II. IS CREDIT A FORM OF CAPITAL ?1

By J. R. MCCULLOCH

It is in the effects resulting from the transference of capital from those who are willing to lend to those who are desirous to borrow that we must seek for the advantages derivable from credit. All the operations supposed to be carried on by its agency, how extensive and complicated soever they may seem, originate, in fact, in a change in the actual holders or employers of capital. Nothing, indeed, is more common than to hear it stated that commodities are produced, and the most extensive operations carried on, by means of credit or confidence; but this is an obvious mistake. Wealth cannot be produced, nor can any sort of industrious undertaking be entered upon or completed, without the aid of labor and capital; and all that credit does, or can do, is, by facilitating the transfer of capital from one individual to another, to bring it into the hands of those who, it is most probable, will employ it to the greatest advantage. A few remarks will render this apparent.

It is plain that, to whatever extent the power of the borrower of a quantity of produce, or a sum of money, to extend this business, may be increased, that of the lender must be equally diminished. The same proportion of capital cannot be employed by two individuals at the same time. If A transfers his capital to B, he necessarily, by so doing, deprives himself of a power or capacity of production which B acquires. It is most probable, indeed, that this capital will be more productively employed by B than by A; for the fact of A having lent it shows that he either had no means of employing it advantageously or was disinclined to take the trouble; while the fact of B having borrowed it shows that he conceives he can advantageously employ it or that he can invest it so as to make it yield an interest to the lender and a profit for himself. It is obvious, however, that except in so far as credit may thus bring capital into the possession of those who, it may be fairly presumed, will employ it most beneficially, it can contribute nothing to the increase of wealth.

The most common method of making a loan is by selling commodities on credit, or on condition that they shall be paid at some future period. The price is increased proportionally to the length of credit given; and if any doubt be entertained with respect to the punctuality or solvency of the buyer, a further sum is added to the Adapted from Principles of Political Economy (1843), pp. 121–25.

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price in order to cover the risk that the seller or lender runs of not recovering the price, or of not recovering it at the stipulated period. This is the usual method of transacting business where capital is abundant and confidence general.

When produce is sold in the way now described, it is usual for the buyers to give bills to the sellers for the price, payable at the expiration of the credit; and it is in the effects growing out of the negotiation of these bills that much of that magical influence that has sometimes been ascribed to credit is believed to consist. Suppose, to illustrate this, that a paper-maker, A, sells to a printer, B, a quantity of paper, and that he gets his bill for the sum, payable at twelve months after date: B could not have entered into the transaction had he been obliged to pay ready money; but A, notwithstanding he has occasion for the money, is enabled, by the facility of negotiating or discounting bills, to give the requisite credit without disabling himself from prosecuting his business. In a case like this both parties are said to be supported by credit; and as cases of this sort are exceedingly common, it is contended that half the business of the country is really carried on by its means. All, however, that such statements really amount to is that a large proportion of those engaged in industrial undertakings do not employ their own capital, but that of others. In the case in question, the printer employs the capital of the paper-maker, and the latter employs that of the banker or broker who discounted the bill. This person had, most likely, the amount in spare cash lying beside him, which he might not well know what use to make of; but the individual into whose hands it has now come will immediately apply it to useful purposes, or to the purchase of the materials, or the payment of the wages of the workmen employed in his establishment. It is next to certain, therefore, that the transaction will be advantageous. But still it is essential to bear in mind that it will be so, not because credit is of itself a means of production, or because it can give birth to capital not already in existence, but because, through its agency, capital finds its way into those channels in which it has the best chance of being profitably employed.

The following extract from the evidence of Mr. Ricardo before the committee appointed by the House of Lords in 1819, to inquire into the expediency of the resumption of cash payments by the Bank of England, sets the principle we have been endeavoring to establish in a very clear point of view:

"Do you not know," Mr. Ricardo was asked, "that when there is a great demand for manufactures, the very credit which that circumstance creates enables the manufacturer to make a more extended use of his capital in the production of manufactures?" To this Mr. Ricardo answered, "I have no notion of credit being at all effectual in the production of commodities; commodities can only be produced by labor, machinery, and raw materials; and if these are to be employed in one place, they must necessarily be withdrawn from another. Credit is the means, which is alternately transferred from one to another, to make use of capital actually existing; it does not create capital; it determines only by whom that capital shall be employed; the removal of capital from one employment to another may often be very advantageous, and it may also be very injurious."

Mr. Ricardo was then asked, "May not a man get credit from a bank on the security of his capital which is profitably employed, whether invested in stock or land; and may he not, by means of that credit, purchase or create an additional quantity of machinery and raw materials, and pay an additional number of labourers, without dislodging capital from any existing employment in the country?" To this Mr. Ricardo answered, "Impossible! an individual can purchase machinery, etc., with credit; he can never create them. If he purchase, it is always of someone else; and, consequently, he displaces some other from the employment of capital."

12. THE MONETARY FUNCTION OF COMMERCIAL CREDIT1 BY J. LAURENCE LAUGHLIN

Credit being in its simplest form a transfer of goods involving an obligation to return an equivalent in the future, we find in practice, however, that credit has in modern society developed instruments that are akin to money. Clearly enough, it does not act as a standard or common denominator. Its relation to the subject of money is to be found in the fact that society has in the forms of credit created a medium of exchange. Credit is the natural result of the premium always existing in business transactions to evolve a means of avoiding the risk and loss attending the actual transfer of the valuable standard; and it remains in use because transactions involving futuAdapted from Principles of Money, pp. 82-85. (Charles Scribner's Sons,

rity are thereby rendered possible and legitimate, to the immense advantage of commerce and industry. It is the evolution of a refined system of barter, rendered necessary by division of labor, the interdependence of industries, and the introduction of the time element.

The reason for the common belief that credit is based upon, and limited by, money is evidently to be found in the fact that all the evidences of credit transactions (such as notes, bills, checks, book credits) are drawn in terms of money; and that every business man assumes that his checks, or deposits account, or bills payable can be liquidated in money. If this were not so, he reasons, what would be their value to him in preparing to meet his own obligations? Paradoxical as it may seem, it is absolutely true that the mass of obligations could not possibly be, and were never really intended to be, liquidated in actual money. The fundamental truth is that the quantity (and value) of goods vastly overpasses the quantity (and value) of money; only a portion of the wealth of any community is, or ought to be, invested in its machinery of exchange. Provided that exchanges go on efficiently, the less of the country's wealth invested in this unproductive form the better. To speak as if a country were better off the greater the amount invested in its money machinery is to glorify the fact of its backward commercial growth; such an attitude would imply that a farmer could turn the soil better with a plow decorated with costly precious stones when one worth one onethousandth as much would do the work quite as well. Inasmuch as all the population of a walled city do not wish to pass through its gates at once, a few gates suffice at any one time; so likewise not all of the mass of goods are seeking exchange at the same moment. As a consequence, the amount of money needed for exchange is, of course, far less than the total amount of goods. This is an economic commonplace.

All transactions cannot be liquidated at once in actual money; and, if it were possible, that is not a process which would most economically satisfy our daily wants. The best machinery of exchange is that which enables our own product to be most easily exchanged for the various goods which we desire; and money is but one of the means to the end. Credit is, also, an important instrument, or medium, of exchange. Certain reserves of money are necessary parts of the system, to provide against lack of confidence, general distrust,

and unreasoning human nature. As McLeod says: "Though in every system of credit there must be an ultimate reserve of specie, yet that ultimate reserve does not bear a constant, fixed ratio to the quantity of credit: but it mainly depends on the organization of credit: the more highly organized the system of credit is, the less is the requisite amount of the ultimate reserve of specie. Any amount of credit may be created and extinguished without any relation to the quantity of money."