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CREDIT - John Joseph Lalor, Cyclopaedia of Political Science, Political Economy, and of the Political History of the United States, vol. 1 Abdication-Duty 
Cyclopaedia of Political Science, Political Economy, and of the Political History of the United States by the best American and European Authors, ed. John J. Lalor (New York: Maynard, Merrill, & Co., 1899). Vol 1 Abdication-Duty.
Part of: Cyclopaedia of Political Science, Political Economy, and of the Political History of the United States, 3 vols.
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CREDIT. If there exists an agency of unquestioned power, it surely is that of credit. Who does not admire its wonderful potency? Who does not recognize the mighty share which is due to it in the economic development of the present age? Men are still far from agreeing as to what are the limits of this power, or comprehending the means by which it accomplishes its wonders. The old difference of opinion regarding the extent and the functions of credit, still continues, and manifests itself from time to time with renewed force. Economists of no little weight continue to claim for credit a creative power, the faculty of increasing capital. The majority of economists, however, and the testimony of experience, seem to assign to it a less ambitious place—The task of treating this question exhaustively we leave to special works on the subject. It is impossible, however, to pass it by here in silence. It is important, for the discussion of a great many of the questions which agitate the present times, to have settled ideas upon the essential functions of credit. Commercial credit has the first claim to our consideration. It was the starting point of the whole system, and is to-day the most important wheel in the whole fiduciary mechanism. Commercial credit marks the third distinctive phase in the history of exchange. First came barter. In exchange for the fruit of his hunting, his fishing, or the crop which he grows, the seller—both parties are sellers—receives a product equal, or nearly equal, in value; one from which he believes he can derive greater advantage than from the product which he sells.
—Then came exchange through the medium of money. This was a complete revolution. In exchange for the special product of which he disposes, the seller now receives a universal product, or rather the means of procuring any obtainable product, service or enjoyment he may desire. Both gain by this exchange; there is no longer any necessity that the one should offer, and the other receive, in exchange a determinate quantity of merchandise. all that is needed is that the person desirous of acquiring a thing, should possess, it matters not in what form, a value equal to the one he wishes to obtain. The mind perceives at a glance how greatly this facilitates the transaction of business.
—Still, if exchange was impossible in the times of barter, when the party who wished to acquire the merchandise offered did not possess an equivalent in merchandise which he could directly or indirectly convey to the party offering, so also, when money is the medium of exchange, the exchange can not be effected if the demander has no money. Here it is that credit comes in. In this third phase of exchange the holder of a product, to be induced to surrender it, no longer asks, as in the times of barter, that he receive in return the product which he needs, or at least a product where with he may be able to procure it; he no longer demands, as in the time of cash sales, the money with the aid of which he may be able to acquire immediately the equivalent of what he has given; he is satisfied with the prospect of receiving, at a stipulated time, the payment of the debt contracted by the purchaser.
—Henceforth the existence of one disposable object will suffice for a commercial transaction; the counter-value may not yet exist. Let us illustrate, by an example, the essential difference between these three phases of exchange. My neighbor, a farmer, has harvested 10 hectolitres of wheat more than he needs to supply the wants of his family. I desire to obtain it, and he would willingly dispose of it for a yoke of oxen. In the age of barter, in order to obtain this available wheat, it would be necessary for me to possess the oxen desired by the farmer in order to effect the exchange; in the age of money payments I must possess a sum equivalent to the price of the oxen; in the age of credit, the farmer delivers me his wheat, and is satisfied with a promise of receiving its equivalent from me at a later period; and this equivalent I will probably obtain from the very commodity itself which he has given me, by selling, at a profit, the bread made from the wheat which I brought from him.
—Thus credit may be truly said to discount the future. We feel at perfect liberty to excuse ourselves from discussing the question propounded by J. B. Say, whether a social state, in which no one made use of credit, and in which all business was transacted on a cash basis, would be preferable to the present economic organism, in which nearly every one gives and asks credit. Can we, indeed, imagine any economic movement without the mainspring of credit? From the time that exchange ceases to aim merely at the satisfaction of the direct and immediate wants of the two contracting parties, credit becomes absolutely indispensable. A peasant proprietor's son inherits a piece of land, which, if cleared, will afford him means of support; a young clerk, possessed of activity, intelligence and a knowledge of business which would make him a successful merchant, wishes to open a store; a mechanic, skilled in his trade, and assured of a ready sale for his handiwork, wishes to start a shop. It is evident that, if the peasant's son must pay cash for the agricultural implements and seeds which he needs, the clerk for the merchandise which he is to sell, and the mechanic for the raw material which he is to use in his work; the farming of the first, the business house of the second, and the manufacturing of the third will be utter impossibilities. They must needs have money to commence work, and they must have worked in order to have money. Credit alone enables us to get out of the vicious circle. It is to credit alone that we are indebted for that intermediate agent which plays so important a part in the transaction of business, whether it be in causing supply and demand to meet, or in applying to the industry of exchange the principle of the division of labor which is so favorable to production. Without credit this intermediary is impossible in most instances. The miller, whose whole fortune consists of the two wheels which grind his grain, the fall of water which sets them in motion, and the cabin which covers them, would not be able, with the best will in the world, to pay the farmer for the grain which he is to make into flour, until he himself has sold this flour, and received his pay therefor from the baker; the merchant who engages to deliver to his customers linen, made in some remote manufactory, can not give the manufacturer its equivalent until he himself has sold the merchandise, and received the price of it. But if credit be indispensable in some cases, it is in others a supreme necessity. In the economic movement of society everything is connected like the links in a chain. The farmer, who can obtain pay for his grain only three months after he has delivered it, can not buy for cash the cattle which he needs in the meantime. The cloth manufacturer who trusts the draper, must remain idle, if, to replenish his stock of wool, he has to await payment from the draper; he also must buy on credit. It is with him just as it was with those who, in the case cited before, are accommodated by means of credit—the farmer who wished to clear his land, the clerk and the mechanic who wished to start in business, and who could not do it without the aid of credit. Thus credit at one time gives birth to both industry and trade, which could not exist without it, and at others it prevents their stoppage or growing sluggish; as a general result the difference is not great Credit multiplies the producing and consuming power of society: by facilitating exchange it accelerates and thus increases it.
—The word credit really still answers to what its etymology and the nature of things indicate, and to what was its primitive object. Credit supposes confidence. Confiding in the good will, the honor, and the intelligence of the purchaser, and also in the law, which, in case of need, will protect my rights, I make a transfer of a piece of property on time. I agree to part with my land, with the product of my industry, of my capital, in return for a counter-value which I shall receive only after a certain length of time. This confidence constitutes the very essence of credit. The rest is merely accessory. The bank note, discounts, the bill of exchange itself, are not constitutive elements of it. During the middle ages credit transactions of great importance and on long time were effected without the intervention of any of these means, and without leaving the slightest trace in writing; and even to this day the Russian producers and merchants who frequent the great fair at Nijni Novgorod, contract credit obligations for 12 months' time, without giving the least evidence of the debt, and that for a very good reason: very frequently they can neither read nor write. What we, in a more highly developed economic state, call instruments of credit, may facilitate and hasten the workings of credit, but they do not change its nature. By giving my creditor a written promise of payment, he is in many respects better secured than he would be by a mere verbal promise; and, besides, this written evidence of it increases the creditor's facility for transferring his claim. But does the nature of the operation change because it has been consigned to writing? Or does it change because the seller has disposed of the document which proves his claim against the buyer? To answer in the negative it is only necessary to understand the nature of this transfer, and of discount.
—We have said that to give credit is to consent to wait for the return of the thing given or its equivalent: immovable property, merchandise, money, service, etc. But very often the seller is not prepared to wait, he therefore substitutes another person in his place, who can afford to do so; it matters not whether it be a creditor of his, whom he pays with a bill of exchange, or a capitalist who has idle money, and buys the credit, to take advantage of the interest, or a person who makes a business of discounting. This last person may not himself be able to await the maturing of the note; he goes to the bank, and rediscounts the discounted values. Bankers, and still more public banks, are peculiarly well able to wait. In other words, they can give a great deal of credit, as this is precisely their office, to utilize—in collecting it by deposit, accounts current, etc.—available money, capital newly acquired, or momentarily idle. In all this there is a manifest acceleration of the economic movement of society; and this has an immense influence, since an amount of capital turned over three times a year performs the same service as three times the amount turned over only once. But there is not in this circulation, nor in the discounting of commercial paper, any creation of capital. All these credit transactions do not multiply capital in any other sense than accelerated motion increases the services of a machine.—"But the bank note!" it is urged, "does not the note which the bank gives me, and with which I operate just as well as with any other value increase by its entire sum the amount of capital? It is," continues our objector, "just as it is with a draft. Without the power of free disposal of the merchandise bought or the money borrowed being in the least affected in the hands of the purchaser or borrower, the creditor (whether seller or buyer), with certain restrictions, makes use of the bill or draft just as he would make use of money or any other value which he might possess." "There are, therefore," it is said, "two amounts of capital in circulation instead of one, and there must surely be an increase of capital." This argument is specious; but let us first turn our attention to the bank note, which is appealed to as a proof of the creative power of credit. Banks, by substituting their notes for convenient amounts, notes generally acceptable in the place of letters of exchange, whose amount is so variable and whose signatures, because so little known, hinder their circulation, simply convert the bill of exchange into money. They render easier of transfer and fitter for circulation the promise to pay which I hold: they transform the bill payable to a specified party into one payable to bearer. Nor is this change the only service which they render. It happens every day in retail trade, that the purchaser, in exchange for a single note of 100 francs, the amount of his purchase, signs 10 notes of 10 francs each; because the creditor will be able to make use of them with much greater facility to pay his various small debts, where his solvability, or that of his debtor, allows them to pass (almost) as money. In this rendering more readily transferable the claims which he signs, the debtor effects, in a partial and imperfect way, what the bank does in giving me 10 20-franc bills for my bill of exchange for 200 francs. But the bank note, which I prefer to the bill of exchange, because it circulates more easily, evidently can have no intrinsic virtues other than those possessed by the document which it replaces. The hypothesis, according to which the issue of bank notes is a creation of capital, can not stand, therefore, unless that same power be attributed to commercial paper also. This has been attempted. To perceive what an amount of error and exaggeration there is in this opinion, it will suffice to consider attentively for a moment the part played by the bill of exchange. A is a cutler. He sells $4,000 worth of his wares to B, a hardware merchant, who, instead of paying the $4,000 immediately, gives his written promise that he will pay them three months from date. Why? Because B needs this delay to dispose of the merchandise and get back the amount of capital which comes to him under the form of knives and similar articles. And so with the as $2,000 in specie loaned to a manufacturer, either to purchase his raw material, or to pay his workmen, and which he repays out of the amount realized from the sale of his merchandise. Far from doubling the as $2,000, the bill of exchange rather certifies that for the time being this sum does not exist at all as capital, in the commercial sense of the word: as a disposable value and an object of trade. But in certifying, also, that the capital will be restored in three months' time, the bill of exchange, whether it circulate by way of indorsement until it mature, or whether the bank in discounting substitute its notes for it, still admits to a certain extent, and under certain circumstances, of the immediate employment of the loaned capital. Thus, if I keep a bill of exchange in my safe, it is simply a security; if I put it in circulation, it prevents the momentary disappearance of a certain amount of capital; it prevents the infertility of that amount of capital during the time which intervenes between its decomposition, so to speak, and its restoration. In neither case do we see any trace of a creation of capital, of new capital added to the amount of capital already existing.
—Here is a palpable proof of this: on the day on which the capital which has been temporarily retired from circulation has been restored, and enters again into circulation, the day on which the hardware merchant pays the cutler the amount of his indebtedness, and receives the note which he gave him, the pretended capital by which this note is thought to have increased the national wealth vanishes. Whether A destroys the bill of exchange or returns it, the pretended capital which it created has no existence whatever: at the end of the operation, there is merely the original capital restored, increased, according to circumstances, by the profits which its use in operation may have produced, the division of which between debtor, creditor, etc., does not concern us here.
—Let us put a whole series of bills of exchange in the place of one, and the proof of this fact will be made clearer still. I am a farmer, and sell on the 1st day of February, 1881, as $2,000 worth of corn, for which the miller will pay me on the 30th of April following. Counting upon this, I go and buy as $2,000 worth of cattle, which I agree to pay for in three months' time; the stock raiser purchases a threshing machine, which he intends to pay for on the 30th of April with the price of the cattle; the agricultural implement manufacturer bargains for as $2,000 worth of iron on 9) days' credit. Here are four bills of exchange signed the 1st day of February, and all payable the 30th of April. Each of the three creditors voluntarily disposes of the claim which he holds, and which in his business renders him the same service as if he possessed its value in merchandise or in coined money. Can any one pretend from this that four distinct amounts of capital of as $2,000 each have been created? Let us see. The time of the maturity of the notes arrives. The grain merchant, by the gradual sale of the corn which he bought from me, has obtained the as $2,000, for which I gave him credit, and he pays me the amount. The $2,000 serves the same day to pay my indebtedness to the agricultural implement manufacturer, and the manufacturer's obligation to the iron merchant. Thus this one amount of actual capital—this 8dollars;2,000 in coin or in paper, obtained by the gradual sale of the corn first sold by the farmer to the miller, annihilates in a single hour the four sums of capital of 8dollars;2,000 each, which the four bills of exchange had created! Now, if it be difficult to admit creation out of nothing; reason absolutely refuses to allow the possibility of the instantaneous and utter disappearance of things once created. In reality, nothing is annihilated on the day of the maturing of the notes but four certificates which have no longer anything to certify, because the debts of which they were the evidence have ceased to exist.
—May we not apply the same reasoning to bank notes? As the drafts discounted mature, the notes issued for them will be returned to the bank; and there will not remain in circulation the least trace of the capital which was "created" by their issue! Besides, this disappearance—a proof no less convincing than the unreality of the pretended capital created by credit—leaves behind it not the least void in the wealth of society. More yet: if commercial bills, bank notes and other instruments of credit were capital, and increased the instruments of labor, we could not too heartily congratulate ourselves upon their multiplication. Would their increase not be the increase of means of progress, and of general well-being? Many a one reasons thus; but rational theory and reasonable practice judge far otherwise. In their opinion, progress consists, not in the multiplication, but in the diminution almost to total abolition, of instruments of credit. At a time not very long past, nations and governments thought that wealth was to be measured by the amount of coin money which a country possessed; that the more abundant money was, the more healthful the circulation of wealth; but who would pretend to say to-day that it is an advantage for France to have 4 000,000,000 francs of coin money in circulation. We all see, rather, that in this respect she is far behind England, which does not possess probably one-quarter of that amount, but which with that quarter transacts infinitely more business than France. Relatively the amount of bank notes and drafts in circulation is also much smaller in England than in France. Does this difference prove a disadvantage to England? On the contrary, it is an advantage which France would gladly acquire. In proportion as the system of accounts current, checks and the clearing house is extended and strengthened, the use of bank notes and bills of exchange is necessarily and fortunately lessened. What are we to conclude from all this, but that commercial paper and bank notes are but instruments, which can be replaced by more perfect means, or which a superior organism will some day dispense with entirely?
—Discounting is not, in reality, the only mode of issuing. "There are especially," we are told, "direct advances, wherein the bank, without requiring any counter-value, without retiring from circulation a corresponding amount of capital provides its client with the instruments of labor, causes capital to appear, by the credit which it gives, where no capital existed before." This is taking only a very partial view of what actually happens. The notes which the bank issues by way of direct advances have all the appearances of real capital. They render the person to whom the credit is extended the same service as if a capitalist had made the loan to him in metallic money, or as if the producer had advanced him the raw material where with to carry on his trade, and which he buys with the notes the bank has loaned him. But what does the bank do but substitute itself in the place of the producer; what does it do but anticipate the operation of discount? Let us suppose that a tanner, A, of whom a shoemaker, B, newly started in business, wishes to but leather, knows that the bank has confidence in B, and will readily discount his paper. In this case A will certainly have no hesitation in furnishing leather to B on credit, for a note which he will get discounted at the bank. The transaction thus becomes an ordinary commercial operation, in which, as we believe we have demonstrated, neither a bill payable to order nor a bill of exchange "creates" anything. Cash credit, such as is now given particularly by the Scotch banks, and certain banks in Germany, is nothing more nor less than the discounting of a note anticipated. Whether A furnishes B with goods on credit, and then goes to the bank, and by discounting B's paper gets the money for the goods furnished B on credit; or whether the bank loans this same money to B himself, that he may buy for cash from A; the amount of active capital is no more increased in one case than in the other. In both cases the bank notes take the place of an amount of capital (that of A) which can not afford to wait (until B can give something in exchange for it), and thus keep it from lying idle. We need scarcely say here that "accommodation notes," which do not grow out of any business transaction, and seem in fact, in the eyes of the multitude, to create capital at will, are not instruments of credit, but most frequently instruments of swindling.
—We have not a much better opinion of another "operation" whereby adroit manufacturers and merchants in embarrassed circumstances seem to multiply capital at will through the instrumentality of credit: we refer to the advances which banks make on the security of commercial paper or bills payable. We do not believe that to make advances on such security comes within the province of a bank; such advances belong rather to the pawnshop. These advances may, perhaps, have their advantages; but such is their character in our own day that they lie outside the domain of political economy. We know how far enterprising speculators have carried this mode of borrowing of late years. A man has 100,000 francs, with which he purchases government bonds or annuities: these he deposits in a bank, and receives from it, on their security, 80,000 francs. This sum he invests in shares of stock to its full amount, and then pledges them to the bank for 60,000 francs. He now buys 60,000 francs worth of bills payable, and repledges them for 40,000 francs, with which he again purchases bills payable, which are once more pledged to the bank. Thus this man may have obtained 300,000 francs' worth of bills payable with a capital of 100,000 francs. In fact, he may not have owned or paid out a single franc, if the first purchase was made on credit. Thanks to such manœuvres as these, "credit" may well appear to multiply capital in the hands of the borrower, and constantly create new capital for him. But without examining whether this appearance be a reality—through it can hardly be so—let us ask ourselves: Is there any advantage to the community in this creation of fictitious capital? We do not thinks so.
—Are we not, perhaps, underrating credit, and questioning its value and power? This is not our intention; nor would it accord with our previous observations on the subject.
—Credit assures us the uninterrupted continuance of production and consumption. Sometimes, as we have already seen, economic action would be entirely impossible without the intervention of credit. the service which credit thus renders to the economy of a nation is great enough to warrant its most zealous partisans not to claim for it any further title to the gratitude of modern society, in which it has acquired a development hitherto unknown. It works wonders. It produces, if we may so speak, perpetual motion. The economic machinery of society seems to stand still, to slacken its motion, or to accelerate its speed, in proportion as credit disappears, grows feeble or revives. The activity of production and consumption of wealth in any country is greater, more general, more fruitful, according as credit is more or less developed there. In a word, credit is the great motive power of economic activity; it is an immense service rendered to the material and moral progress of society. Is there any use in claiming for credit imaginary powers, which, far from increasing its utility, frequently vitiate it in its very essence?
—We need not dwell here upon the elementary conditions which the strengthening and development of credit require. Among the most indispensable the following are admitted on all hands: the reign of justice; good legislation; the guarantee of the creditor against the bad faith of the debtor; a liberal legal policy in matters of industry and commerce, allowing each one to make use of his powers, and to turn what he produces to the best advantage; facility and safety of communication; a rational and honest monetary system. We shall insist upon only one point: if to give credit means to wait for payment, if to give a great amount of credit we must have at our disposal a great amount of capital which can wait, it becomes necessary, that credit may be developed on a large scale, to put into and to retain in active circulation all the capital accumulated or in process of formation and accumulation, which, because it is idle capital, may be substituted wherever needed for the capital which can not afford to lie idle for a time, that is, drop out of circulation. To attract to itself all capital momentarily idle by means of the savings bank, deposits, accounts current, etc., and to employ it again to liberate bound-up capital, which it is not desired to withdraw from circulation again: such should be the aims of a bank, whether private or public, free or a monopoly, if it wish to attain its end as an institution of credit. This is the only healthful and desirable way for credit to develop and progress; and it is the way, also, in which its services promise to become more numerous and more important with time.
—What we have just said of commercial credit applies equally well to all the other forms of credit, whatever the purpose of the credit may be. This is not the place for us to dwell on what is called national credit. Suffice it here to say, that in its essence public credit does not differ from private credit; it does not, nor can it possess any power which is not inherent in the nature of the latter. We can loan to the state, as to an individual, only money which exists somewhere. If a public loan absorb only the capital in process of formation and not yet invested; if, at its best, it attract, in addition to this, the capital invested in a rather unproductive manner; and if the capital thus concentrated in the public treasury be employed in a rational way for the general good; public credit may become an effective instrument of progress to the community at the same time that it furnishes a good and profitable investment for disposable capital. But when, attracted by a high rate of interest, by premiums and lotteries, the state borrows more than is warranted at a given time by the amount of uninvested or badly invested capital; when it thus induces capital to withdraw from agricultural, industrial, commercial, and other investments, in which it was contributing to the general economic good of the nation; when the capital thus wrested from its natural and beneficial function, is employed by the state in unproductive outlay (luxurious buildings, excessive ornamentation, etc.,) or even in destructive outlay (war-like expeditions); then public credit becomes a real national scourge. It wrongs the present generation by robbing it of its instruments of labor and production; it weighs down generations to come with an excessive load of interest, with which it forever burdens them. Besides this, it has the danger of facilitating war-like and other enterprises, the enormous cost of which is not their greatest inconvenience.
—The same danger attends another kind of credit which has been largely developed in our day, and which holds a middle place between private credit and public credit: we might call it enterprise-credit. It is given, by way of preference, in the case of great works of public utility and to vast industrial, commercial and other enterprises; and to these it renders great and undeniable service. But here, also, we must remove a misunderstanding which has contributed not a little to cause the influence of credit to be exaggerated, and to produce a belief in its magic power. We hear it said every day: We are indebted to credit. for the construction of railroads, for the development of steam navigation, for the exploration of mines on a vast scale, for our immense manufactories, and other enterprises more or less great, which are the pride of the nineteenth century, and the cause of its prosperity. Let us see. When a company is formed, and collects, by the issuing of 2,000 shares of stock at 5,000 francs each, a capital of 10,000,000 francs to build a railway 50 kilomètres in length, credit has absolutely nothing to do with the enterprise. The stock-holders by whom the capital is furnished are in a situation precisely similar to that of the 10 or 20 capitalists, who put their capital together for the purpose of building a hotel, or for the erection of a manufacturing establishment. The credit which a railroad company asks of the contractor, material-man, and other persons with whom it enters into business relations, is private credit. it differs only in extent from the credit which is every day asked and received. Enterprise-credit, or quasi-public credit, enters into the transactions of the company, only when, instead of asking the additional capital it may need from the stockholders themselves, from those interested in the enterprise, it asks it of the public generally; in other words, when it issues bonds, instead of issuing shares of stock. The rules which we have laid down relative to public credit, apply equally to what we have called enterprise-credit. To companies, as to individuals, or to the national treasury, can be loaned only money which people actually have. The credit the capitalist gives in taking the 100 bonds of 500 francs each, no more acquires "creative power" because it is a company which gets it, than if the capitalist had used this same sum to discount bills of exchange, for, say 10 merchants, to the amount of 50,000 francs. Before it can go into the coffer of the company, it is absolutely necessary that this money should come out of other coffers. Now, if the company, by the real and solid advantages which it offers, succeeds not merely in liberating and putting in circulation capital temporarily idle, but also in stimulating the creation of capital by the accumulation of savings, it may render great service to the economic community. It happens, however, frequently enough, that, by the allurement of premiums and other means, companies induce capital engaged in useful enterprises to abandon these in order to avail itself of this apparently more productive investment. The investment may prove so, for a time at least, to the capitalist: it certainly is not so for the public generally. The people see the railroad constructed by means of the capital thus borrowed, and extol the power of credit: they do not see how, deprived of a large part of the capital invested in them, agricultural and industrial enterprises, which alone could furnish a profitable traffic to the railroad constructed at their expense, languish and decline.
J. E. HORN.