set at 1645. A pamphlet written in 1676 entitled The Mystery of the Newfashioned Goldsmiths or Bankers Discovered informs us that the goldsmiths had extended their previous business to lending money and to most of the operations of modern banking, their largest advances being made to the king upon the security of the taxes. The goldsmiths allowed interest to those who placed money with them, and the receipts which they gave for these deposits passed from hand to hand as currency in much the same manner as Bank of England notes do now. That this business soon grew considerably is evident from the testimony of Sir Dudley North in 1680, who, on returning from abroad after many years, was greatly astonished at the new practice of merchants and others making payments by drawing bills on bankers, i.e., goldsmiths. Hence it will be seen that the goldsmiths, from the middle of the seventeenth century onward, assisted greatly to accustom people to the use of a paper currency. The English goldsmiths of the seventeenth century in issuing their notes acted on quite a different principle from the continental banks of that date. Most of the continental banks professed to be merely banks of deposit of coin or bullion, and to hold in this form. the full value of the bills issued against these deposits. Our goldsmiths and the Bank of England, following them, purported to give in their bills the equivalent of what they had received, but never pretended to take the deposit for any other purpose than that of trading with it. They did not make their issues square exactly with the deposits of coin and bullion entrusted to them, "but coined their own credit into money." In other words, they kept a comparatively small reserve as a basis for extensive deposit accounts in precisely the same manner as do modern commercial banks. This resulted occasionally in difficulties. The first recorded run on the private banks, or goldsmiths, was in 1667 after the disastrous defeat suffered by the English fleet at the hands of the Dutch at Chatham. Then the stoppage of the exchequer in 1672 seriously affected their credit; even their honesty was impugned; and in course of time it was found that paper money issued on the security of a small number of individuals could not circulate profitably in competition with that of a powerful joint-stock corporation, such as the Bank of England became in spite of the goldsmiths' opposition. II THE NATURE AND FUNCTIONS OF CREDIT Introduction An analysis of the principles underlying the institution of credit is fundamental to an understanding of banking. Indeed, it is often stated that banks are credit institutions, that banks deal in credit, or, in a word, that credit and banking are virtually synonymous. Again, it is often stated that modern industrial society is a credit society, the implication being that credit is the most significant factor in the present-day organization of industry and commerce. "Credit is the life-blood of commerce, "Credit is the heart and core of the modern business structure," are other common statements emphasizing the tremendous importance of this phenomenon that is called credit. While credit may be readily enough defined, an understanding of its real nature and significance is not so easily gained. It is a concept rather than a visible something; or perhaps one might better say that it is incorporeal rather than tangible. It is therefore an elusive phenomenon: "Now you see it and now you don't see it." At any rate, the student usually has at first no little difficulty in grasping its essential nature. In particular, credit is very often confused with the instruments of credit. One can see a check or a promissory note, and such instruments are therefore likely to appear as the very essence of credit. They are, however, merely evidences of the antecedent credit process or transaction and as such are quite irrelevant to credit itself. It should be observed in this connection that in the treatment below the "Instruments of Commercial Credit" are discussed in a separate division following the general analysis of credit itself. The subject may best be understood through a study of the reasons for giving and receiving credit and an analysis of the many ways in which it manifests itself in our everyday business activities. It will be found that, whatever the particular classification, all credit operations involve at bottom a common principle; though there has been much discussion as to just what this basis of credit is a discussion, however, which appears to have been largely due to a loose or differing use of words. The selection below on "The Basis of Credit" seeks to set forth the essential requirements for credit without attempting to reduce the matter to a definite word or statement. All credit operations will be found to involve an analysis more or less similar to the one there given. But while the granting of credit always involves a similar sort of analysis, there emerges, in the use of the funds or goods borrowed on credit, a sharp differentiation, one that is fundamental to the entire study of banking; namely, the distinction between commercial and investment credit. The one is related to the process of manufacturing and marketing consumers' goods, converting raw materials into finished products in the hands of their final consumers; the other, to the creation of capital goods, machinery, tools and equipment, stores, factories, railroads, etc. The former usually gives rise, because of the very nature of the operations, to short-time credit instruments, notes, drafts, checks, etc.; the latter as a rule to long-time credit instruments, stocks, bonds, mortgages, etc. In practice, however, this fundamental difference between commercial and investment credit has not always been clearly perceived, and some of the most serious problems of finance throughout our history have arisen from the frequent failure to differentiate in practice between investment and commercial operations. The readings in the present chapter are designed to set forth these fundamental differences, while the remainder of the book is devoted to an application of the principles here outlined. Indeed, banking in all its forms, so far as principles, as distinguished from the details of banking practice, are concerned, centers primarily around the use of either commercial or investment credit. 5. A DEFINITION OF CREDIT1 BY J. LAURENCE LAUGHLIN With the division of labor, the marvelous inventions of machinery, the prolongation of industrial processes (so that a unit of product can be more cheaply sold in the end), the growth and prodigious increase of all forms of capital have naturally led, as a help to this movement, to the evolution by society of the practical means by which men of affairs, when preparing for the future, are enabled with the least waste of efficiency to obtain control of property and capital in productive efforts. As a part of this evolution, as a practical means to an 'Adapted from Principles of Money, pp. 72-76. (Charles Scribner's, Sons, 1903.) end involving futurity, credit has come into existence. In its simplest terms it is a transfer of commodities involving the return of an equivalent at a future time. Whenever the time element is eliminated from a transaction, it will be seen at once that credit does not enter into it. A transfer of goods for which an equivalent is rendered on the spot would never be thought of as a credit operation. In fact, buying and selling for an immediate consideration (or "cash") is generally understood to be the very opposite of credit. By general agreement usage would never allow an obligation entered into for the future delivery of personal service to be spoken of as credit; and rightly. A contract to work ten hours a day for the coming three months should not be regarded as a credit obligation. We may, therefore, agree to confine credit operations to goods or property of a transferable kind. And, in the conception of credit, with the transfer goes the right to make any ordinary use of the goods; not merely to keep possession, but to destroy entirely-and commonly with the purpose of reproductionif that is the best means of increasing product and getting back goods for repayment. The specific goods borrowed need not always be returned in kind; an equivalent will suffice; not the same wheat, or wool, or gold which was borrowed, but the equivalent of them. Many contracts appear as results of credit transactions. For instance, A borrows the means to finish the building of his house; he obtains certain goods which he inserts into his structure, and gives a promissory note to B for its repayment, secured by a pledge of his property in the form known to the law as a mortgage. The note and the mortgage are merely the legal methods adopted to make repayment more certain; they are not essential in the credit itself. The real importance should be put on the transfer to A of means returnable to B in the future. Legal and customary forms intended to secure repayment have created different devices in the same community, while the prevailing habits of different countries have given rise to varying methods of obtaining the same result. In one situation, for instance, a book entry, in another a bill of exchange, in another a promissory note is found most suitable. In short, the circumstances of the loan, the opinions and convenience of the parties to the contract, and the like, may bring into use a great variety of legal forms, all resulting from the primary transfer of goods. The undue insistence upon legal forms arising out of credit draws attention away from the economic processes essential and intrinsic in it to the nonessential and external forms outside of it. The familiar case of a bank loan illustrates this truth: there is the essential element in the transfer of capital to the borrower on an obligation to return an equivalent value at a fixed future time; but the evidences of the transaction, whether in the form of a book entry as a deposit, or the passing of the bank's own notes, or the giving of a cashier's draft for the sum, are secondary matters, or consequences, arising out of the original credit operation. As said before, the latter merely form the machinery for obtaining greater or less security with a view to repayment. 6. THE BASIS OF CREDIT 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 of 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 2. Age and general experience 3. Success in this line of busi ness 4. Success in other lines of business Pertaining to Character of the 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 |