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View of the progress of political economy in Europe since the sixteenth ... By Travers Twiss
" Capital can only be acquired by saving. It is impossible that one capital can be employed by two persons at the same time, or for two objects. The greatest advantage will be sought and obtained at all times by the employer of capital: that is, capital will always be directed towards that one employment, which is most advantageous." Credit, then, according to the above view, is but the means of transferring the use of capital from one to another person, or from one to another employment. Circulating credit, for instance, in the form of notes payable on demand, enables specie to be transferred
from an unproductive employment as a medium
of exchange, to a productive employment as an article
of commerce. For instance, when a person opens an
account with a banker, he deposits a certain amount
of capital with the banker, who in his turn lends his
credit to the depositor.
Let us suppose the capital to be the commodity of
gold or silver, in the form of money. The depositor
would have contented himself with using this capital
unproductively, simply as an instrument of exchange,
to procure for himself, from time to time, its equivalents ;
the banker, on the other hand, will employ it as
a commodity, in discounting bills, &c. The depositor
will, meanwhile, employ the credit of the banker,
the use of which is transferred to him in exchange for
the use of his capital, as an instrument of exchange.
Will it therefore be correct to say that the capital
of the depositor is now employed for two uses ?
Namely, by the banker as a commodity, and by the depositor,
through the banker's credit, as an instrument
of exchange ?
If we admit for the moment a double use, it will be
seen that these two uses are not in the same sense
productive uses. The banker uses his depositor's
capital as a commodity, productively; the depositor
uses the banker's credit, as an instrument of exchange,
unproductively. Had the depositor retained
his capital in the form of money, and used it as an
instrument of exchange, he would have been using it
unproductively, just as he now uses the banker's
credit. By depositing it with the banker, he enables it
to be used by the banker productively, and contents
himself with using the banker's credit unproductively.
Consequently a bank of credit enables a part of the
capital of the country, which would have been employed
unproductively as money, to be employed
productively as a commodity; but it does not enable
capital to be employed in two ways productively: it
enables more capital to be employed productively,
because in combination with the credit of the banker
a comparatively small reserve of capital, whatever be
the amount which experience determines to be sufficient
to answer occasional demands, will fulfil all
the purposes of a circulating medium of exchange.
Now when gold or silver is employed as an instrument
of exchange, it is employed in a different way
from that in which it is generally employed as a commodity :
in the former case it is employed in small
quantities; in the latter in masses. And so it happens
that the credit of the banker, which has been lent to
the depositor of capital, is employed very seldom
indeed in one mass, but for the most part in portions.
Hence a large portion of the credit of the banker performs
no monetary function, it remains in the banker's
book, set down to the depositor's account. And Mr.
Norman in his Letter on Money, addressed in 1841 to Mr.
the present Chancellor of the Exchequer (Mr. Charles
Wood) says that the aggregate minimum of deposit Money,
accounts existing at any given time, hardly falls short
of from sixty to seventy-five per cent. Now it is
evident, that the amount of capital corresponding to
these accounts, if retained by the depositor in his own
chest, would have not been used at all; whereas it
will now be employed by the banker productively, as
an article of commerce. Again, of the remaining 40
or 25 per cent of credit, of which the depositor is
making use from time to time as an instrument of
exchange by means of orders upon his banker, a considerable
portion discharges the function of money by
being transferred from the account of one banker to
that of another, and so through the medium of a set-
off between different bankers, the use even of credit
is further economised. To what extent this economy
of credit can be carried on, may be inferred from the
return, in the Second Report of the Committee of
Banks of Issue, of the extent of business transacted
in the Clearing House in London in 1839, from which
it appears that 970,000,000/. passed through that
house in a single year, and about one fifteenth of that
sum in bank notes, viz., 66,000,000/. was all the circulating
credit required in settling the balances. IV. The London Clearing House.
When, however, a person invests his capital in the
purchase of land, he hands over a certain amount of
capital to the owner of a natural agent, who in his
turn transfers to him the ownership of that natural
agent. The purchaser of the land, in this case, has
parted with, and relinquished all control over his
capital. The vendor, on the other hand, has the free
disposal of that capital, and may use it at his pleasure.
The investment, however, as it is termed, of
capital in the purchase of the land misleads many
persons to suppose that the capital is as it were encased
in a shell, and that the capital is as it were
deposited in the land, instead of its having been exchanged
away for it. They consequently imagine
that the capital, which has really been parted with in
exchange for the land, is still under the control of the
purchaser, just as if it were stored up in a chest, and
therefore that it may at any time be used produc- ,
tively, if occasion should require. But if the owner
of the land should wish to use the capital, which he
has invested in the land, under any other form than
that of the natural agent, he must obtain it from some
other person in exchange for his land, just as the
owner of so much capital deposited in the hands of
his banker, if he wishes to employ that capital productively,
must obtain it back from the banker at
the sacrifice of his credit at the bank, or he must exchange
that credit with a third person for capital;
but he cannot use his capital in two forms; he cannot
at the same time employ it both as fixed, and as
circulating capital.
Now a bank of circulation, resting on deposits of Banks of
capital, may use its credit, as money, unproductively,
and its capital, as a commodity, productively. It may
on the one hand issue notes, on the other discount
bills. In the former case, it borrows money on its
credit without paying interest; in the latter, it lends
money with interest, on the credit of others. It thus
uses the capital of those who use its credit; but it uses
that capital only once, instead of its customers using
it, namely, when it lends it at interest. But it may
be said that the depositors may use the credit of the
bank productively by lending it at interest. Not so.
No one pays interest for the use of credit, but for the
use of the capital, of which that credit enables him
to command the employment. Interest is defrayed
from the net profits of capital. If A. pays 10 per
cent interest to B. for the use of his credit with
C., a banker, it is the same as if A. paid it to C.
for the use of the capital which B. has deposited
with him. If again A. transfers B.'s credit with his
banker C- to D., in exchange for D.'s capital, A. transfers
the use of B.'s capital deposited with C. to D., and . . . ,. 1.1 circulation.
having exchanged with A., for the moment,
capital for credit, will ultimately realise the credit by
demanding back B.'s capital from C. It is this
capital, of which the use was transferred by B.
when he lent his credit with his banker. The credit
which he lent, was but the medium of the ultimate
transfer.
A bank of circulation resting upon land, or upon
shares in a commercial undertaking, is a bank resting
not on capital, but on credit. A bank, on the other
hand, founded on deposits of money, may act in the
Banks of double capacity of a bank of issue and a bank of dis-
count It may i8SUe notes in exchange for deposits
of money, which notes are, in fact, merely acknowledgments
of such deposits, and promises to repay
them; and again, it may use those deposits in discounting
the promissory notes of merchants. But
let us suppose for a moment a bank of issue to
be grafted not upon deposits of money, but upon
the security of land. The bank issues notes payable
on demand in money, upon the security of
its land: in other words, instead of so much circulating
capital, it sets afloat so much circulating
credit on the security of so much fixed capital.
But supposing difficulties to arise, and circulating
capital of a certain amount to be required for a time
in the place of circulating credit, from what sources
will it be forthcoming ? The security of the land is
but the mortgage of eventual, not realised capital;
but realised capital is required for circulation to set
labour in operation, and when the credit of the land
cannot purchase raw materials, the land itself cannot
create them, or be a substitute for them. It has been
already observed that Law had studied the operations
of the Banks of Amsterdam and England—the former
a bank of deposit, the latter of circulation—and he
contemplated the combining the advantages of the
two in one establishment. It may be as well to keep
in mind the distinction between a bank of deposit, in .
its proper signification, and a bank of circulation. Banks of
In the former, as at Amsterdam, are deposited values, deposit
as silver, for instance, or gold, and in return a certificate
of the value deposited is issued, payable on demand,
and this certificate is put into circulation, and
passes current as bank-money. The advantage of
such a system consists in the convenience of employing
paper certificates, or notes, instead of metal; and
at a time when the weight and quality of metal coin
was continually subjected to arbitrary alterations, such
certificates being convertible into a given quantity of
metal of a given purity, had a more certain value, and
would thus be preferred as a common measure. A bank
of circulation, on the other hand, has a more extensive
field of operation: it examines the promissory notes
of individual merchants ; and, where it considers the
solvency of the merchant may be relied upon, it discounts
his note, lending on its security the notes of
the bank, which circulate as money. Its business
therefore consists in giving circulation to the unrecognised
credit of the merchant, by lending him its
own established credit. In order, however, to do this
with safety, it must have a fund first of all set apart,
sufficient to make good any losses which it may incur
from discounting securities, which prove ultimately
worthless; secondly, it must keep a reserve of bullion
or coin, as its own notes are convertible into specie on
demand, and their credit will only be maintained by
the demand being immediately complied with. The
issues of a bank of deposit do not then increase the
quantity of the circulating medium, but merely substitute
a paper for a metallic currency; but the
issues of a bank of circulation, on the other hand, do
augment the circulating medium, because after setting
aside the necessary reserve to meet the average
demand for specie, it lends the remainder of its specie,
IV- in addition to its notes, for the
purposes of commerce.
The disadvantage indeed which those countries are
exposed to which have only banks of deposit is, that
a large portion of their capital remains unproductive,
whereas those which have banks of circulation use all
their capital productively, except that portion which
is kept in reserve to meet the occasional demand for
specie. It must never be forgotten that the capital of ^
a country which is employed as money, is not employed
as an instrument of production, but simply as
an instrument to facilitate the exchange of other
capital.
We may now proceed to follow Law through the
various stages of his financial enterprise at Paris.
Having in vain submitted various schemes for a National
Bank to the Council of Finance,
Sapiens
10-08-07, 11:11 PM
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Principles of Political Economy: With Some of Their Applications to Social ... By John Stuart Mill
INFLUENCE OF CREDIT ON PRICES. §
I. HAVING now formed a general idea of the modes in which credit
is made available as a substitute for money, we have to consider in what
manner the use of these substitutes affects the value of money, or, what is
equivalent, the prices of commodities. It is hardly necessary to say that
the permanent value of money—the natural and average prices of commodities—
are not in question here. These are determined by the cost of
producing or of obtaining the precious metals. An ounce of gold or silver
will in the long run exchange for as much of every other commodity, as
can be produced or imported at the same cost with itself. And an order,
or note of hand, or bill payable at sight, for an ounce of gold, while the
credit of the giver is unimpaired, is worth neither more not less than the
gold itself.
It is not, however, with ultimate or average, but with immediate and
temporary prices, that we are now concerned. These, as we have seen,
may deviate very widely from the standard of cost of production. Among
other causes of fluctuation, one we have found to be the quantity of
money in circulation. Other things being the same, an increase of the
money in circulation raises prices, a diminution lowers them. If more
money is thrown into circulation than the quantity which can circulate at
a value conformable to its cost of production, the value of money, so long
as the excess lasts, will remain below the standard of cost of production,
and general prices will be sustained above the natural rate.
But we have now found that there are other things, such as bank notes,
bills of exchange, and cheques, which circulate as money, and perfornvall *
According to Mr. Tooke (Enquiry into the Currency Principle, p. 27), the
adjustments at the Clearing-house ' in the year 1839 amounted to 954,4Oi,6oo/.,
making an average amount of payments of upwards of 3,000,000«'. of bills of exchange
and cheques daily effected through the medium of little more than
2OO,ooo/. of bank notes.'
Loading...Loading...INFLUENCE Of CREDIT ON PRICES. 359
was easy to obtain almost any amount of credit, so now when everybody
seems to be losing, and many fail entirely, it is with difficulty that firms of
known solidity can obtain even the credit to which they are accustomed,
and which it is the greatest inconvenience to them to be without ;
because all dealers having engagements to fulfil, and nobody feeling sure
that the portion of his means which he has entrusted to others will be
available in time, no one likes to part with ready money, or to postpone
his claim to it. To these rational considerations there is superadded, in
extreme cases, a panic as unreasoning as the previous over-confidence ;
money is borrowed for short periods at almost any rate of interest, and
sales of goods for immediate payment are made at almost any sacrifice.
Thus general prices, during a commercial revulsion, fall as much below
the usual level, as during the previous period of speculation they had risen
above it : the fall, as well as the rise, originating not in anything affecting
money, but in the state of credit—an unusually extended employment of
credit during the earlier period, followed by a great diminution, never
amounting, however, to an entire cessation of it, in the later.
It is not, however, universally true that the contraction of credit,
characteristic of a commercial crisis, must have been preceded by an extraordinary
and irrational extension of it. There are other causes ; and
the most recent crisis, that of 1847, is an instance, having been preceded
by no particular extension of credit, and by no speculations ; except those
in railway shares, which, though in many cases extravagant enough, yet
being carried on mostly with that portion of means which the speculators
could afford to lose, were not calculated to produce the widespread ruin
which arises from vicissitudes of price in the commodities in which men
habitually deal, and in which the bulk of their capital is invested. The
crisis of 1847 belonged to another class of mercantile phenomena. There
occasionally happens a concurrence of circumstances tending to withdraw
from the loan market a considerable portion of the capital which usually
supplies it. These circumstances, in the present case, were great foreign
payments (occasioned by the high price of cotton and the unprecedented
importation of food), together with the continual demands on the circulating
capital of the country by railway calls and the loan transactions of
railway companies, for the purpose of being converted into fixed capital
and made unavailable for future lending. These various demands fell
principally, as such demands always do, on the loan market. A great,
though not the greatest part of the imported food, was actually paid for
by the proceeds of a government loan. The extra payments which purchasers
of corn and cotton, and railway shareholders, found themselves
obliged to make, were either made with their own spare cash, or with
money raised for the occasion. On the first supposition, they were made
by withdrawing deposits from bankers, and thus cutting off a part of the
streams which fed the loan market ; on the second supposition, they were
made by actual drafts on the loan market, either by the sale of securities,
or by taking up money at interest. This combination of a fresh demand
for loans, with a curtailment of the capital disposable for them, raised the
rate of interest, and made it impossible to borrow except on the very best
security. Some firms, therefore, which by an improvident and unmer-
cantile mode of conducting business had allowed their capital to become
either temporarily or permanently unavailable, became unable to command
that, perpetual renewal of credit which had previously enabled them to
struggle on. These firms stopped payment : their failure involved more,
Loading...Loading...302 EXCHANGE.
Of the extraordinary height to which speculative transactions can be
carried upon mere book credits, without the smallest addition to what is
commonly called the currency, very few persons are at all aware. ' The
power of purchase,' says Mr. Tooke,f 'by persons having capital and
credit, is much beyond anything that those who are unacquainted practically
with speculative markets have any idea of. ... A person having
the reputation of capital enough for his regular business, and enjoying
good credit in his trade, if he takes a sanguine view of the prospect of a
rise of price of the article in which he deals, and is favoured by circumstances
in the outset and progress of his speculation, may effect purchases
to an extent perfectly enormous, compared with his capital.' Mr. Tooke
confirms this statement by some remarkable instances, exemplifying the
immense purchasing power which may be exercised, and rise of price
which may be produced, by credit not represented by either bank notes
or bills of exchange. specula
tive times, it cannot, I think, be denied, that prices are likely to rise higher if the speculative purchases are made with bank notes, than when they are made with bills, and when made by bills than when made by book credits. This, however, is of far less practical importance than might at first be imagined ; because, in point of fact, speculative purchases are not, in the great majority of cases, made either with bank notes or with bills, but are made almost exclusively on book credits. ' Applications to the Bank for extended discount,' says the highest authority on such subjects* (and the same thing must be true of applications to other banks), ' occur rarely if ever in the origin or progress of extensive speculations in commodities. These are entered into, for the most part if not entirely, in the first instance, on credit for the length of term usual in the several trades ; thus entailing on the parties no immediate necessity for borrowing so much as may be wanted for the purpose beyond their own available capital. This applies particularly to speculative purchases of commodities on the spot, with a view to resale. But these generally form the smaller proportion of engagements on credit. By far the largest of those entered into on the prospect of a rise of prices, are such as have in view importations from abroad. The same remark, too, is applicable to the export of commodities, when a large proportion is on the credit of the shippers or their consignees. As long as circumstances hold out the prospect of a favourable result, the credit of the parties is generally sustained. If some of them wish to realize, there are others with capital and credit ready to replace them ; and if the events fully justify the grounds on which the speculative transactions were entered into (thus admitting of sales for consumption in time to replace the capital embarked) there is no unusual demand for borrowed capital to sustain them. It is only when by the vicissitudes of political events, or of the seasons, or other adventitious circumstances, the forthcoming supplies are found to exceed the computed rate of consumption, and a fall of prices ensues, that an increased demand for capital takes place ; the market rate of interest then rises, and increased applications are made to the Bank of England for discount.' So that the multiplication of bank notes and other transferable paper does not, for the most part, accompany and facilitate the speculation ; but comes into play chiefly when the tide is turning, and difficulties begin to be felt. t Inquiry into the Currency Principle, pp. 79 and 136-8. * Tooke's History of Prices, vol. iv. pp. 125-6.
Loading...Loading...INFLUENCE Of CREDIT ON PRICES. 359
was easy to obtain almost any amount of credit, so now when everybody
seems to be losing, and many fail entirely, it is with difficulty that firms of
known solidity can obtain even the credit to which they are accustomed,
and which it is the greatest inconvenience to them to be without ;
because all dealers having engagements to fulfil, and nobody feeling sure
that the portion of his means which he has entrusted to others will be
available in time, no one likes to part with ready money, or to postpone
his claim to it. To these rational considerations there is superadded, in
extreme cases, a panic as unreasoning as the previous over-confidence ;
money is borrowed for short periods at almost any rate of interest, and
sales of goods for immediate payment are made at almost any sacrifice.
Thus general prices, during a commercial revulsion, fall as much below
the usual level, as during the previous period of speculation they had risen
above it : the fall, as well as the rise, originating not in anything affecting
money, but in the state of credit—an unusually extended employment of
credit during the earlier period, followed by a great diminution, never
amounting, however, to an entire cessation of it, in the later.
It is not, however, universally true that the contraction of credit,
characteristic of a commercial crisis, must have been preceded by an extraordinary
and irrational extension of it. There are other causes ; and
the most recent crisis, that of 1847, is an instance, having been preceded
by no particular extension of credit, and by no speculations ; except those
in railway shares, which, though in many cases extravagant enough, yet
being carried on mostly with that portion of means which the speculators
could afford to lose, were not calculated to produce the widespread ruin
which arises from vicissitudes of price in the commodities in which men
habitually deal, and in which the bulk of their capital is invested. The
crisis of 1847 belonged to another class of mercantile phenomena. There
occasionally happens a concurrence of circumstances tending to withdraw
from the loan market a considerable portion of the capital which usually
supplies it. These circumstances, in the present case, were great foreign
payments (occasioned by the high price of cotton and the unprecedented
importation of food), together with the continual demands on the circulating
capital of the country by railway calls and the loan transactions of
railway companies, for the purpose of being converted into fixed capital
and made unavailable for future lending. These various demands fell
principally, as such demands always do, on the loan market. A great,
though not the greatest part of the imported food, was actually paid for
by the proceeds of a government loan. The extra payments which purchasers
of corn and cotton, and railway shareholders, found themselves
obliged to make, were either made with their own spare cash, or with
money raised for the occasion. On the first supposition, they were made
by withdrawing deposits from bankers, and thus cutting off a part of the
streams which fed the loan market ; on the second supposition, they were
made by actual drafts on the loan market, either by the sale of securities,
or by taking up money at interest. This combination of a fresh demand
for loans, with a curtailment of the capital disposable for them, raised the
rate of interest, and made it impossible to borrow except on the very best
security. Some firms, therefore, which by an improvident and unmer-
cantile mode of conducting business had allowed their capital to become
either temporarily or permanently unavailable, became unable to command
that, perpetual renewal of credit which had previously enabled them to
struggle on. These firms stopped payment : their failure involved more,
Loading...Loading...36o EXCHANGE.
§
4. The general operation of credit upon prices being such as we have
described, it is evident that if any particular mode or form of credit is
calculated to have a greater operation on prices than others, it can only
be by giving greater facility, or greater encouragement, to the multiplication
of credit transactions generally. If bank notes, for instance, or bills,
have a greater effect on prices than book credits, it is not by any difference
in the transactions themselves, which are essentially the same,
whether taking place in the one way or in the other : it must be that there
are likely to be more of them. If credit is likely to be more extensively
used as a purchasing power when bank notes or bills are the instruments
used, than when the credit is given by mere entries in an account, to that
extent and no more there is ground for ascribing to the former a greater
power over the markets than belongs to the latter. or less deeply many other firms which had trusted them ; and, as usual in such cases, the general distrust, commonly called a panic, began to set in, and might have produced a destruction of credit equal to that of 1825, liad not circumstances which may almost be called accidental, given to a very simple measure of the government a fortunate power of allaying panic, to which, when considered in itself, it had no sort of claim.
Now it appears that there is some such distinction. As far as respects
the particular transaction, it makes no difference in the effect on price
whether A buys goods of B on simple credit, or gives a bill for them, or
pays for them with bank notes lent to him by a banker C. The difference
is in a subsequent stage. If A has bought the goods on a book credit,
there is no obvious or convenient mode by which 13 can make A's debt to
him a means of extending his own credit. Whatever credit he has, will
be due to the general opinion entertained of his solvency ; he cannot
specifically pledge A's debt to a third person, as a security for money lent
or goods bought. But if A has given him a bill for the amount, he can
get this discounted, which is the same thing as borrowing money on the
joint credit of A and himself: or he may pay away the bill in exchange
for goods, which is obtaining goods on the same joint credit. In either
case, here is a second credit transaction, grounded on the first, and which
would not have taken place if the first had been transacted without the
intervention of a bill. Nor need the transactions end here. The bill
may be again discounted, or again paid away for goods, several times
before it is itself presented for payment. Nor would it be correct to say
that these successive holders, if they had not had the bill, might have
attained their purpose by purchasing goods on their own credit with the
dealers. They may not all of them be persons of credit, or they may
already have stretched their credit as far as it will go. And at all events,
either money or goods are more readily obtained on the credit of two
persons than of one. Nobody will pretend that it is as easy a thing for a
merchant to borrow a thousand pounds on his own credit, as to get a bill
discounted to the same amount, when the drawee is of known solvency ;
or that he can as easily obtain goods on a book credit, as by paying for
them with such a bill.
If we now suppose that A, instead of giving a bill, obtains a loan of
bank notes from a banker C, and with them pays B for his goods, we
shall find the difference to be still greater. B is now independent even of
a discounter : A's bill would have been taken in payment only by those
who were acquainted with his reputation for solvency, but a banker is a
person who has credit with the public generally, and whose notes are
Loading...Loading...INFLUENCE OF CREDIT ON PRICES. 357
power he finds a sufficient motive only under peculiar circumstances ; but
he always possesses it ; and the portion of it which he at any time does
exercise, is the measure of the effect which he produces on price. §
3. The inclination of the mercantile public to increase their demand
for commodities by making use of all or much of their credit as a purchasing
power, depends on their expectation of profit. When there is a
general impression that the price of some commodity is likely to rise, from
an extra demand, a short crop, obstructions to importation, or any other
cause, there is a disposition among dealers to increase their stocks, in
order to profit by the expected rise. This disposition tends in itself to
produce the effect which it looks forward to, a rise of price ; and if the
rise is considerable and progressive, other speculators are attracted, who,
so long as the price has not begun to fall, are willing to believe that it will
continue rising. These, by further purchases, produce a further advance :
and thus a rise of price for which there were originally some rational
grounds, is often heightened by merely speculative purchases, until it
greatly exceeds what the original grounds will justify. After a time this
begins to be perceived ; the price ceases to rise, and the holders, thinking
it is time to realize their gains, are anxious to sell. Then the price begins
to decline : the holders rush into the market to avoid a still greater loss ;
and, few being willing to buy in a falling market, the price falls much
more suddenly than it rose. Those who have bought at a higher price
than reasonable calculation justified, and who have been overtaken by
the revulsion before they had realized, are losers in proportion to the
greatness of the fall, and to the quantity of the commodity which they
hold, or have bound themselves to pay for. Suppose that, in the expectation that some commodity will rise in price, he determines, not only to invest in it all his ready money, but to take up on credit, from the producers or importers, as much of it as their opinion of his resources will enable him to obtain. Every one must see that by thus acting he produces a greater effect on price, than if he limited his purchases to the money he has actually in hand. He creates a demand for the article to the full amount of his money and credit taken together, and raises the price proportionally to both. And this effect is produced, although none of the written instruments called substitutes for currency may be called into existence ; though the transaction may give rise to no bill of exchange, nor to the issue of a single bank note. The buyer, instead of taking a mere book credit, might have given a bill for the amount ; or might have paid for the goods with bank notes borrowed for that purpose from a banker, thus making the purchase not on his own credit with the seller, but on the banker's credit with the seller, and his own with the banker. Had he done so, he would have produced as great an effect on price as by a simple purchase to the same amount on a book credit, but no greater effect. The credit itself, not the form and mode in which it is given, is the operating cause.
Now all these effects might take place in a community to which credit
was unknown : the prices of some commodities might rise, from speculation,
to an extravagant height, and then fall rapidly back. But if there
were no such thing as credit, this could hardly happen with respect to
commodities generally. If all purchases were made with ready money,
the payment of increased prices for some articles would draw an unusual
proportion of the money of the community into the markets for those
articles, and must therefore draw it away from some other class of com-
Loading...Loading...36o EXCHANGE.
§
4. The general operation of credit upon prices being such as we have
described, it is evident that if any particular mode or form of credit is
calculated to have a greater operation on prices than others, it can only
be by giving greater facility, or greater encouragement, to the multiplication
of credit transactions generally. If bank notes, for instance, or bills,
have a greater effect on prices than book credits, it is not by any difference
in the transactions themselves, which are essentially the same,
whether taking place in the one way or in the other : it must be that there
are likely to be more of them. If credit is likely to be more extensively
used as a purchasing power when bank notes or bills are the instruments
used, than when the credit is given by mere entries in an account, to that
extent and no more there is ground for ascribing to the former a greater
power over the markets than belongs to the latter. or less deeply many other firms which had trusted them ; and, as usual in such cases, the general distrust, commonly called a panic, began to set in, and might have produced a destruction of credit equal to that of 1825, liad not circumstances which may almost be called accidental, given to a very simple measure of the government a fortunate power of allaying panic, to which, when considered in itself, it had no sort of claim.
Now it appears that there is some such distinction. As far as respects
the particular transaction, it makes no difference in the effect on price
whether A buys goods of B on simple credit, or gives a bill for them, or
pays for them with bank notes lent to him by a banker C. The difference
is in a subsequent stage. If A has bought the goods on a book credit,
there is no obvious or convenient mode by which 13 can make A's debt to
him a means of extending his own credit. Whatever credit he has, will
be due to the general opinion entertained of his solvency ; he cannot
specifically pledge A's debt to a third person, as a security for money lent
or goods bought. But if A has given him a bill for the amount, he can
get this discounted, which is the same thing as borrowing money on the
joint credit of A and himself: or he may pay away the bill in exchange
for goods, which is obtaining goods on the same joint credit. In either
case, here is a second credit transaction, grounded on the first, and which
would not have taken place if the first had been transacted without the
intervention of a bill. Nor need the transactions end here. The bill
may be again discounted, or again paid away for goods, several times
before it is itself presented for payment. Nor would it be correct to say
that these successive holders, if they had not had the bill, might have
attained their purpose by purchasing goods on their own credit with the
dealers. They may not all of them be persons of credit, or they may
already have stretched their credit as far as it will go. And at all events,
either money or goods are more readily obtained on the credit of two
persons than of one. Nobody will pretend that it is as easy a thing for a
merchant to borrow a thousand pounds on his own credit, as to get a bill
discounted to the same amount, when the drawee is of known solvency ;
or that he can as easily obtain goods on a book credit, as by paying for
them with such a bill.
If we now suppose that A, instead of giving a bill, obtains a loan of
bank notes from a banker C, and with them pays B for his goods, we
shall find the difference to be still greater. B is now independent even of
a discounter : A's bill would have been taken in payment only by those
who were acquainted with his reputation for solvency, but a banker is a
person who has credit with the public generally, and whose notes are
Loading...Loading...302 EXCHANGE.
Of the extraordinary height to which speculative transactions can be
carried upon mere book credits, without the smallest addition to what is
commonly called the currency, very few persons are at all aware. ' The
power of purchase,' says Mr. Tooke,f 'by persons having capital and
credit, is much beyond anything that those who are unacquainted practically
with speculative markets have any idea of. ... A person having
the reputation of capital enough for his regular business, and enjoying
good credit in his trade, if he takes a sanguine view of the prospect of a
rise of price of the article in which he deals, and is favoured by circumstances
in the outset and progress of his speculation, may effect purchases
to an extent perfectly enormous, compared with his capital.' Mr. Tooke
confirms this statement by some remarkable instances, exemplifying the
immense purchasing power which may be exercised, and rise of price
which may be produced, by credit not represented by either bank notes
or bills of exchange. specula
tive times, it cannot, I think, be denied, that prices are likely to rise higher if the speculative purchases are made with bank notes, than when they are made with bills, and when made by bills than when made by book credits. This, however, is of far less practical importance than might at first be imagined ; because, in point of fact, speculative purchases are not, in the great majority of cases, made either with bank notes or with bills, but are made almost exclusively on book credits. ' Applications to the Bank for extended discount,' says the highest authority on such subjects* (and the same thing must be true of applications to other banks), ' occur rarely if ever in the origin or progress of extensive speculations in commodities. These are entered into, for the most part if not entirely, in the first instance, on credit for the length of term usual in the several trades ; thus entailing on the parties no immediate necessity for borrowing so much as may be wanted for the purpose beyond their own available capital. This applies particularly to speculative purchases of commodities on the spot, with a view to resale. But these generally form the smaller proportion of engagements on credit. By far the largest of those entered into on the prospect of a rise of prices, are such as have in view importations from abroad. The same remark, too, is applicable to the export of commodities, when a large proportion is on the credit of the shippers or their consignees. As long as circumstances hold out the prospect of a favourable result, the credit of the parties is generally sustained. If some of them wish to realize, there are others with capital and credit ready to replace them ; and if the events fully justify the grounds on which the speculative transactions were entered into (thus admitting of sales for consumption in time to replace the capital embarked) there is no unusual demand for borrowed capital to sustain them. It is only when by the vicissitudes of political events, or of the seasons, or other adventitious circumstances, the forthcoming supplies are found to exceed the computed rate of consumption, and a fall of prices ensues, that an increased demand for capital takes place ; the market rate of interest then rises, and increased applications are made to the Bank of England for discount.' So that the multiplication of bank notes and other transferable paper does not, for the most part, accompany and facilitate the speculation ; but comes into play chiefly when the tide is turning, and difficulties begin to be felt. t Inquiry into the Currency Principle, pp. 79 and 136-8. * Tooke's History of Prices, vol. iv. pp. 125-6.
Loading...Loading...INFLUENCE Of CREDIT ON PRICES. 359
was easy to obtain almost any amount of credit, so now when everybody
seems to be losing, and many fail entirely, it is with difficulty that firms of
known solidity can obtain even the credit to which they are accustomed,
and which it is the greatest inconvenience to them to be without ;
because all dealers having engagements to fulfil, and nobody feeling sure
that the portion of his means which he has entrusted to others will be
available in time, no one likes to part with ready money, or to postpone
his claim to it. To these rational considerations there is superadded, in
extreme cases, a panic as unreasoning as the previous over-confidence ;
money is borrowed for short periods at almost any rate of interest, and
sales of goods for immediate payment are made at almost any sacrifice.
Thus general prices, during a commercial revulsion, fall as much below
the usual level, as during the previous period of speculation they had risen
above it : the fall, as well as the rise, originating not in anything affecting
money, but in the state of credit—an unusually extended employment of
credit during the earlier period, followed by a great diminution, never
amounting, however, to an entire cessation of it, in the later.
It is not, however, universally true that the contraction of credit,
characteristic of a commercial crisis, must have been preceded by an extraordinary
and irrational extension of it. There are other causes ; and
the most recent crisis, that of 1847, is an instance, having been preceded
by no particular extension of credit, and by no speculations ; except those
in railway shares, which, though in many cases extravagant enough, yet
being carried on mostly with that portion of means which the speculators
could afford to lose, were not calculated to produce the widespread ruin
which arises from vicissitudes of price in the commodities in which men
habitually deal, and in which the bulk of their capital is invested. The
crisis of 1847 belonged to another class of mercantile phenomena. There
occasionally happens a concurrence of circumstances tending to withdraw
from the loan market a considerable portion of the capital which usually
supplies it. These circumstances, in the present case, were great foreign
payments (occasioned by the high price of cotton and the unprecedented
importation of food), together with the continual demands on the circulating
capital of the country by railway calls and the loan transactions of
railway companies, for the purpose of being converted into fixed capital
and made unavailable for future lending. These various demands fell
principally, as such demands always do, on the loan market. A great,
though not the greatest part of the imported food, was actually paid for
by the proceeds of a government loan. The extra payments which purchasers
of corn and cotton, and railway shareholders, found themselves
obliged to make, were either made with their own spare cash, or with
money raised for the occasion. On the first supposition, they were made
by withdrawing deposits from bankers, and thus cutting off a part of the
streams which fed the loan market ; on the second supposition, they were
made by actual drafts on the loan market, either by the sale of securities,
or by taking up money at interest. This combination of a fresh demand
for loans, with a curtailment of the capital disposable for them, raised the
rate of interest, and made it impossible to borrow except on the very best
security. Some firms, therefore, which by an improvident and unmer-
cantile mode of conducting business had allowed their capital to become
either temporarily or permanently unavailable, became unable to command
that, perpetual renewal of credit which had previously enabled them to
struggle on. These firms stopped payment : their failure involved more,
Loading...Loading...INFLUENCE Of CREDIT ON PRICES. 359
was easy to obtain almost any amount of credit, so now when everybody
seems to be losing, and many fail entirely, it is with difficulty that firms of
known solidity can obtain even the credit to which they are accustomed,
and which it is the greatest inconvenience to them to be without ;
because all dealers having engagements to fulfil, and nobody feeling sure
that the portion of his means which he has entrusted to others will be
available in time, no one likes to part with ready money, or to postpone
his claim to it. To these rational considerations there is superadded, in
extreme cases, a panic as unreasoning as the previous over-confidence ;
money is borrowed for short periods at almost any rate of interest, and
sales of goods for immediate payment are made at almost any sacrifice.
Thus general prices, during a commercial revulsion, fall as much below
the usual level, as during the previous period of speculation they had risen
above it : the fall, as well as the rise, originating not in anything affecting
money, but in the state of credit—an unusually extended employment of
credit during the earlier period, followed by a great diminution, never
amounting, however, to an entire cessation of it, in the later.
It is not, however, universally true that the contraction of credit,
characteristic of a commercial crisis, must have been preceded by an extraordinary
and irrational extension of it. There are other causes ; and
the most recent crisis, that of 1847, is an instance, having been preceded
by no particular extension of credit, and by no speculations ; except those
in railway shares, which, though in many cases extravagant enough, yet
being carried on mostly with that portion of means which the speculators
could afford to lose, were not calculated to produce the widespread ruin
which arises from vicissitudes of price in the commodities in which men
habitually deal, and in which the bulk of their capital is invested. The
crisis of 1847 belonged to another class of mercantile phenomena. There
occasionally happens a concurrence of circumstances tending to withdraw
from the loan market a considerable portion of the capital which usually
supplies it. These circumstances, in the present case, were great foreign
payments (occasioned by the high price of cotton and the unprecedented
importation of food), together with the continual demands on the circulating
capital of the country by railway calls and the loan transactions of
railway companies, for the purpose of being converted into fixed capital
and made unavailable for future lending. These various demands fell
principally, as such demands always do, on the loan market. A great,
though not the greatest part of the imported food, was actually paid for
by the proceeds of a government loan. The extra payments which purchasers
of corn and cotton, and railway shareholders, found themselves
obliged to make, were either made with their own spare cash, or with
money raised for the occasion. On the first supposition, they were made
by withdrawing deposits from bankers, and thus cutting off a part of the
streams which fed the loan market ; on the second supposition, they were
made by actual drafts on the loan market, either by the sale of securities,
or by taking up money at interest. This combination of a fresh demand
for loans, with a curtailment of the capital disposable for them, raised the
rate of interest, and made it impossible to borrow except on the very best
security. Some firms, therefore, which by an improvident and unmer-
cantile mode of conducting business had allowed their capital to become
either temporarily or permanently unavailable, became unable to command
that, perpetual renewal of credit which had previously enabled them to
struggle on. These firms stopped payment : their failure involved more,
Loading...Loading...Loading...Loading...358 EXCHANGE.
tnodities, and thus lower their prices. The vacuum might, it is true, be
partly filled up by increased rapidity of circulation ; and in this manner
the money of the community is virtually increased in a time of speculative
activity, because people keep little of it by them, but hasten to lay it out
in some tempting adventure as soon as possible after they receive it.
This resource, however, is limited : on the whole, people cannot, while
the quantity of money remains the same, lay out much more of it in some
things, without laying out less in others. But what they cannot do by
ready money, they can do by an extension of credit. When people go
into the market and purchase with money which they hope to receive
hereafter, they are drawing upon an unlimited, not a limited fund.
Speculation, thus supported, may be going on in any number of commodities,
without disturbing the regular course of business in others. It
might even be going on in all commodities at once. We could imagine
that in an epidemic fit of the passion of gambling, all dealers, instead of
giving only their accustomed orders to the manufacturers or growers of /
heir commodity, commenced buying up all of it which they could procure,
as far as their capital and credit would go. All prices would rise enormously,
even if there was no increase of money, and no paper credit, but
a mere extension of purchases on book credits. After a time those who
had bought would wish to sell, and prices would collapse.
This is the ideal extreme case of what is called a commercial crisis.
There is said to be a commercial crisis, when a great number of merchants
and traders at once, either have, or apprehend that they shall have,
a difficulty in meeting their engagements. The most usual cause of this
general embarrassment, is the recoil of prices after they have been raised
by a spirit of speculation, intense in degree, and extending to many commodities.
Some accident, which excites expectations of rising prices,
such as the opening of a new foreign market, or simultaneous indications
of a short supply of several great articles of commerce, sets speculation at
work in several leading departments at once. The prices rise, and the
holders realize, or appear to have the power of realizing, great gains. In
certain states of the public mind, such examples of rapid increase of
fortune call forth numerous imitators, and speculation not only goes much
beyond wnat is justified by the original grounds for expecting rise of price,
but extends itself to articles in which there never was any such ground :
these, however, rise like the rest as soon as speculation sets in. At
periods of this kind, a great extension of credit takes place. Not only do
all whom the contagion reaches employ their credit much more freely
than usual ; but they really have more credit, because they seem to be
making unusual gains, and because a generally reckless and adventurous
feeling prevails, which disposes people to give as well as take credit more
largely than at other times, and give it to persons not entitled to it. In
this manner, in the celebrated speculative year 1825, and at various other
periods during the present century, the prices of many of the principal
articles of commerce rose greatly, without any fall in others, so that
general prices might, without incorrectness, be said to have risen. When,
after such a rise, the reaction comes, and prices begin to fall, though at
first perhaps only through the desire of the holders to realize, speculative
purchases cease : but were this all, prices would only fall to the level from
which they rose, or to that which is justified by the state of the consumption
and of the supply. They fall, however, much lower ; for as,
when prices were rising, and everybody apparently making a fortune, it
Loading...Loading...INFLUENCE OF CREDIT ON PRICES. 361
It appears, therefore, that bank notes are a more powerful instrument
for raising prices than bills, and bills than book credits. It does not,
indeed, follow that credit î«//be more used because it can be. When the
state of trade holds out no particular temptation to make large purchases
on credit, dealers will use only a small portion of the credit-power, and it
will depend only on convenience whether the portion which they use will
be taken in one form or in another. It is not until the circumstances of
the markets, and the state of the mercantile mind, render many persons
desirous of stretching their credit to an unusual extent, that the distinctive
properties of the different forms of credit display themselves. Credit
already stretched to the utmost in the form of book debts, would be
susceptible of a great additional extension by means of bills, and of still
greater by means of bank notes. The first, because each dealer, in addition
to his own credit, would be enabled to create a further purchasing'
power out of the credit which he had himself given to others : the second,
because the banker's credit with the public at large, coined into notes, as
bullion is coined into pieces of money to make it portable and divisible, is
so much purchasing power superadded, in the hands of every successive
holder, to that which he may derive from his own credit. To state the
matter otherwise ; one single exertion of the credit-power in the form of
book credit, is only the foundation of a single purchase : but if a bill is
drawn, that same portion of credit may serve for as many purchases as
the number of times the bill changes hands : while every bank note
issued, renders the credit of the banker a purchasing power to that amount
in the hands of all the successive holders, without impairing any power
they may possess of effecting purchases on their own credit. Credit, in
short, has exactly the same purchasing power with money ; and as money
tells upon prices not simply in proportion to its amount, but to its amount
multiplied by the number of times it changes hands, so also does credit ;
and credit transferable from hand to hand is in that proportion more
potent, than credit which only performs one purchase. taken in payment by every one, at least in his own neighbourhood : insomuch that, by a custom which has grown into law, payment in bank notes is a complete acquittance to the payer, whereas if he has paid by a bill he still remains liable to the debt, if the person on whom the bill is drawn fails to pay it when due. B therefore can expend the whole of the bank notes without at all involving his own credit ; and whatever power he had before of obtaining goods on book credit, remains to him unimpaired, in addition to the purchasing power he derives from the possession of the notes. The same remark applies to every person in succession, into whose hands the notes may come. It is only A, the first holder, (who used his credit to obtain the notes as a loan from the issuer,) who can possibly find the credit he possesses in other quarters abated by it ; and even in his case that result is not probable ; for though, in reason, and if all his circumstances were known, every draft already made upon his credit ought to diminish by so much his power of obtaining more, yet in practice the reverse more frequently happens, and his having been trusted by one person is supposed to be a reason why he may safely be trusted by others also. §
5. All this purchasing power, however, is operative upon prices, only
according to the proportion of it which is used : and the effect, therefore,
is only felt in a state of circumstances calculated to lead to an unusually
extended use of credit. In such a state of circumstances, that is, in
Loading...Loading...356 EXCHANGE.
the functions of it : and the question arises, Do these various substitutes
operate on prices in the same manner as money itself? Does an increase
in the quantity of transferable paper tend to raise prices, in the same
manner and degree as an increase in the quantity of money ? There
has been no small amount of discussion on this point among writers on
currency, without any result so conclusive as to have yet obtained general
assent.
I apprehend that bank notes, bills, or cheques, as such, do not act on
prices at all. What does act on prices is Credit, in whatever shape given,
and whether it gives rise to any transferable instruments capable of passing
into circulation, or not. §
2. Money acts upon prices in no other way than by being tendered in
exchange for commodities. The demand which influences the prices oi
commodities consists of the money offered for them. But the money
offered is not the same thing with the money possessed. It is sometimes
less, sometimes very much more. In the long run, indeed, the money
which people lay out will be neither more nor less than the money which
they have to lay out : but this is far from being the case at any given
time. Sometimes they keep money by them for fear of an emergency, or
in expectation of a more advantageous opportunity for expending it. In
that case the money is said not to be in circulation : in plainer language,
it is not offered, nor about to be offered, for commodities. Money not in
circulation has no effect on prices. The converse, however, is a much
commoner case ; people make purchases with money not in their possession.
An article, for instance, which is paid for by a cheque on a banker,
is bought with money which not only is not in the payer's possession, but
generally not even in the banker's, having been lent by him (all but the
usual reserve) to other persons. We just now made the imaginary
supposition that all persons dealt with a bank, and all with the same
bank, payments being universally made by cheques. In this ideal case,
there would be no money anywhere except in the hands of the banker ;
who might then safely part with all of it, by selling it as bullion, or lending
it, to be sent out of the country in exchange for goods or foreign
securities. But though there would then be no money in possession, or
ultimately perhaps even in existence, money would be offered, and commodities
bought with it, just as at present. People would continue to
reckon their incomes and their capitals in money, and to make their usual
purchases with orders fcr the receipt of a thing which would have literally
ceased to exist. There would be in all this nothing to complain of, so
long as the money, in disappearing, left behind it an equivalent value in
other things, applicable when required to the reimbursement of those to
whom the money originally belonged. I proceed to explain and substantiate this opinion.
In the case however of payment by cheques, the purchases are at any
rate made, though not with money in the buyer's possession, yet with
money to which he has a right. But he may make purchases with money
which he only expects to have, or even only pretends to expect. He may
obtain goods in return for his acceptances payable at a future time : or on
his note of hand ; or on a simple book credit, that is, on a mere promise
to pay. All these purchases have exactly the same effect on price, as if
they were made with ready money. The amount of purchasing power
which a person can exercise, is composed of all the money in his posses-
sion or due to him, and of all his credit. For exercising the whole of this
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