CREDITS AND COLLECTIONS IN THEORY AND PRACTICE CHAPTER I NATURE AND FUNCTIONS OF CREDIT Credit Defined.-Notwithstanding slight differences in the wording, practically all definitions of credit include directly or by implication the two most important characteristics of confidence and of futurity. With very few exceptions, these definitions may be divided into two classes, depending upon whether credit is viewed as an executed act resulting in a right to receive and demand payment, or as a power, both realized and potential. The former is a legalistic conception, according to which credit is conceived of as the other side of debt-it is a right to receive and demand payment-while a debt constitutes an obligation to make payment. Thus, credit is a relation involving both a creditor and a debtor, and this identical relation is at the same time a credit or a debt, depending upon the way in which it is viewed. It is this conception that is responsible for the numerous attempts at defining the term as a "right to demand money." Although correct when viewed from the standpoint of the creditor, the legalistic conception reveals the truth but partially, for, according to the above definition, credit does not exist until goods have been transferred or services rendered and the debt created. It follows, therefore, that the credit of an individual or firm would always equal the amount of indebtedness actually incurred and that it would be improper to use expressions similar to the following, namely, "a person's credit is good," or "a person has unlimited credit," when, as a matter of fact, no or very little credit has been utilized as yet. Such restriction in usage of the term would thus run against the current of simple business parlance. Obviously, it appears more reasonable to think of credit as a power, at least from the standpoint of borrowers, to obtain goods or services on the basis of the seller's belief that payment will be made as agreed. Thus, in its commonly understood business use, credit may be defined as the power to secure economic goods or services in return for a promised equivalent payable at a future time. The equivalent may consist of commodities or services. Usually, however, credit obligations are discharged by money payments or credits of more or less general acceptability, which ordinarily pass as money, as will be shown in the following pages. Thus, credit may be something potential or realized, that part which has been used becoming a debt, while the unutilized portion constitutes the residue of power up to the limit which is placed upon it by creditors. From the foregoing it would appear incorrect for a seller of goods to state "we do not give credit." Instead, he should have said "we do not accept credit," for it is the prospective buyer who gives or offers his credit in exchange for the merchandise purchased or services obtained. The seller may accept or reject this intangible commodity, depending upon whether or not, in his opinion, the buyer possesses the willingness and ability to redeem his promise at maturity. It is said that, in practice, credit is stood on its head and sellers on time are referred to as credit grantors; but since it is difficult to inaugurate changes of this nature successfully, the practical application of the term is generally adopted. It seems, however, that it is possible to reconcile the practical usage with the definition laid down, by thinking of the seller as granting the buyer permission to use his purchasing power as represented by his ability and willingness to pay at a future time. It is probably because of this conception that John Stuart Mill defined credit as "the permission to use another's capital." Various Conceptions of Credit. In addition to the conceptions mentioned in preceding paragraphs, the term has many different shades of meaning. Few of the attempts at defining it otherwise than the manner in which it is employed in the previous paragraphs are at once clear and comprehensive. Prendergast, for example, states that "credit is the confidence that is reposed in the ability and purpose of men to meet their obligations," while Laughlin defines credit as "the machinery invented to accomplish the purposes of capital." Although the 1 PRENDERGAST, W. A., "Credit and Its Uses," p. 8. Ibid., p. 10. word "credit" is derived from the Latin credo, "I believe," it is by no means synonymous with confidence, but simply indicates that confidence is essential as a basis for a credit system or credit transaction. In the second case, "credit" is apparently confused with "credit system," the latter consisting of the mechanical aids by means of which credit transactions are conducted. Credit is also frequently confused with a "credit transaction," which involves the actual transfer of goods or services for a future equivalent. Then, too, a person is "given credit" upon the completion or performance of a heroic deed, or something which is looked upon with favor. Finally, from the bookkeeper's point of view, credit is something owed on an account; it is the converse of debit. Relation Between Credit and Wealth.-The layman ordinarily confuses credit with wealth. Such conception must be emphatically denied. Credit is not wealth, although frequently employed as such. Wealth is any material or physical thing that satisfies a human want, provided that thing is limited in amount. From the viewpoint of the seller, credit is, technically speaking, a right to the future use of wealth. The distinction between the two economic terms may be easily demonstrated by an illustration as follows: $10,000 $20,000 Case I In the foregoing illustration it is assumed that in Case I, X possesses no property or money with which to purchase the building from its present proprietor Y, and that Z, a building and loan association, has the money available for loans on property. The total wealth in possession of the three parties as given amounts to $20,000. Case II shows that X has borrowed on a mortgage from Z the sum of $10,000 with which to make payment for the building to its present owner. In this transaction, credit is extended by the third party to the first. The total amount of wealth is not changed, however. The physical property still consists of the two items: the building, and cash. The mortgage is but a piece of paper granting the mortgagee the right to the use of the building in case of default in payment of the debt incurred, in accordance with the terms of the agreement, by the mortgagor. Although credit is not wealth, nevertheless a very close and intimate relationship exists between the two. Credit is indirectly an aid in production. It leads to an enhancement in wealth through the transfers of title which it involves, as will be shown in another connection. "Credit makes possible an increase in the production of wealth and facilitates the utilization of capital. However, it is neither wealth nor capital." It should be noted at this point that the foregoing discussion involving a definition of the exact relationship between credit and wealth, is viewed entirely from the standpoint of society at large. Society may thus be likened to a parent corporation, the balance sheets of whose subsidiaries are combined into one consolidated statement. In this process, numerous items on the assets side of some of the subsidiary balance sheets are automatically eliminated and canceled by corresponding items on the liabilities side of the statements of other subsidiaries, and only the net results are recorded on the final report of the parent organization. A similar procedure would be followed were the total wealth of society compiled in one statement. Many items listed among the assets of some individuals or businesses would be canceled by similar amounts listed among the liabilities of others. From the standpoint of individuals or business firms, credit does constitute wealth and should be reckoned as such. Thus, we find that the largest portion of the wealth of most of our millionaires consists in a great measure in securities of different types, which constitute but instruments of credit. The Importance of Credit in Modern Business.-Unfortunately, there are no exact data available indicating the extent to which credit is utilized in the conduct of modern business. An approximate idea of the situation, however, may be gathered from an analysis of the figures compiled by Dr. David Kinley in a comprehensive investigation conducted by him for the National Monetary Commission. According to this authority, the average retail and wholesale business done with various credit instruments, including checks, approximated 86 per cent of the total. In view of the fact that this investigation extends back to HAGERTY, J. E., "Mercantile Credit," p. 17. 1910, the data presented cannot be taken as a final barometer of the present-day uses of credit. The changing character of the retail business has brought about numerous important changes in the volume of credit since that date. With the growth and development of the chain-store type of retail organization and its attendant "cash-and-carry" system, there has come about a diminution in the use of open book accounts. On the other hand, purely credit stores have increased in size and number. In addition, sales on the instalment plan have increased in amount, particularly in the marketing of products such as pianos, washing machines, automobiles, and the like. Again, the use of checks in payment of accounts has been on the up grade since 1910. Then, too, the enormous amount of commercial paper, including trade acceptances and Federal Reserve notes brought into existence by virtue of the favorable rediscounting provisions of the Federal Reserve System established since the date in question, must be given adequate consideration in determining the extent to which credit is used in present-day business. It is, therefore, the belief that, were an investigation conducted with a view of determining the importance of credit in modern business, a large net change in its favor as compared with its status of 1910 would be disclosed, for the reasons aforementioned.* Functions of Credit.-One of the essential services rendered by credit to society at large consists in substituting the regular media of exchange. Its use in that capacity is highly essential, and at the same time most convenient. Without it, the volume of business transactions would be entirely contingent upon the supply of the precious metals making up our media of exchange. The amount of "hard" money is far from adequate in caring for our normal business needs. Besides, the delay incident to the transfer of either gold or silver in payment for individual purchases would make such a process both clumsy and inconvenient. Furthermore, the expense involved in physically transporting the precious metals and insuring them while In this discussion, the enormous amounts of irredeemable paper or fiat currency issued through the medium of central banks controlled by the various governments of the continental countries of Europe are entirely disregarded because such development in the practical exclusion of gold or its equivalent is obviously abnormal and constitutes but an aftermath of the Great War. |