, and where the "pure principle,"

"essence" or "_Wesen_" of the thing defined never presents itself, but

is only to be reached by violent abstraction. To pick out one

element--as "futurity"[503]--as marking off credit from other things

would be an illustration of this. Or to take the notion of _promise_, or

contract obligation, in connection with futurity, is likewise to limit

the field unduly, on the one hand, and to include things which do not

belong there on the other. Thus, a contract whereby A is to build a

house for B by the end of a year, receiving at that time, or in

instalments as the work proceeds, a sum of money, is not a credit

transaction. We have, however, promise, futurity, and a future payment

of money all called for in the contract. On the other hand, if A sends B

a telegraphic order for money, which B receives three minutes after the

money is entrusted by A to the telegraph company, we have a credit

transaction, with no element of futurity in it. Certainly there is less

of futurity there than in the case where a laborer, working all day, is

paid only at night for work done in the morning. Futurity enters into

the values of all goods which are not destined for immediate

consumption--capital values of long-time goods are discounted present

worths of _future_ values. Contracts, promises, and beliefs in promises

run through the whole range of economic life,--the domestic servant,

paid weekly, illustrates all three. Yet only a special class of these

economic activities are commonly counted as credit transactions. Credit

is really a part of the system of economic value relations not easily

marked off in economic nature from the rest. Its clearest _differentiae_

are juridical rather than economic. It will be the purpose of the

present chapter, in part, to blur, rather than to make precise, the line

between credit and non-credit in economic phenomena, and to assimilate

the laws of credit to the general laws of value.

This will involve, however, a careful analysis and precisioning of

certain phenomena commonly counted as credit phenomena. Buying and

selling on the one hand; borrowing and lending on the other: the

distinction seems clear. It is in law. But what is it in economic

nature? When a merchant discounts his own note at the bank, it is

borrowing. When he discounts the note of another, his debtor, it is

selling. If he writes before his endorsement of the note, "without

recourse," (unusual at a bank, but common enough with real estate

mortgage-notes) he has made a perfect sale, and is entirely out of the

transaction. Is it, however, in economic nature a different transaction

from the original one in which he got the note from a borrower? Legally

bonds are credit instruments, and stocks are not. Stocks represent

_ownership_. But practically, as an economic matter, both represent the

alienation of control, on faith, to a small group of men, and

practically, too, the difference between preferred stocks and bonds is

often very slight. Whatever the legal rights of a bondholder, under the

terms of his contract, the legal fact itself often is, under the growing

practice of receiverships, that he cannot exercise his right to

foreclose without such difficulty that it doesn't pay to do it. Very

frequently indeed the junior bondholder will come out of a

reorganization as simply a preferred stockholder--which is what he

practically was all the time. He couldn't vote as a bondholder, but his

voting rights as a stockholder commonly mean little! As a bondholder, if

he held enough bonds, he might even have more influence on the affairs

of the corporation than as a stockholder. The market is moved by other

forces than the legal distinctions in corporate contracts! And market

facts are not necessarily correctly told by the accountant's categories

either. I shall trouble myself little, in what follows, with the

juridical and accountancy problems of credit, save in so far as these

bear directly on the more pertinent economic aspects of the matter. I am

interested in the question of credit as a part of the problem of value

and prices--and particularly from the standpoint of the problem of the

value of money.

What difference is made in values and prices by lending and borrowing?

What kinds of lending and borrowing are there? What shall we say of

bank-notes, of bank-deposits, of bills of exchange? What difference is

made by the money market? Behind the legal forms and the technical

methods, what are the psychological forces at work? How are these

psychological forces modified by the technical forms and methods? What

are the economic differences between long and short time loans? How

shall we draw the distinction between the "money-rates" and the long

time interest rate on "capital?" Why can some things serve as collateral

in the money market when others cannot? What sorts of credit are

appropriate to commerce, to manufacturing, to agriculture? Is credit

capital? Is an increase in credit an increase in values? The last two of

these questions imply that we have a definition of credit. Perhaps the

answers to some of the other questions may have given us such a

definition. But analysis and description will precede definition.

The etymology of "credit" has sometimes been taken as the clue to the

meaning of the word for economics, and the idea of confidence, or

belief, has been made the heart of the matter. A man has good credit

when others have confidence in his integrity, etc. Men lend to others

when they can trust them to repay. Doubtless something of this sort was

responsible for the original choice of the word. But when loans are made

on good mortgage security, or on collateral security, the personality of

the borrower may count for little or nothing. Confidence there is, but

not confidence in the intentions of the borrower. The confidence is in

the "goodness" (_i. e._, the value and marketability) of the collateral.

The same questions are raised by the lender here which he would raise if

he were going to buy the thing, instead of lending with it as security.

None the less, I think that in the etymology of the word we have an

important clue. We must generalize the notion, however, beyond the

limits of confidence in personal intentions. It involves confidence in

the general economic situation, in the future of business, in the

permanence of values, in the certainty of future incomes, etc. Thus

viewed, the element of confidence, though important in highest degree,

is not peculiar to the phenomena which we call credit phenomena in

economics. It appears wherever there are values which depend on future

events. One does not need much confidence in buying potatoes or apples

or meat--though in the case of meat quite a lot of confidence may be

involved--and misplaced! But whenever the future is involved, whenever

capital values of any kind are involved--lands, stocks, bonds, houses,

horses, manufacturing equipment, etc.--the element of belief,

confidence, hopeful attitude toward the future, is quite as much present

as in the case of a loan. Nor is the element of personal confidence

less present, often, in these things than in the case of a loan. Very

often the value of a horse may depend in considerable degree on the

integrity of the man who offers it for sale; the value of a piece of

land may be much enhanced if a trustworthy owner makes certain

statements as to the yields he has got from it; the values of stocks

(really credit instruments, from the angle of economic analysis) may

depend very much on the personality of the organizers and managers of a

corporation. Personal prestiges may count for much more in these cases

than in the case of a collateral loan.

Further, in connection with the element of belief, or confidence.

Borrowing is expensive, and men do not borrow for amusement. That

borrowing and lending may increase, it is not enough that lenders have

confidence in the ability of borrowers to repay. Borrowers must also

have confidence in the future of their businesses, in their ability to

make enough out of the loan to pay the expense involved, and have a

surplus left over. I abstract here from consumption loans. They play a

very minor role.[504] The analysis in an earlier chapter, based on

Kinley's figures, showing that retail trade is less than one-eleventh of

the total pecuniary transactions in 1909, and that the percentage of

credit instruments used in retail trade is much lower than in other

transactions, will justify us, when quantitative questions are involved,

in abstracting from consumption loans. Since such loans will be chiefly

employed in retail buying, and since we know that most retail buying

does not result from loans for consumption purposes, we may conclude

that modern credit is overwhelmingly of a different sort. Most of it

arises from business activities of one kind or another, and rests on

expectation of profit and loss.[505] Such loans are not made when

borrowers, as well as lenders, have not confidence in the transactions

they mean to put through.

So far the thing has run in terms of individual calculation of profit

and loss. But even the most sagacious business men do not play a lone

hand. No one is uninfluenced by the expectations and feelings of others.

In general, business confidence is in large degree a matter of social

psychology, resting on suggestion, contagion, etc., as well as on cool

calculation of profit and loss. Even where men are able in considerable

degree to free themselves from the prevailing optimism or pessimism,

they must take it into account. The man who extends his business when

nobody is in the mood to buy, when no one will make contracts with him,

runs a very fair chance of bankruptcy, even though there be, in the

technical facts of industry, no reason for the prevailing pessimism. A

man with large resources, which are not fully employed, seeing that the

prevailing "bad business" is "largely psychological" may, indeed, take

advantage of the fact, get his labor and raw materials cheaply, and

produce some staple in advance of his market. If he can afford to hold

his surplus, he may make large profits by so doing. But usually business

men will not, in such a situation, have the surplus resources to enable

them to put through such an undertaking, and hence, even though they may

recognize that the rest of the business world is irrational, they must,

perforce, conform to its irrationality, and their sober estimate of the

prospects of a given undertaking may be just as much adverse as if they

shared the feeling of gloom which all about them feel. They meet it

from the banker from whom they wish to borrow. Even if able to borrow,

they meet it from the dealers to whom they are accustomed to sell their

products. The prevailing gloom is as much a fact with which they must

reckon as is the price of their raw materials, or the technical

qualities of those raw materials.

Further, business confidence is not a matter in which each man counts

one! There are centers of prestige, men and institutions whose attitude

toward the future counts heavily indeed in determining the attitudes of

others. These prestiges may arise from various causes. Recognized wisdom

and probity may give a man great prestige in economic matters. There are

financial writers and students of the market, not necessarily men of

great wealth, whose opinions are exceedingly influential in making

business confidence. The wisdom without the probity is not enough. Some

men, known to be sagacious students of the market, have been known to

succeed in their plans by telling the truth, with the result that

everybody else did the wrong thing! They made business confidence, but

not the sort that was complimentary to them. Other men have prestige,

influence in making business confidence, by virtue of possession of

large wealth. They are, first, in position to lend largely. Their

decisions count directly for more than the decisions of thousands of

other men. The very fact that they have confidence in the future, apart

from anything else, means a tremendous increase in _effective_ business

confidence--which we are here concerned with. The optimism of a man who

can neither buy nor sell nor borrow nor lend, because he himself has no

economic resources, and no prestige, is like the desire of a penniless

beggar for an economic good--its effect on the market is not great! But

further, the fact that a rich man is lending makes possible activities

which would not otherwise be possible, and so justifies confidence on

the part of those who wish to deal with those to whom he lends. Such a

man may, on the other hand, borrow. His borrowing, for business

activity, justifies confidence on the part of those who would deal with

him. Quite apart, therefore, from any influence on the opinions of

others growing out of respect for his judgment, or less rational

reaction to him, he can do much to make or unmake business confidence.

But commonly, also, such a man is a center of prestige, as well as a

controller of economic power by virtue of his wealth. Men look to him

for their cue. If _he_ has confidence enough in the future to risk his

great wealth, surely smaller men with smaller interests need not be

afraid. Vitally important centres for the making and controlling of

business confidence are the banks. Having intimate knowledge of the

affairs of many business men, of business men in many different lines,

they are in a position to judge wisely of business prospects. Having

great power to make or refuse loans, they can encourage or chill the

enthusiasm which business men may independently develop. The whispered

word of a banker may well count for more than the half-page

advertisement of a promoter. But the banker is not all powerful. His

influence is much greater, often, in restraining than in evoking

business confidence. Bankers may during long periods be quite unable to

increase their loans, though they tempt borrowing by easy rates.

Business confidence is a fact of social psychology. It is an organic

phenomenon, with radiant points of control. It is a matter of

inter-mental activity, rather than a thing in which each man makes an

independent choice.

But this is to say nothing of credit phenomena that is not true of all

value phenomena. All economic values are social values. The values of

wheat or sugar or bicycles are social values. There are centers of power

and prestige, growing out of the distribution of wealth, or various

other social factors, which have a dominating influence on economic

values, as a rule. Credit phenomena are merely part and parcel of the

general system of economic motivation and control.

In _Social Value_ (pp. 102-103) I have denied the doctrine of Meinong

and Tarde that explicit belief, existential judgments, are essential to

the existence of values, taking value in the generic sense, which

includes aesthetic value, religious and patriotic value, legal, moral,

and other values. I have pointed out that we do, at times, value ideal

objects, the creatures of our imaginations. The dead sweetheart, or the

Beatrice that never was (or that never was what she was imagined to be)

may have tremendous value. Not merely things hoped for, but things

hopelessly gone, as "The Lost Cause" to the Southerner, may be objects

of value so high that other things, known to be real, may sink into

insignificance beside them. Even in these cases, however, there must be

a "reality-_feeling_" an unconscious presumption or assumption that the

object valued is real. Indeed, belief, as distinguished from mere

ideation, is an emotional "tang," an essentially emotional, rather than

intellectual, fact. If it be present, the ideation and explicit judgment

may be dispensed with.

It is, however, characteristic of economic values, particularly of the

values of instrumental goods and of the goods with which business men

make profits, that the tendency to raise the question of reality, to

require explicit judgment, is strong. The successful business man is

necessarily the man who does this, who does not too highly value the

creatures of his imagination, when he imagines a vain thing. One need

not, perhaps, seriously raise the question as to the reality of the loaf

of bread he buys. Explicit judgment there would be superfluous. But

very serious questionings come in whenever lands or houses or

securities or bills of exchange come in. One needs to know what the

facts are, and to make judgments based upon them. Hence, for all values

of capital goods and income-bearers, for the values which pass in

wholesale and speculative trading in general, the matter of _belief_ is

vitally important. Here, again, then, we have nothing in the

psychological principles underlying credit phenomena to mark them off

from the general field of value phenomena.

The general laws of value, then, apply in the case of credit phenomena.

We find nothing unique in essence in them. The juridical relations,

also, in so far as they have economic significance, shade into one

another. To buy a bond from a bondholder is purchase and sale. To pay a

borrower money for his personal note is lending. But from the standpoint

of the theory of value and prices this distinction may be ignored. We

may extend the idea of buying, selling, and price to cover all contracts

where values are balanced against values, and expressed in terms of each

other. Future money has its price in present money, just as much as

present wheat has its price in present money. Really it is not future

money against present money. It is a case of _rights_, which involve the

payment of money in the future, sold for money, and priced in money. In

general, it is _rights_, rather than _things_, which pass in economic

exchange. Physical delivery does not constitute selling. Delivering a

load of wheat to a railroad does not constitute sale of the wheat to the

railroad; selling a farm does not involve any physical moving of the

farm. Rights, _in personam_ or _in rem_, are objects of economic value,

and the exchange of these rights makes up the bulk, if not the whole, of

economic exchange. (Exchange may be limited to the transfers of juristic

rights, without value being so limited. I have discussed the relations

of value and exchange in the chapter on "Value," above.) Property rights

are commonly conceived of as the proper objects of buying and sale.

Contracts involving the future services of free men stand legally on a

different footing from contracts regarding physical goods. But economic

analysis is not greatly concerned with these distinctions, except in so

far as they affect the values of the things exchanged, and so the terms

of the exchanges. I do not believe that the legal distinctions can be

made to run on all fours with any significant economic distinctions, and

shall not undertake to make them do so. In the phenomena we have simply

cases of buying and selling (in a generalized sense of those terms) of

_rights_, at _prices_ (by a very slight extension of the term, price, to

which the market is well accustomed). The terms of these exchanges, the

prices, are governed by values, social economic values, in no wise

different from the values which govern the prices in exchanges which we

do not class as credit transactions. I say that credit phenomena are

exchanges of rights. This is true of all exchanges. We do not exchange

rights for money. We exchange rights to other things for rights to

money. The mere physical transfer, even of money, does not give rights

to the money. I may merely be giving you the money for safe keeping, or

for use for my purposes. While the law makes the rights to money that

has left the hands of its owner less lasting, as against innocent third

parties, than in the case of other objects, and while the right to money

is always, or almost always, met by returning other money of equal

amount, even in the case of money it is a right, and not a mere physical

transfer, that is significant.

Our problem regarding credit is, then, much simplified. We have simply

to pick out certain economic exchanges to which the name of credit

transactions has been applied,--a various and heterogeneous set of

exchanges, in many ways--and study them, to find their peculiarities.

These peculiarities will not make them exceptions to the general laws of

value. They will make them merely special cases. To find essential

principles marking off credit transactions, at large, from non-credit

transactions is an exceedingly difficult thing. There are more

differences among credit transactions themselves, than there are between

the genus, credit transactions, and the class of things not called by

that name.

Thus, monthly payments of rent, of wages, of college professors'

salaries, are not commonly called credit transactions. The monthly

payment of grocery bills, or of telephone bills, involves credit. Where

is a real difference to be found? On the other hand, between book credit

between grocer and patron on the one hand, and a bank-note or deposit

credit on the other, the difference is large, in many practically

important ways. Between a call loan and a ten year agricultural

mortgage-note, the differences are even greater.

One may be disposed to find the differences between credit transactions

and non-credit transactions in the fact that the former stipulate a

definite sum of money, due at definite times. This would partly

differentiate a bond, say, from a stock. The bond not merely calls for

stipulated yearly payments, but also calls for a definite payment at the

end. This would, however, exclude British Consols from the list of

credit instruments! British Consols differ from safe preferred stocks in

legal, rather than in economic, ways. Legally they are alike in that no

terminal payment is called for. Practically they are alike in that

annual regular sums may be expected. It may at least be said of credit

transactions that stipulated money payments, either at a different time

or a different _place_, are called for. This would include the

telegraphic transfers of funds, and would exclude the case where A, a

farmer, does a day's work for B, a neighbor, for the promise of a day's

work in return at a later season. The latter transaction involves many

of the elements that definitions of credit have included, but I think

that we may at least limit our conception of credit transactions to

transactions within a money economy, where money, as a measure of

values, functions in the calculations. Shall we, however, limit credit

transactions to cases where a stipulated _amount_ of money is named in

the contract, for a stipulated time?

Shall we exclude contracts where the payment of money is made contingent

on anything? By contingency here I mean legal contingency. This test

would exclude the highest grade preferred stock. It would include the

shakiest bonds that contained, in the terms of the contract, no

contingency. But where, then, would one place such an instrument as the

Seaboard Airline Adjustment 5% Bonds, which may default in a given year

half of the interest, if it is not earned,[506] and which yet call for

the payment of the principal at a stipulated time?

What shall we say of "borrowing and carrying" transactions on the stock

exchange? Is not the loan of stocks a real credit transaction?

Ordinarily, when stocks are put up as collateral, one thinks of the

money as being lent, and the stock merely as a pledge. But in the case

of borrowing stocks by a bear to deliver next day, the transaction is

definitely thought of as a loan of stock. It is sometimes paid for, the

bear paying the bull a premium, instead of receiving interest on the

money he has turned over to the bull as a "pledge." The more usual

thing, is, of course, for the bull to pay the bear interest. But in a

contract like this, there are many contingencies. As the stock rises in

value, the bear must lend more money to the bull; if the stock falls,

the bull must return part of the money to the bear. Both times and

amounts are here contingent, even though in the end the amounts lent and

repaid balance. Call loans, of course, do not call for payment at a

stipulated time, and the same is true of bank-deposits and bank-notes,

and of many other forms of credit. Interest on deposits in mutual

savings banks is contingent, legally, as to amount. Are insurance

policies credit instruments? What of endowment policies?

It is easy to draw legal distinctions in all these cases, but to show

that definite and uniform economic consequences flow from these legal

distinctions is quite impossible. Rather, it is easily possible to show

that uniform or certain economic consequences do not, in general, flow

from them.

I shall refrain from the effort to give a general, fundamental

definition of credit. I shall rather discuss certain of the more

important types of what have been called credit, with a view to seeing

what bearing they have on the problems with which this book is

concerned; the value of money, and prices. The general class of

transactions to which the name, credit transactions, has been applied

may be roughly designated as transactions in which the consideration on

one side, at least, is the assumption of a debt, running in terms of

money (though not necessarily to be paid in actual money), payable

either at a future time or at another place. Objections can be found to

this definition. It does not meet the fundamental test of a definition

that, for the purpose in hand, it should seize upon the essential and

unique characteristic of the things marked off. I am not sure that it

meets the tests of inclusiveness and exclusiveness even for those

transactions which we call credit transactions. Thus, if A and B go to

the bank together, and A there buys B's horse, standing in front of the

bank, giving B in return a check, which B immediately cashes in the same

room where the check is drawn, the idea of different time or different

place is not realized in any but a technical sense. A, in drawing the

check is, of course, assuming a debt. The check, if repudiated by the

bank, becomes a note, which A must pay. A, moreover, is paying B, not

with money, but with the transfer of a claim on the bank, and the fact

that his check, if unpaid, becomes a note is not the main fact about the

check. Understanding our definition of credit to cover this case also,

however, and attaching no fundamental importance to the definition save

as a means of marking off a class of more or less related phenomena

which we mean to discuss, the definition will serve.

Thus defined, we have in credit a concept susceptible to quantitative

treatment. Debts, in terms of money, can be summed up, and we may have

the concept of the "volume of credit" as the sum of such debts at a

given time, or through a given period of time, or as an average through

a period of time. We may distinguish credit transactions from credit,

defining credit as the volume of debts, and credit transactions as

transactions in which the debts are passed in exchange. This would be to

broaden the notion of credit transactions beyond the usual conception,

since it would include transactions in which A sells ("without

recourse") B's note to C. It would also include cases where bonds are

sold. It would exclude cases where stocks are sold, since they are not

legally debts. Some would prefer to limit the notion of credit

transaction to transactions in which there remains some contingent

responsibility on the part of the one who uses the credit instrument,

but this would be to deny the name, credit transaction, to cases where

bank-notes or government paper are used in payments, as well as to deny

it to the case where bonds are sold. It is not important, for my

purposes, to draw a sharp line about the concept, credit transaction,

however. And about the concept credit itself I have drawn a line resting

on a legal, rather than an economic, distinction.

Within the field of credit, thus defined, we may single out for especial

consideration certain forms of demand or short time credit, particularly

bills of exchange, bank-notes and bank-deposits, and merchants'

book-credit. We shall also have something to say regarding long-time

credit, including bonds, and mortgage-notes that have no general market.

All these debts in terms of money, to which, in the aggregate, we have

given the name, volume of credit, have grown out of _exchanges_.

Exchange is here used in a wide sense, and is not confined to the case

where goods or services are bought and sold. It is an exchange, if a man

gives his note to a banker in return for a deposit credit. But, on the

assumption that exchanges are made only when gains are to be realized,

it follows that all debts, and so all credit, have been created in view

of anticipated gains (or to avert anticipated losses). In a society

where everything is in equilibrium, a "static state," where there are no

"transitions" to be effected, where there is no occasion for

speculation, and where exchanges of lands, etc., are negligible, the

volume of all exchanges, including those where debts are passed in

exchange, would be small. The occasion for the creation of the debts

which make up the volume of credit would not be nearly so numerous as

under dynamic conditions. The _volume_ of credit, in other words, is

largely a function of dynamic conditions, even though credit would exist

in a static condition of economic life. The bulk of credit, as the bulk

of exchanging, grows out of dynamic conditions, transitional changes,

and the like.

This will be clearer when we raise the question as to _why_ debts are

created, as to what function debts perform in economic life. Why should

a man borrow? Let us suppose that a farmer has 600 acres of land. He

wishes to sell 100 acres, and use the proceeds in buying equipment for

his farm. But he finds it difficult to sell the 100 acres. There is no

ready market. He can sell it immediately only at a great sacrifice. By

waiting, and looking industriously for a customer, or by engaging a real

estate dealer to do so, he could finally find a buyer, but the thing is

slow and uncertain, and he wishes to get the equipment at once. He

borrows, therefore, giving his farm as security, or a part of the farm

as security. He exchanges a claim on the future income of the farm for

present money, and with this he can buy the equipment he needs. The net

result has been that the credit transaction has transformed his

unmarketable quantum of value into a marketable form of value. He has

been able, by an indirect step, to do what he could not do directly--to

trade a part of the farm (which in its economic essence is a prospect of

future income) for the equipment. In this illustration, _credit has

functioned as a means of increasing the marketability or saleability of

non-pecuniary forms of wealth_. Credit is primarily a device for

effecting exchanges that could not otherwise be effected, or for

effecting exchanges more easily than they could otherwise be effected.

This means that credit transactions are a part of the productive

process, and that they increase values. It is the function of credit to

universalize the characteristic of money, high saleability. It is the

function of credit to "coin," so to speak, rights to goods on shelves,

lands, etc., etc., into liquid rights, bearing the dollar mark, which

are much more highly saleable than the rights in their original form

were, and which often become as saleable as money itself, functioning

perfectly as money.

Credit thus tends to universalize that characteristic which Menger[507]

considers the unique characteristic of money. By means of credit

transactions, a man borrows up to 50% of the value of the farm, makes

his farm in effect, 50% saleable or fluid. The man who owns livestock

may not be able, on a given day, to market them without loss, but he can

use their value in the market, up, say, to 75%, by a loan. The man who

owns a hundred shares of United States Steel may not be able, at a given

time, to market them to his satisfaction--though in the case of articles

and stocks dealt in the speculative markets saleability is very high

indeed, and in the case of United States Steel, in particular, the

"spread" between "buying price" and "selling price" is very narrow--but

he can borrow, with the stock as security, up to 80% of its value. On a

bond of the United States government, he may borrow up to 100%.[508] The

process of creating credit is a process of transforming rights from

unsaleable to saleable form. Often this means the subdivision of rights,

preferential rights to a _portion_ of the value of a piece of wealth

being more saleable, because of greater certainty, than the total right

to the whole. Another reason why partial rights may be more saleable is

that the value represented by each partial right is smaller. It is

easier to market things worth a thousand dollars than things worth fifty

thousand, as a rule. In any case, a chief economic function of credit

is,--_the_ chief function for our purposes--to make fluid and saleable

articles of wealth other than money; to universalize the quality of

saleability.

This justifies us in our contention made before that _all_ corporate

securities, whether stocks or bonds,[509] are, in economic nature,

alike. Driven to a legal concept for a definition of credit, we were

obliged to exclude stocks from our rough definition. But corporate

organization does precisely what the various other transactions that we

have called credit transactions do. Lands and buildings and machinery,

or the roadbed and rolling stock of a railroad, are highly specialized,

often unfit for use in any form other than that in which they now

appear. As concrete instruments of production, they would be highly

unsaleable. In their totality, as a going concern, they are highly

unsaleable, because in the aggregate so very valuable. Grouped together,

however, but still subdivided, the objects of many thousands of partial

rights, represented by stocks and bonds, they become saleable in high

degree.

As objects other than money gain in saleability, they tend to gain in

value, also. This is not necessarily true, always. If wealth is already

in the best place, at the proper time, and in the proper hands, no point

is involved in further exchanges. Additional saleability--or an increase

in the qualities that make for saleability--could make no difference.

But when objects could be employed to greater advantage if in different

hands, if, in other words, there is occasion for exchange, then whatever

adds to the saleability of a good adds to its value. What would

otherwise have gone into the trouble and expense of marketing now is

saved. In general, items of wealth tend to gain in value as they gain in

saleability--though not in any definite proportion.

Further, as objects of value other than money gain in saleability, money

tends to lose its _differential advantage_ in this respect, and so

tends to lose that part of its value which comes from the money-uses. If

all things, including gold, were equally saleable, there would be no

_raison d'etre_ for money, and gold would have only the value that comes

from its commodity functions. In so far as credit-arrangements give to

partial rights to wealth the capacity to serve as a medium of exchange

or for other money purposes--and this is true to a high degree of

bank-credit--this tends to cut under the sources of value of money.

Credit thus, from two angles, tends to raise prices; it raises the

values of goods; and it tends to lower the value of money. The limits on

this, however, are reached when gold ceases entirely to function as

money, and when all items of value are perfectly saleable. Then credit

has done its perfect work for prices, and can do no more. No incentive

remains for further borrowing, if all items of value that need to be

exchanged are perfectly saleable.

These theses will meet objection, particularly from those who are

accustomed to quantity theory reasoning, and who look upon the volume of

credit as something independent of the volume of trade. On the logic of

the quantity theory there is no reason why prices might not mount

indefinitely, if only credit could increase indefinitely. The causes

controlling the volume of credit are, on this view, quite independent of

the volume of trade. I have given this line of thought sufficient

criticism, perhaps, in Part II, but shall find occasion to recur to it

at a later point in this chapter. However, writers not bound by quantity

theory ideas, may still find reason to question these theses, and it is

necessary that I should take account of various complications, and make

what may well be called substantial qualifications and modifications,

before the theses are acceptable.

First, objection will be offered to the doctrine that all credit is

merely rights to wealth, that credit rests on wealth. It will be urged

that many loans are made without collateral, or mortgage security, that

the "personal credit" of the borrower is the only security, and the only

basis of the loan. This objection is not serious. There are, doubtless,

loans which are disguised benevolences, where the lender gets nothing

good in return for his loan. I abstract from such cases. Quantitatively

they are not important, and qualitatively they are not really commercial

transactions. In general, when a good merchant borrows at the bank on

his personal note, the bank knows very well what goods he has in stock,

what prospects he has for marketing them, what other debts he has, what

his "net worth" is. And the bank knows that it has legal claims, even

though not preferred claims, on his wealth. When a young business man

borrows capital from a neighbor, giving no security because he has no

marketable wealth which would serve as security, he is, none the less,

exchanging a valuable right for the loan. He is giving the lender a

right to a preferential share in his future income. The lender has

considered the young man's abilities as sources of income, in

conjunction with the capital lent. Incidentally, the lender retains

rights, preferential rights as against the young man himself, in the

quantum of value he has turned over to him. If a young man borrows the

resources with which he buys a farm, the lender takes a mortgage on the

farm itself. Transactions of this sort frequently have in them the

element of benevolence, and the considerations are not always strictly

commercial. In the case of a young man of unusual ability, however, who

insures his life for the benefit of the lender, such transactions may be

perfectly good commercial transactions, value balancing value in the

exchange. The thing traded is commonly present money (or its equivalent)

for rights to future money income.

Public loans present no exception to our rule. They represent the

transfer of present wealth for the future income which the government,

by virtue of its public domain, or, more commonly, its taxing power, may

expect to receive. With a strong government, this future income may be a

very substantial part of the total income of the people. Public loans

may often be for commercial purposes, as when municipalities borrow to

build or extend municipal enterprises. In cases of this sort, the market

frequently will consider the prospects of commercial success of the

enterprises in fixing the value of the municipal bonds. Where the

proceeds of the loan are for non-commercial purposes, as war, the

question of the future income of the government will still, ordinarily,

be a dominant factor in determining the value of the securities. Often,

however, there is the direct action of patriotic fervor, etc., enhancing

the values of government securities. We have seen this in the case of

government money. It is no part of our theory to maintain that men's

calculations are always rational, or that the whole of the value of a

long-time income-bearer rests on the anticipated income. But this is no

peculiarity of credit phenomena. The same thing is true of lands, for

example. Capital values often get independent in part of their

"presuppositions," as we have seen in the chapter, _supra_, on "Economic

Value." War security issues often represent the effort of the

government--as at the present time--to bring into the present every

possible bit of future values, as a means of increasing their power in a

desperate struggle. The high prices of goods in such a situation

represent the concentration of future values into the present, an

increase in the motivating power which stimulates the people to unwonted

exertions. In war time, moreover, many _ideal_ values,--those whose fate

is dependent on the outcome of the war--enter into and increase the

values of those goods which are needed for carrying on the war. This

leads to larger sacrifices of future income than would ordinarily be

tolerated. It is not so much a case of present goods rising because of

extra credit, as of extra credit because present goods are more

valuable.

A second objection would be raised that in many cases, the values

pledged by the borrower could not exist if the lender did not make the

loan. This would be particularly the case with credit granted for the

starting of a new or novel enterprise, which as yet exists only in idea.

The established merchant, with goods on his shelves, or with a bill of

lading for goods which he has sold, has a very tangible, concrete basis

for a loan, whose value is independent of the decision of any given

banker. If my doctrine is to be taken as holding that all credit rests

on concrete physical goods, very many exceptions indeed could be found.

But this is not my doctrine. It is that credit rests on valuable

_rights_. These rights may be rights to existing concrete goods; they

may be rights to future incomes. In any case, it is the values, rather

than the physical quantities, that are significant. Witness cotton

before and after the outbreak of the World War. Ultimately, in

general,[510] economic values come from the "primary values" or "first

order" values of consumption goods and services. These values are

reflected back, by the imputation processes, to the various "factors of

production" which have made the existence of the goods and services

possible, in accordance with well-known laws which need not be here

elaborated. But the category of "factors of production" is far from

exhausted when we have named land, labor, and produced instruments of

production! Some writers have rejected the notion of "factors of

production" largely or altogether, and prefer such a term as "agents of

acquisition."[511] I certainly have no intention to give to the term,

factor of production, any ethical connotation. Even though a factor of

production be, like land or labor, a _sine qua non_ of production, it

does not follow that the owner of that factor gets his proper, or

ethically just share, under the laws of economic imputation. Many of the

"factors of production," in the sense of factor which derives a value

from the economic laws of imputation, may well be parasitic from the

angle of ultimate social welfare. The only test is as to whether, under

existing social arrangements, a portion of the income _of a given

establishment_ would cease to exist if that factor should disappear, or

be reduced. From the angle of this test, monopoly power, trade-marks,

established trade connections, the big idea of an entrepreneur, a

dynamic personality, capacity for winning other men's confidence and

good will, and sometimes that brutal selfishness which makes other men

shrink from conflict, or the reputation of being a dangerous and

vindictive man, may be equally "factors of production" with land, labor,

and produced instruments of production. In Part IV of this book, "The

Reconciliation of Statics and Dynamics," we have discussed the

"intangible capital items" of this class, and have indicated that many

of them perform really important and necessary social functions. Others

are doubtless pernicious. Production involves leadership, organization,

the making and maintaining of "interstitial connections," as well as the

technology of muscle and machine. But credit is based on values, rather

than on concrete goods as such, and if these "intangibles" have value,

they may have credits based upon them.[512]

That some of these values exist only by virtue of the fact that credit

is granted is no marked peculiarity. The granting of credit is an

exchange of the rights of the creditor for rights to the future income

of the borrower. If the exchange were not made, in certain cases, the

borrower would have no future income to which he could give rights. The

entrepreneur with a big idea cannot actualize that big idea unless he

can bring it into conjunction with land, labor, capital, and a market

for the products. The exchange of rights to the value of the products

for the banker's deposit-currency, or the private lender's money is

merely one of many necessary exchanges required to bring about the

combination which will create the products. If there were no possibility

of marketing the products, he would be equally helpless, and his idea be

equally valueless. The general range of values, under our present system

of division of labor, private property, private enterprise, etc., depend

on the possibility of exchange. Men produce for the market, rather than

for their own consumption, or for the consumption of a communist

society. Without exchange, many values would persist, but most values

would at least be diminished. Exchange is part of the productive

process. The only peculiarity in the case under discussion is that the

man getting credit for the exploitation of a big new idea commonly has a

very limited market--is dependent on the decision of one bank or lender,

or at most of one out of a few possibilities. The narrower the market,

the more dependent are the values of things that must be exchanged upon

the decisions of a few men. Wheat is free, virtually, from individual

caprices, though even there a big operator may organize a pool and

temporarily affect the value very greatly. But the immediate power of a

few men on values is increasingly great as we get closer to those things

which are unique, which are capable of only specialized employment, and

which call for the cooeperation of elaborate and expensive systems. And,

of course, the influence of individual caprice, or individual decisions,

on all values grows greater as wealth and power are concentrated.

Economic social value is an institutional value, specially weighted and

controlled by individuals, classes and institutions.[513]

Joseph Schumpeter, in his _Theorie der wirtschaftlichen Entwicklung_,

has made much of the role of the banker in economic evolution. He sees

in the banker a creator of "_Kaufkraft_," by means of which an

entrepreneur, a dynamic man who has a new idea which he wishes to

actualize, is able to wrest from the unwilling "static economic

subjects" their land, labor and instrumental goods for the purpose of

putting his new plan through. This new _Kaufkraft_ is the true _Kapital_

which the new enterprise requires. Capital, thus defined, is not an

accumulation of goods, is not embodied in goods. It is an _agent_, a

_power_, which the banker creates. It makes dynamic change possible.

Schumpeter is particularly anxious, in clearing the way for his new

theory of interest, to get rid of all the notions of saving,

accumulations of stocks of goods, etc., which have commonly been made

prominent in the discussion of capital and interest. We need not here

discuss his theory of interest.[514] He maintains that the new dynamic

credit, credit granted by a banker for a really new enterprise, as yet

not concretely in existence, represents something new in the world,

anomolous from the angle of static values, and static credit. Indeed, he

regards credit as unessential for the static analysis, and banishes it

from the "_Wesen_" of his static state. But this new credit is different

from such credit as there may be in the static state, because, he holds,

the new credit does not rest on goods, and has no _Deckung_. Schumpeter

himself calls these doctrines "heresies." They become less dangerous,

however, when we learn that by "saving" Schumpeter means mere trenching

upon accustomed expenditure, so that the entrepreneur who saves part of

unusual profits is really not saving at all, and when one discovers that

his contention that there need be no accumulation of goods prior to the

starting of a new enterprise means merely that there need be no special

accumulation of goods _ad hoc_. Of course if saving means trenching upon

accustomed expenditure, it is banished by hypothesis from the static

state, but there may still be plenty of capital (in the ordinary sense

of accumulated produced means of production) for Schumpeter's

entrepreneur to get hold of by means of his new _Kapital_. His

contentions that the new credit does not rest on goods, that it has no

_Deckung_, and that we have a new thing in the world since in dynamic

credit we have a case of temporal discrepancy between the making of

obligations and the ability to pay them, calls for further analysis.

It is true that there is a time during which the new credit has no basis

in concrete goods. Very speedily, however, the new credit is exchanged

for concrete goods, and the enterprise is started. Further, the banker

commonly insists on a margin at the start. Further, the claims of the

borrower on the banker are themselves, prior to their expenditure for

the things needed in the enterprise, assets to which the banker may look

as a basis for his confidence in the goodness of the entrepreneur's

promise to pay him. There is never a moment when the new credit does not

rest on _values_. The loan by the banker to the borrower is,

essentially, like the case of the purchase of any bearer of future

incomes, say a machine, or a factory. The machine is, after all, in

economic nature, merely a "promise" of future goods and future values,

as an Austrian economist should be quick to recognize, and machines are

almost as frequently poor performers as borrowers--indeed, most

commonly, the borrower's inability to repay comes from the failure in

the value of the goods which his physical equipment produces. The

_raison d'etre_ of the new credit is the new values which have come into

existence: the new plan of the entrepreneur, _validated by the banker_,

attains a value equal to the present worth of the extra products which

it promises. I repeat that it is values which are significant as the

basis of loans, that values are not all embodied in physical goods, and

that value is essentially a psychological thing.

The banker's validation of the plan may be an essential factor in its

value. _Belief_ is often an essential factor in values. The new value,

and the new credit, have a large element of belief in them. The value of

the new plan rests proximately in the belief of the banker, manifested

by his granting of credit. But the value of the _bank-credit_ rests

ultimately in the _prestige_ of the banker, which is a fact of social

psychology, resting in a massing of belief on the part of the public in

him, in the validity of his bank-notes and deposit-currency, coupled

with support from legal and other institutions. But this is to

anticipate the discussion of the nature of bank-credit. The point

involved is sufficiently illustrated by the case where a man who is not

a banker lends his money to an entrepreneur of a new undertaking. Here

again the enterprise is impossible without the loan. Here the loan is

made on the basis of an anticipated income. Here again the anticipated

income is made possible only by the loan; one of the values that enters

into the exchange exists only because the exchange is possible. None the

less, the credit rests on value. It is a right to an anticipated income.

The man who has made the loan has his security in the value which he has

lent, plus the present worth of the extra income which the new idea is

expected to create.

Now a great practical difference is made in the course of economic life

by the decisions of lenders to lend to men who plan new things, instead

of to men who plan old things. It makes an enormous difference whether

or not new plans appeal to the imaginations of those who control the

economic resources of society. It makes a great difference whether

static values (the capital values of incomes to be created in familiar

ways) or dynamic values (capital values of incomes to be created in

novel ways) win out in the competition for loans from those who have

loans to make. But _as values_, the two are of the same psychological

stuff and substance: futurity and belief are essential elements in both

of them.

Stable belief, and strong belief, are easier to evoke in the case of the

established and the familiar. New ways of creating wealth must promise

larger returns, and make more dramatic appeals to the imagination, than

old ways. Schumpeter indicates that it is the essential function of the

banker to give preference to the new ways, that the mass of men are

"static" in their attitude, and that, for some reason which he does not

clearly indicate, the banker is not. This has not been our American

experience, on the whole. The contrast which Schumpeter makes between

the timid, static masses, and the few highly important dynamic

entrepreneurs, holds very much less true in America than in Continental

Europe. There it is doubtless true that new industrial enterprises have

had their main encouragement from bankers. Here, such enterprises have

appealed largely to the mass of men, to the investing and speculative

public. Our commercial banks have lent largely upon stock exchange

collateral, which means that, indirectly, bank-loans have gone to

finance industry. The extent of this is enormous, as will later appear.

However, the banks, as banks, have not been large _buyers_ of stocks.

They have guarded themselves by requiring "margins" from those to whom

they have lent on such collateral. Seasoned bonds have been bought in

great volume by our commercial banks, but few stocks. Even the

underwriters and investment bankers have been primarily intermediaries,

expecting to pass on to private buyers the securities they hold

temporarily. My point here is, merely, that there is nothing in the

distinction between static and dynamic credit, when by that is meant the

distinction between credit for new enterprises and credit for old

enterprises, to mark off a peculiar or essential province for

bank-credit. The need for bank-credit does arise out of dynamic

conditions, primarily, but it is not the need for credit to _start_

dynamic changes, even though bank-credit may do, and does do, that. The

chief reason for bank-credit is to enable economic society to readjust

itself quickly and readily to dynamic changes, by putting through

without friction the necessary exchanges that such readjustment

requires, and by holding in liquid form a fund of rights which can meet

the emergencies and unexpected occurrences which dynamic conditions

involve. To this we now turn.

Bank-credit is the debt of responsible institutions, payable on demand

in money. It may take the form of notes, or of the right to draw checks.

Long evolution has begot a system of legal relationships, and of banking

technique which makes these promises easily performed. The same process

of development has led to social reactions toward banks and bankers

which give them enormous prestige. Legal regulation, in the case of many

banks, requiring adequate capital, and, in this country, requiring

minimum cash reserves, have added to that prestige. The promise of the

bank is commonly so liquid and saleable that the banks are not called

upon to fulfill it by the actual payment of money--the promise alone is

an object of value which is perfectly saleable, which runs in terms of

money, and which functions as a perfect substitute for money in almost

every use except for very small retail transactions. Even there, it is

very much used.

Among the features of banking technique to which we must give especial

attention are the following: (1) the banker has substantial resources of

his own, his "capital," which constitutes the "margin" of protection

which he offers to those who give him valuable things in return for his

promises to pay money on demand; (2) the banker exchanges his promises

to pay on demand, as far as possible, for those things which have a high

degree of "liquidity," _i. e._, for those things which he can quickly

dispose of for cash, or for the promises of other bankers which are the

equivalent of cash. Farm mortgages are not good assets for a banker to

hold in large amount. They are long-term obligations, with a very

limited market, and they will not help him in emergencies to meet his

obligations to pay on demand. Agricultural loans, and other mortgage

loans are made in considerable volume by our State banks and trust

companies. All classes of commercial banks make many non-liquid loans,

as we shall later see. But all of them get as high a proportion of

liquid loans as they can. Bills of exchange, running ten, thirty, sixty

or ninety days, growing out of commercial transactions which

automatically terminate themselves in the payment of cash or the

promises of other bankers, constitute admirable assets. In return for

these, the banker may give his promises freely. This is especially true

where there is, in the banking practice, a wide "rediscount market," in

which he can sell these bills before maturity if he wishes to get even

more liquid assets. Promissory notes, for short periods, thirty, sixty,

or ninety days, growing again out of commercial transactions, which,

like those for which the bills of exchange were drawn, automatically

bring in cash or the promises of other banks, are in many respects like

the bills of exchange, even though the rediscount market for such notes

has not been so highly developed as the market for bills of exchange in

Europe. Whether such notes are as available for rediscount as bills of

exchange is a question of technical banking which we need not here

discuss in detail, though I venture the opinion that bills of exchange

are superior decidedly for this purpose, especially "documentary" bills.

The element of personal credit is commonly larger in the promissory

note, and that limits the market. Banking organization, and particularly

our new Federal Reserve System, may greatly reduce the disadvantages of

the promissory note from this angle, but it seems not unlikely that the

bill of exchange may be a factor of increasing importance in our

internal banking arrangements. The general test, however, of what is

available for a banker's assets depends on varying conditions, and is

not to be answered by a simple formula. A bank in a rural region which

loads up heavily with the safest local bonds is little better off than

with farm mortgages. For neither is there a quick market in an

emergency. A city bank, near the stock exchange, may very safely buy in

large amounts highly saleable as a profitable substitute for part of its

cash reserve. Even country banks may, and do, safely own such bonds.

Short loans on stock and bond security, constitute the most important

single type of bank-loan in the United States, as we shall later see.

(3) The third feature of banking technique to which attention must be

given is the reserve policy. The banker must keep some actual money on

hand (how much we have in part considered in Part II, and shall again

discuss).

I shall give attention to these points in what follows. The first point

needs little discussion. Large "capital" for a bank gives prestige and

security. Some capital is a _sine qua non_ for a bank which expects its

notes or deposit currency to have general acceptability.

It will be well to consider further the circumstances determining the

form which a bank's assets shall take. Though commercial banks own

enormous quantities of high grade bonds, it is rare for commercial banks

in America to buy stocks of corporations.[515] They will often lend to

owners of such stocks with the stocks as collateral, up to a high

percentage of the value of the stocks, but they will rarely trade their

demand obligations for the stocks directly. In general, a bank wishes

to have its assets in the form of obligations of other people, expressed

in terms of dollars, and having a definite term to run (or callable on

demand).

One reason for this is a bookkeeping reason. "Par value" of stocks has

little meaning any more. Market-prices of stocks, even the best stocks,

are not absolutely fixed. They fluctuate, even though within narrow

limits. This fact presents complications to the bookkeeper! Of course,

the bank's buildings and fixtures, listed among its assets, fluctuate

also, in value, and in the price that could be obtained on a given day,

but the bookkeeper can abstract from that, since the bank has no

intention of selling its buildings and fixtures. The notes and bills

held in the bank's portfolios also in fact fluctuate in value, and in

the price at which they might be sold on a given day, but they are

expressed in terms of dollars, and the bookkeeper commonly has no need

to look beyond the figures written on them. At irregular intervals, a

small percentage of them may be marked off the books as "bad," but

usually the minor fluctuations are abstracted from. The bank does not

like to have assets whose published prices fluctuate. But this is, I

suppose, not the main objection which banks have to stocks as assets

since it does not prevent their buying bonds. I abstract from the legal

restrictions that prevent many banks from buying stocks. The fundamental

reason is to be found elsewhere. The point is to be found here: the

transaction whereby property rights in roadbed, rolling stock, etc.,

were collected into property rights in a going, organic whole increased

the saleability of all these rights; the further subdivision of these

rights into many thousands of equal parts enormously increased the

saleability of these rights, especially when coupled with listing in an

organized market; the further transaction, by which a preferential claim

upon these subdivisions of rights is embodied in a collateral note

still further increases the saleability of the value of these rights.

The whole of the value embodied in a share of stock has not the

certainty and saleability which a banker wishes for his assets. It might

not be possible to market the stock on a given day without loss. But a

collateral note, embodying 80% of that value, with provision for

additional collateral in case the margin is reduced, is highly liquid

and the banker has no doubt that, with watchfulness, he can always

realize the full face value of such a note. It becomes saleable enough

for his purposes. The transaction by which this note is exchanged for

the banker's demand obligation gives the drawer of the collateral note a

perfectly saleable form of value with an almost universal market, which

he can convert without loss into practically anything that money can

buy. We have here a series, a scale, saleability of rights growing

steadily greater, through a series of transformations and exchanges,

till at last the virtually perfect saleability is reached. Again we are

reminded of Menger's analysis[516] of the methods of primitive barter,

whereby the man who possesses a good of low saleability, through

successive exchanges, gradually gets goods of higher and higher

saleability, until he finally reaches his goal. Bank-credit, this most

highly saleable of all forms of rights except the rights to actual money

in hand, and in general not inferior to money, cannot usually be had by

direct offer to the bank of crude property rights. These must be refined

and distilled, till a central core of highly saleable value emerges, and

then they may enter the bank's assets in return for bank-credit. The

best bonds likewise offer such a central core of highly saleable value.

A further point is to be noticed about this scale of saleabilities. At

each stage of the exchanges of less saleable for more saleable rights,

the holder of the less saleable rights must make concessions to the

holder of the more saleable rights. And the degree of his concession is,

in general, correlated with the lack of saleability of what he offers.

Commonly this takes the form of giving up a right which has a higher

yield for one which has a lower yield. Or, viewed more fundamentally,

from the angle of the capitalization theory, income-bearers of low

saleability are capitalized at a higher discount rate than

income-bearers of higher saleability, with the same yield. Farm lands

may be capitalized on a 10% basis. (There will be great differences

between regions in this, depending in considerable measure, often, on

the activity of farm sales. I would refer here to the facts mentioned in

my chapter on "The Quantity Theory and International Gold Movements,"

contrasting Cass Co., Iowa, with Yazoo Co., Mississippi. Of course, the

risks of agriculture count heavily, also, and the prestige of owning

land as compared with other forms of property.) The farmer's mortgage

note may bear 7%. A merchant who holds that note may use it as

collateral, with a margin, backing his own note, and get accommodation

for three months at 6%. The bank may rediscount the note of the

merchant, giving it its own endorsement, on a 4-1/2% basis. The coal

mine owned by a small company may yield 12%; sold to a large iron

company, which combines mining and smelting and manufacturing, that mine

may be represented by 7% stock; a collateral loan, for sixty days, based

on 80% of the value of the stock may be had for 4%; the demand liability

of the bank given in exchange for the collateral note will either yield

nothing at all, or else yield a low per cent, one, one and a half, or

2%, on large checking accounts. If the collateral note be a call note,

the rate will be lower, in general, than on a time note. I here refer to

what was said in the chapter on the functions of money with reference to

the relation of short loans, especially call loans, to the "bearer of

options" function of money. Part of the yields of these loans is in the

bearing of options. This function grows out of the uncertainties of a

dynamic market. It would disappear if uncertainties, "friction," and

dangers disappeared.

The importance of liquidity and saleability in the assets of a banker

needs little discussion. It has been reiterated by virtually every

writer on the subject. Its connection with the need for meeting demand

obligations is obvious. The point that I would here emphasize is,

however, that this, too, grows out of dynamic changes, uncertainties,

etc. An economic life in "normal equilibrium," in static balance, with

all things going smoothly, in anticipated ways, could dispense in large

measure, or wholly, with such liquidity. Obligations which matured at

the time that the holders of the obligations had maturing obligations,

would serve their purpose perfectly. Again I would emphasize the fact

that the theory of money and bank-credit is essentially a dynamic

theory, and that the notion of "normal equilibrium" which underlies the

quantity theory has no bearing whatever on these fundamental matters.

The market where fluid bank-credit is exchanged for less fluid rights

has been given the name, "the money market." The prices fixed in this

market are "money-rates," figured as percentages on the amounts of

bank-credit exchanged for the less fluid rights. It is, of course,

strictly speaking, not a money market. Money, as the term has been used

in this book, has been taken to mean gold coin, subsidiary coin,

government paper, and for the United States, bank-notes. In a country

where much bank-credit is elastic bank-notes, it is better to

distinguish money from bank-notes. The term, money, is not one easily

defined in a logical manner. A good logical definition should seize on

some essential characteristic of the object defined, should include all

the objects of that class, and should exclude all others. We can meet

the tests of inclusiveness and exclusiveness in a definition of money,

but we can hardly meet the first test. The differences between gold

money, for example, and gold bullion are less than the differences

between gold money and government paper. The differences between

bank-notes and bank-deposits are less than the differences between

bank-notes and government paper, or bank-notes and gold. The term,

money, covers a group of more or less miscellaneous things, concerning

all of which few general laws are possible. Gold, or other standard

money, in particular, may obey different laws from other forms of money.

I have been careful, in the foregoing, to avoid the danger of letting

the argument rest on any ambiguity in the meaning of the term, however,

and for the present shall not attempt further definition. For the

present, we shall use the term, "money market," in its familiar sense,

as meaning that market in which bank-credit is exchanged for less fluid

rights. An organized money market commonly appears only in larger

cities. In smaller places, relationships between banks and customers are

much more personal, and indeed, even in larger cities, regular business

houses have particularly intimate relations with special banks. A fluid,

impersonal market, to which men may repair without reference to anything

but the marketability of the collateral they have to offer, is a

distinctively metropolitan affair. Only large dealers commonly have

relations with more than one or two banks. Larger houses in the big

cities often do sell their "commercial paper" through brokers, and some

of the big New York mercantile houses have had their paper scattered a

good deal throughout the country. The lack of protection which houses

which sought such credit faced during the Panic of 1907 tended to check

the practice in some measure, but it has revived, and even

increased.[517] In the matter of a wide market for commercial paper,

however, an impersonal market, with great fluidity, we are well behind

not only England, but also Continental Europe. The London acceptance

house has especially contributed to an impersonal market. The American

money market is _par excellence_ a New York market, and the primary type

of paper discounted in the American money market is stock exchange

paper, and foreign bills of exchange. For commercial paper, however,

there are innumerable more personal, more restricted, markets, and

commercial paper constitutes a very considerable part of banking assets,

though much less than is often supposed. But this we shall discuss in

the next chapter.

CHAPTER XXIV

CREDIT--BANK ASSETS AND BANK RESERVES

In traditional discussions of banking, the impression is given that

commercial paper is the normal and dominant type of banking assets.[518]

To one accustomed to this view, the figures of the Comptroller of the

Currency for banking investments in the United States for 22,491 banks

of all kinds (State, national, private, and savings banks, and trust

companies) in 1909,[519] will occasion dismay:

(000,000 omitted)

Loans on real estate $ 2,505

Loans on other collateral security 3,975

Other loans and discounts 4,821

Overdrafts 69

United States bonds 792

State, county and municipal bonds 1,091

Railroad bonds and stocks 1,560

Bonds of other public service corporations 466

Other stocks, bonds, etc 703

Due from other banks and bankers 2,562

Real estate, furniture, etc 544

Checks and other cash items 437

Cash on hand 1,452

Other resources 111

--------

Total Resources $21,095

These figures, however, call for further analysis. They include figures

from institutions which should not be counted with commercial banks. The

percentage of real estate loans, especially, is too high to represent

the workings of commercial banks, a very high percentage of real estate

loans being held by stock and mutual savings banks. The other items,

however, are not much changed by the inclusion of savings banks and

private banks. It will be well to draw some conclusions from these

aggregate figures for all classes of institutions, before taking up a

more detailed analysis of State and national banks, and trust companies.

Where, among these items, does one find "commercial paper"? In the

reports of the metropolitan papers, giving daily variations in interest

rates, it is usual to find "commercial paper" listed as a separate

category, cooerdinate with "sixty day paper," "ninety day paper," etc.

Recent periodical discussion has gone elaborately into the question as

to what should be called "commercial paper," from the standpoint of the

policy of the Federal Reserve Banks. I think it safe to say that no two

markets, at present, in the United States will use the term in precisely

the same way, and that all would restrict the term to a small portion of

the "other loans and discounts" listed above. The most general

definition of "commercial paper" would be paper bought through

note-brokers. Despite the decided increase in loans and discounts which

our war prosperity has involved, there has been very frequent complaint

of the scarcity of "commercial paper." I shall use the term, "commercial

paper" in a much more liberal sense than the American money market does,

and shall mean by it all loans of a really liquid character, made by

banks to merchants and others to pay for the purchase of goods in

anticipation of a resale within the term of the loan which will enable

the loan to be repaid at maturity. From this should be excluded,

however, loans made to speculators. With this liberal, and not very

precise, definition of commercial paper, we raise again the question as

to where it may be found in the items above given.

Virtually all of it, I think, must be found in the item, "other loans

and discounts"--an item which, in all, is slightly less than 23% of

total banking assets.[520] But not all of this "other loans and

discounts" is commercial paper. Very much indeed represents loans of a

non-liquid character, regularly renewed, which manufacturers and others

have put, not into moveable goods, but into fixed forms of

capital-goods, as machinery, and even buildings. One case in New York,

which the writer is informed by a business man well acquainted with both

banking and business in many sections of the country is typical of many

cases, is as follows: a New York bank is at present lending to a small

manufacturer of automobile supplies about $30,000. Of this, about

$10,000 is liquid, periodically covered by "bills receivable," and if

the bills receivable should fail, in the period in question, to cover

the $10,000, the bank would insist on a reduction of the loan. The

remaining $20,000, however, is not liquid. It was spent for non-moveable

equipment; the bank expects to renew the notes for this loan

periodically, and is well aware that it could not force collection

without bringing the business to a close--or else forcing the factory to

get accommodation elsewhere. The $10,000 that is liquid is by no means

all spent for goods, but is spent, in part, for wages. _None_ of the

$10,000 is spent for goods which are to be resold without being

transformed by manufacture. None of the $30,000, therefore, is, in the

strict sense, "commercial paper." It is manufacturer's paper. Part of it

is virtually as liquid as commercial paper; two-thirds of it is not

liquid.

A very large part indeed of bank-loans are of this character. A large

part of the loans made to farmers are in no sense liquid: when the loan

is made, for, say, six months,[521] it is perfectly understood by both

bank and borrower that a renewal will be asked for and granted. It is

impossible to say what fraction of this $4,821,000,000 of "other loans

and discounts" is really liquid commercial paper, or liquid paper of any

kind, in the sense that it can be automatically paid off at maturity. I

venture the statement with entire confidence, however, that the

proportion of liquid paper is not one-half of the amount. I should

question if more than one-fourth of it is truly liquid, in the sense in

which that term is commonly used: meaning that the loan is made to put

through a transaction which will be completed during the term of the

loan, and permit the loan automatically to be paid off. I do not mean by

this merely that the banks could not reduce this item by one-fourth

suddenly. Even in a market made up wholly of highly liquid paper, an

arbitrary refusal to renew one-fourth of the loans, with the effort to

reduce loans and discounts by one-fourth, would occasion great

embarrassment and even disaster. The test of liquidity here applied

relates to the items separately, on the assumption that other things are

not radically changed. Even in this sense, however, viewing each loan

transaction separately, it may well be questioned if the banks in the

United States could find among their "other loans and discounts" items

exceeding a fourth of the total (in value) which they could refuse to

renew, at least in large part, without disappointing reasonable

expectations, and embarrassing good business men.[522]

Of this paper, not truly liquid, no doubt a good deal is advanced to

wholesale and retail merchants, and is, in this sense, commercial paper.

The terms, "liquid paper" and "commercial paper" by no means run on all

fours! As will later appear, the bulk of liquid banking assets are not

commercial paper at all. And only that part of a bank's loans to a

merchant may be called "liquid" which can be paid off by the merchant

without disappointing his reasonable expectations,--causing him to seek

other banking connections.

There is, however, another item in which we may find some commercial

paper, and this is the item, "loans on other collateral security." This

has commonly been supposed to be virtually all stock exchange loans.

Thus, Conant[523] cites the growth in this item in New York as evidence

of the growth of loans on stocks and bonds. For New York, loans on

stocks and bonds do make up the great bulk of this item. Even in New

York, however, there are other factors in it, absolutely, even though

not relatively, important, and in the country outside, the other

elements are not at all negligible, even though for the outside country

the part secured by stocks and bonds is the major part, and even though

the growth of this item in our total banking assets is, in general,

fairly indicative of the growth of loans secured by stocks and bonds.

Figures for the other items are not available for State banks, trust

companies or savings and private banks. They are not till very recently

available for national banks. In 1915,[524] however, the Comptroller

separates the item, "loans on other collateral security," for national

banks, into two parts, (1) loans "secured by stocks and bonds"

($1,750,597,273), and (2) loans "secured by other personal securities,

including merchandise, warehouse receipts, etc." ($882,749,812). Is

there any commercial paper in this last, not inconsiderable, item?

Let us locate the item, in the effort to find out. The percentage runs

highest in Chicago, where this class of collateral loan exceeds the

loans on stocks and bonds. The inference is strongly suggested,

therefore, that much of it, there, at least, represents advances to

live-stock, grain and produce traders and speculators on the Board of

Trade, at the stock yards, etc. The inference is strengthened by the

fact that St. Louis, where there is a good deal of grain and commodity

speculation, shows more than twice as much of this kind of paper as does

Boston, where this kind of speculation is unimportant--despite the fact

that Boston's aggregate collateral loans of all kinds greatly exceed

such loans in St. Louis. In New York, where there is a great deal of

coffee and cotton speculation, and some other commodity speculation, the

amount of this paper, though relatively small, is absolutely greater

than in any other city. No doubt, in New York, which is the country's

centre for foreign commerce, a fair amount of the paper secured by

"other personal securities, including merchandise, warehouse receipts,

etc.," is really commercial paper, representing advances to importers

and exporters--though the difficulties of giving this kind of security

where goods are in transit would prevent most of our foreign trade being

financed in this manner. The total of this kind of paper in New

York--all these figures are for national banks alone--was only 113

millions on June 23, 1915.[525] It may be doubted if very much of this

paper, in the great cities, represents goods in transit. With the

caution that the view here expressed is based on inference, and not on

actual knowledge of what the large city banks are doing, the writer

concludes that probably the bulk of this paper, in large cities,

represents loans to speculators rather than to merchants. It is liquid,

but it is not commercial paper.

What of such paper in the country districts? Nearly

one-half--$436,000,000 out of $882,000,000--of these national bank-loans

on "other personal security, including merchandise, warehouse receipts,

etc.," are in the country, outside the Reserve and Central Reserve

Cities. Much of it is in the South. Much of it in the grain and

live-stock producing regions. What do such loans mean?[526] Much of it

is loans to farmers and planters. In the South, much of it is on crop

liens. The loans on cotton warehouse receipts, at least in the country

parts of the South, are not as great as is commonly supposed. In the

North and West, there are a great mass of farmers' chattel mortgage

loans, including loans on horses, grain in cribs, hogs, sheep, cattle,

mules, etc. The use of this type of paper for financing the breeding and

feeding of live-stock, particularly hogs, cattle and sheep, is very

extensive. Virtually all loans to farmers and feeders for these purposes

are secured by such chattel mortgages. It seems improbable that a great

deal of this paper could represent ordinary commerce. Neither

wholesalers nor retailers can easily handle merchandise on which chattel

mortgages have been given. The usual method of granting credit to them

is to advance loans on one and two name paper, unsecured. Not many

loans to retailers and wholesalers will fall in the category under

discussion.

To what extent are the loans of this type to farmers liquid? Well, the

crop lien loans in the South have a natural term, and, though commonly

longer loans than bankers have in mind when speaking of liquid paper,

are liquid in the sense that they are automatically paid off at

maturity. Loans on work-animals need not have a natural term. Loans on

animals being fed for the market have such a natural term, and are truly

liquid. Loans, however, on breeding animals are not thus liquid, such

loans are commonly regularly renewed at maturity, and the banks do not

count on them in emergencies. It is the opinion of Dr. J. E. Pope that

fully two-thirds of the aggregate loans on live-stock chattel mortgage

security are to breeders rather than to feeders, and hence are not

liquid. Of course, none of these loans are commercial paper.

I conclude, therefore, that the thesis with which we started that the

overwhelming bulk of commercial paper is to be found in the item, "other

loans and discounts" is correct. I see no reason to suppose that an

analysis of the loans of State banks and trust companies would show a

different conclusion. We lack the figures for breaking up the collateral

loans of State banks and trust companies into the two classes, "secured

by stocks and bonds" and "secured by other personal securities,

including warehouse receipts, merchandise, etc." We have merely the

gross figures for collateral loans. As the State banks are in large

degree country banks, it is probable that the percentage of commodity

collateral as compared with stock exchange collateral for State banks

would be larger than for national banks. However, the total of

collateral loans for State banks is relatively small--559 millions, for

1909, as against "other loans and discounts" for State banks in that

year of 1,112 millions, and as against a total of collateral loans of

all banks reporting in that year of 3,975 millions. On the other hand,

the collateral loans of the trust companies are very large: 1,222

millions for 1909, as against "other loans and discounts" for the trust

companies in the same year of 460 millions. As the trust companies are

chiefly city institutions, and as the concentration of trust company

loans and capital in New York City is relatively very great, it would

seem pretty clear that taking both State banks and trust companies into

account would substantially lessen the percentage of loans "secured by

other personal security, including merchandise, warehouse receipts,

etc.," to total collateral loans. As the amount of commercial paper in

this class of loans for national banks is probably small, it may be

expected to be still smaller in the aggregate of collateral loans.

The following figures, for State and national banks, and trust

companies, only, will, in the light of the foregoing, give us basis for

some further conclusions regarding the character of banking assets in

the United States. As before, the year 1909 is chosen:

(000,000 omitted)[527]

_State _National _Trust _Aggre-

_Resources_ Banks_ Banks_ Companies_ gate_

Real estate loans 414 57 377 848

Collateral loans 559 1,939 1,222 3,720

All other loans 1,112 2,966 460 4,538

U. S. bonds 5 740 3 748

State, county and municipal

bonds 65 156 155 376

Railway stocks and bonds 75 351 362 788

Bonds of other public service

corporations 50 148 168 366

Other bonds, stocks, etc 95 208 769 1,072

Total of items here listed 2,375 6,565 3,516 12,456

----- ----- ----- ------

Total Resources 3,338 9,368 4,068 16,774

This table makes clear that the figures for real estate loans given in

the table for all banks, a few pages preceding, were much too high. It

leaves the relations among the other items, however, not greatly

changed. "All other loans" increase from slightly less than 23% of total

assets to 27%. If we concede that one-half of the "all other loans"

represents liquid "commercial paper"--a very liberal estimate, as we

have previously concluded--we get about 13-1/2% of the assets of these

institutions in the form of "commercial paper," an increase over the

11-1/2% to be assigned on the basis of the other table. The figure is

the roughest sort of approximation. I attach little importance to the

exact percentage, and the argument which follows is not dependent on any

exact figure here. The proportion of collateral loans to total resources

is changed also, and even more: collateral loans are 18% of total bank

resources when all kinds of banks are included, and are over 22% of

total bank resources when only State and national banks and trust

companies are counted. If the foregoing is correct within very wide

limits of error as to the amount of commercial paper, collateral loans

very substantially exceed commercial paper. If all the "all other loans"

should be counted as commercial paper, collateral loans are still not

far behind them--22% as against 27-1/2%.

What is the significance of this? We have seen that for national banks,

the great bulk (over 66%) of the collateral loans were secured by stocks

and bonds in June, 1915. We saw reasons for supposing that a higher

percentage of stock exchange collateral would be found when State banks

and trust companies are included. Suppose we assume that 75% of the

collateral loans of all three classes of institutions here in question

are based on stock exchange collateral.[528] This would mean 16-1/2% of

the total resources of these institutions in stock exchange loans--still

well above the 13-1/2% we have assigned to "commercial paper." In any

case, it is at least justifiable to contend that loans on stock exchange

collateral are as great in volume as commercial loans. I think that they

very substantially exceed them. But further, we have another large

percentage of bank resources invested in stock exchange securities

outright--chiefly in bonds. The aggregate for those investments in the

institutions under consideration is 3,250 millions. This is something

over 19% of the total assets of these institutions. Combining this with

the loans on stock exchange collateral, we get nearly 36% of bank and

trust company assets invested, directly or indirectly, in stock exchange

securities, as against an assumed 13-1/2% in commercial paper. Conceding

that all the "all other loans" are commercial loans, the stock exchange

assets still exceed them in the ratio of 36 to 27-1/2.

In our second table, we have listed items which aggregate only 12,456

millions of the total resources for these institutions of 16,774

millions. The items listed, however, represent virtually all the credit

extended by banks to industry, commerce, agriculture, the stock market,

other speculation, and the State. The excluded items of main importance

are: Due from other banks and bankers, 2,302 millions; checks and other

cash items, 432 millions; and cash on hand, 1,411 millions--the three

items aggregating 4,146 millions, which virtually closes the gap. These

three items are of immense importance as making for liquidity in

banking assets, and as making possible extensions of credit to the

business world, but it is not proper to count them when an estimate of

the extent of bank-credits is in question. Our second table contains,

for the three classes of institutions, all the items properly counted

there, except overdrafts (small in amount) and one other big item which

does not get into bank statements at all, namely, _overcertifications_

and "_morning loans_." Of this last item, more later. We may, then,

recalculate our percentages on the basis of the credit extended by the

three classes of institutions, instead of on the basis of total

resources. On this basis, the percentages are:

Real estate loans, 7.4%;

Collateral loans, 30%, of which we assign to stock exchange

collateral, 22-1/2%, and to other collateral, 7-1/2%;

All other loans, 36.4%, of which we assign to "Commercial

paper" 18.2%;

Total stocks and bonds, 26%.

Adding the percentages for stock exchange collateral loans and for

stocks and bonds owned, we get 48-1/2% of all extensions of bank-credit

for these three classes of institutions in the form of credits extended

to the security market. If everything else except the real estate loans

should be counted as "commercial loans" the stock exchange credit would

still exceed the commercial credit. If my estimate of 18.2% of

bank-credit based on commercial paper is high enough,[529] the banks and

trust companies have extended over two and a half times as much credit,

at a given time, to the security market as they have to commerce. This

on the face of the record. But there is, as above indicated, a further

item which does not get into the record, namely, overcertifications and

"morning loans." Every day in the great speculative centres, and very

especially in Wall Street, enormous advances are made to brokers, which

are canceled during the day, but which, during their short life, are a

real addition to bank-credit. To attempt to estimate this with any

accuracy is hopeless, but the total on any ordinary day is enormous, and

most of it is extended in connection with stock market transactions.

A final comparison,[530] which will conclude this perhaps too wearisome

analysis of these figures, will consider the loans alone, neglecting the

securities owned:

Of total loans:

Real estate loans, 9.3%;

Collateral loans, 40.8%, of which we assign to stock exchange

collateral, 30.6%, and to other collateral, 10.2%;

All other loans, 49.6%, of which we assign to "Commercial

paper," 24.8%.

The development of bank loans on stock exchange collateral is a

remarkable feature of the three or four decades preceding 1909. The

following figures, of national bank loans in New York City,[531]

illustrate the tendency:

(000,000 omitted)

_Loans on _Advances on

_Date_ Commercial Paper_[532] Securities_

1886 146 107

1890 151 145

1892 160 183

1894 168 192

1896 151 162

1898 181 260

1900 185 384

1902 210 396

1903 239 391

1904 268 538

The tendency is not peculiar to America, however. The following table

gives a classification of the loans and discounts of all the great

European banks[533] in selected years from 1875 to 1903:

(Figures in francs, 000,000 omitted)

_Note _Commercial _Advances on

_Date_ Circulation_ Loans_ Securities_

1875 9,699 4,027 828

1880 10,482 3,384 1,112

1885 11,662 4,050 1,231

1890 13,194 5,192 1,549

1895 15,896 5,328 3,669

1899 14,992 8,352 4,037

1900 15,906 8,514 4,171

1902 16,215 6,939 4,178

1903 16,539 6,147 4,129

We conclude, therefore, that the great bulk of banking credit in the

United States, even of "commercial banks," is not commercial credit.

Much of it, in the smaller places, especially, represents in fact,

whatever the form, long time advances to agriculture and industry. Most

of it, in the great cities, and to a large extent in even the smaller

places, represents advances to the permanent financing of corporate

industry. Excluding real estate loans, more than half of bank-credit

represents either ownership of bonds (with some stocks) or else advances

on stocks and bonds. Another important part of bank-credit, which I

shall not even attempt to measure, is employed in financing commodity

speculation.

It is worth while to compare our figures concerning bank loans with

Kinley's figures, which we have previously considered, for deposits made

on March 16 of 1909, the year we have chosen for the bank loans figures.

It is important to remember that "deposits," as used by Kinley in this

investigation, does not mean what the term means in a bank balance

sheet. Kinley's figures relate to the actual items deposited on the day

in question, and not to the net balance after deposits and withdrawals

have been compared when the bank has closed for the day. A large deposit

in the balance sheet sense might show no "deposits" in Kinley's sense,

in a given day; while enormous "deposits" in Kinley's sense might be so

offset by incoming checks that virtually nothing is left on the balance

sheet at the end of the day, for a given depositor. Kinley's figures

thus give us a means of getting at the degree of _activity_ of different

classes of deposits in the balance sheet sense, and so, indirectly, of

different classes of _loans_.

Loans and deposits (in the balance sheet sense) are, as we know, closely

correlated. This is true for banks in the aggregate, and for banks

individually at a moment of time. It is not generally true of a given

individual deposit account at a moment of time, but through a period of

time, for business deposits, it tends to be true that the items

deposited offset the amounts borrowed.[534] If the items deposited are

numerous, if the depositor has an "active" deposit account, receiving a

large flow of banking funds, as compared with his net deposit balances,

we may infer that his loans are also active, that he pays off loans

frequently, that his paper, in the assets of the bank, is "liquid."