sense of the term. A credit transaction involves time before it is completed; that is to say, a commodity, or the use of a commodity for a time, or some kind of service is rendered now, whilst the reciprocal service or commodity is given after a specified interval. Much controversy has taken place as to the distinction between capital, in the sense of production capital, and credit. The individual merchant or manufacturer regards his credit as one of the principal requisites in carrying on his business. A manufacturer with good credit can at once expand his business to meet a growing demand, whilst his inferior in mercantile standing must proceed more slowly. It thus appears that, from the individual point of view, it is naturally regarded as giving increased productive power. Then, as so often happens in economics, a simple summation is made of the advantages of individuals, and credit comes to be regarded as part of the national (production) capital just in the same way as a national protectionist policy is fallaciously constructed from considering the gains to particular protected industries. It is evident, however, that in its simplest form, so far as production is concerned, credit cannot directly increase the actual means of production which are potentially at the service of a nation, but can only transfer the right to use these means from one member of the community to another. But, although a sharp distinction may be drawn logically between exchange and production, it is obvious that in a modern industrial society exchange is practically a necessary part of production. For without exchange, division of labor, which is fundamental in production, could not be carried out, and without credit, exchange itself, in the present state of society, could not be effected sufficiently for division of labor. Accordingly, so far, a well-organized system of credit may be regarded as one of the productive forces of industry. At the same time, however, it seems useful to retain the old distinction so sharply emphasized by Ricardo, M'Culloch, Mill, etc., between the actual material (production) capital and the mere transference of the right to use that capital. If this is done, it will still be open to the economist to point out the different methods by which indirectly credit tends to increase production and also the accumulation of capital (in the narrower sense). (1) By means of credit capital finds its way into the hands of those who can use it to most advantage, as is shown in the increased discount of bills when a trade begins to flourish. (2) By means of credit also the amount of national capital available for production is increased. Those whose savings would be too small (e.g., the working classes) if used alone, and those (e.g., the professional classes) who cannot use their wealth in material production, are enabled by credit institutions and all kinds of joint-stock associations to add to the means of production. Credit is evidently essential to the full development of competition, and the growth of credit is historically one of the most marked characteristics of the progress of society from status to contract. In nearly all contracts there is a deferred element on one side at least; in other words nearly all contracts involve credit, and thus again, indirectly at least, credit, by giving play to freedom of contract and competition, increases production. 121. THE BASIS OF CREDIT1 There has been a long-continued discussion over the basis of credit operations, that is, the reasons why credit is extended by one person to another. One party to the controversy has stoutly insisted that confidence is the basis of all grants of credit; that if one did not have confidence that a borrower would repay a loan he would never think of making the loan, unless perchance for personal or philanthropic reasons. Others have held that property, rather than confidence, is the basis of all genuine credit transactions. Without attempting to analyze the causes for this apparent difference in view, a tabular exhibit of the points usually investigated before credit is extended by up-to-date business concerns will show that while confidence must exist before a loan will be granted, such confidence is based in part on the borrower's property and in part on his personal characteristics. The customary matters investigated may be grouped in two general classes as follows: PERTAINING TO CHARACTER OF BORROWER a) Record for honest dealing b) Personal habits 1. Church affiliations 2. Gambling and drinking tendencies 3. Political ambitions 4. Style of living; wife's social ambitions c) Reputation for ability 1. Common sense and shrewdness ness 1 Taken by permission from H. G. Moulton, Principles of Banking, pp. 15–16. (The University of Chicago Press, 1917.) PERTAINING TO CHARACTER OF BUSINESS a) Ratio of quick assets to current liabilities b) Amount of capital invested and proportion owned c) Character of stock of goods d) Rate of turnover of stock e) Location of business, and character of competition f) Insurance carried It will be apparent that these points are not entirely unrelated. A man of excellent business ability, for instance, would have his business properly organized, and on the other hand, if it were found that a business was poorly equipped and managed, it would be certain that the man's business experience or business capacity was strictly limited. Investigation of these two kinds, however, usually serves to furnish a more adequate basis for a sound judgment of the risks involved. Perhaps one may conclude from this analysis that before deciding to extend credit one should at any rate have confidence in two points: (1) in the ability of the borrower to pay as promised; and (2) in his willingness or intention to pay. One is a matter of property and business ability; the other a question of honesty and business reliability. 122. THE DEVELOPMENT OF FORMAL CREDIT From the point of view of credit, industrial development may be divided into five stages. Wheat-growing may be taken as rudely typical of the development: I. In the first stage the wheat-grower is practically isolated from the rest of the world, thrown entirely on his own resources. Wheat does not satisfy all his wants. He must, therefore, after producing a certain amount of wheat, shift his labor to the production of other things. Credit has no place in such an economy. II. In the second stage our farmer has a few neighbors—a blacksmith, a shoemaker, a tailor, a storekeeper, a school-teacher, a parson, and the editor of a country newspaper. The farmer has learned that he gets a greater surplus utility by producing more wheat than he needs for personal uses, and bartering this excess with his various neighbors in return for their goods and services. The wheatgrower has now taken the first and most difficult step in industrial civilization. I Adapted by permission from Sidney Sherwood, "The Nature and Mechanism of Credit," Quarterly Journal of Economics, VIII (1893-94), 156-67. III. In the third stage regular markets for wheat and other goods have become established, and money is in common use. Our farmer sells his surplus wheat for money, and afterwards buys the desired goods with money. There is no essential difference between this case and the last. Physically, gold coin is imperishable; wheat is not. This is an advantage. Psychically, gold coin is a claim upon all men. No one in the market will refuse it. Money is generic, not specific. This is another advantage. The bullion, as collateral, is much better than wheat. This is still another advantage. IV. In the fourth stage our farmer believes that, if he had more capital, so as to enlarge his operations yet farther, he would still gain. His neighbor, also a wheat-grower, now getting old and wishing to retire partially from active business, lends him $1,000 worth of capital in return for our farmer's note, payable in a year. There is, furthermore, at the nearest village a grain-dealer who also deals in agricultural supplies. Our farmer, from time to time, buys from him various articles needed "on credit" and brings him wheat from time to time, for which he receives credit. He has now become a formal debtor as well as a formal creditor. He has given express, definite, legally enforceable promises to other men to pay them at a future time certain amounts of wheat or money. These credits, book credits or promissory notes, I call "formal" credits. He will be able to borrow so long as he proves his ability to pay more for the use of capital than its owners will gain by using it themselves. Thus the "credit" which will be given to our farmer will depend upon his industrial worth as a manager of capital, and thus the capital of society tends to get into the hands of the competent managers. V. This is the most highly developed stage of industry, with credit organized in banks and banking systems. There is no need to describe the familiar processes of banking. In the further specialization of industry due to credit a special class of dealers in credit instruments themselves has grown up. Credit, to attain its highest usefulness, must be capable of easy generalization. This is accomplished mainly in two ways: (1) by expressing credits in terms of money, which is generic; and (2) by such an organization of credit instruments and credit institutions that the owner of personal industrial capacity may readily exchange his individual credit, a purely specific thing, for wider credits. The banks do this, and the great banking systems which have grown up in the present century carry the process still farther. Our national banking system realizes in a marked degree the idea of universalizing individual credit. A man getting his note discounted by a national bank has at his disposal a credit which is everywhere accepted, and this, too, with a remarkable economy of gold money as a reserve. 123. THE VARIOUS KINDS OF CREDIT The divisions of credit have been classified as follows: Public Credit; Capital Credit; Mercantile Credit; Individual or Personal Credit; and Banking Credit. By Public Credit is meant chiefly the borrowing operations of governments, whether national, state, or local, through the issue of interest-bearing securities. The government promises to pay interest on a bond from year to year and to repay the principal at some stated future date. The purchaser of the bond accepts the government's promise of intention to pay and has faith in its ability to keep that promise. The government by means of its credit is therefore able to secure funds for present needs. An issue of paper money by the government is another example of a credit operation. Even without any fund for redemption purposes an issue of paper money will not for a time depreciate to worthlessness; a promise of ultimate redemption will give it some value so long as faith in the word of the government is not entirely shattered. At any rate, a partial reserve in coin, as in the case of our greenbacks at present, will maintain the value of paper currency. To the extent of the uncovered issue we have a pure credit currency. By Capital Credit, or Industrial Credit, to employ another term, is meant the credit used by corporations in procuring the necessary capital required in their business operations. The corporation agrees to return to the purchasers of its bonds at some future date the equivalent of the funds borrowed, with interest. The bondholder thus extends funds to the corporation because he believes the credit of the corporation is good. The purchaser of stock, also, trusts his funds to the managers of a corporation, and it is understood that he is to receive dividends in the future (if earned) and ultimately, if the business is liquidated, a return of his share of the capital. There is the obvious difference between a holder of stock and of bonds that one is an owner and the other a creditor, that the returns to the one are I Taken by permission from H. G. Moulton, Principles of Banking, pp. 16–21 ̧ (The University of Chicago Press, 1916.) |