seeks to set forth the essential requirements for credit without attempting to reduce the matter to a definite word or statement. All credit operations will be found to involve an analysis more or less similar to the one there given.

But while the granting of credit always involves a similar sort of analysis, there emerges, in the use of the funds or goods borrowed on credit, a sharp differentiation, one that is fundamental to the entire study of banking; namely, the distinction between commercial and investment credit. The one is related to the process of manufacturing and marketing consumers' goods, converting raw materials into finished products in the hands of their final consumers; the other, to the creation of capital goods, machinery, tools and equipment, stores, factories, railroads, etc. The former usually gives rise, because of the very nature of the operations, to short-time credit instruments, notes, drafts, checks, etc.; the latter as a rule to long-time credit instruments, stocks, bonds, mortgages, etc.

In practice, however, this fundamental difference between commercial and investment credit has not always been clearly perceived, and some of the most serious problems of finance throughout our history have arisen from the frequent failure to differentiate in practice between investment and commercial operations. The readings in the present chapter are designed to set forth these fundamental differences, while the remainder of the book is devoted to an application of the principles here outlined. Indeed, banking in all its forms, so far as principles, as distinguished from the details of banking practice, are concerned, centers primarily around the use of either commercial or investment credit.

5. A DEFINITION OF CREDIT1

By J. LAURENCE LAUGHLIN

With the division of labor, the marvelous inventions of machinery, the prolongation of industrial processes (so that a unit of product can be more cheaply sold in the end), the growth and prodigious increase of all forms of capital. have naturally led, as a help to this movement, to the evolution by society of the practical means by which men of affairs, when preparing for the future, are enabled with the least waste of efficiency to obtain control of property and capital in productive efforts. As a part of this evolution, as a practical means to an

'Adapted from Principles of Money, pp. 72-76. (Charles Scribner's, Sons, 1903.)

end involving futurity, credit has come into existence. In its simplest terms it is a transfer of commodities involving the return of an equivalent at a future time.

Whenever the time element is eliminated from a transaction, it will be seen at once that credit does not enter into it. A transfer of goods for which an equivalent is rendered on the spot would never be thought of as a credit operation. In fact, buying and selling for an immediate consideration (or "cash") is generally understood to be the very opposite of credit. By general agreement usage would never allow an obligation entered into for the future delivery of personal service to be spoken of as credit; and rightly. A contract to work ten hours a day for the coming three months should not be regarded as a credit obligation. We may, therefore, agree to confine credit operations to goods or property of a transferable kind. And, in the conception of credit, with the transfer goes the right to make any ordinary use of the goods; not merely to keep possession, but to destroy entirely-and commonly with the purpose of reproductionif that is the best means of increasing product and getting back goods for repayment. The specific goods borrowed need not always be returned in kind; an equivalent will suffice; not the same wheat, or wool, or gold which was borrowed, but the equivalent of them.

Many contracts appear as results of credit transactions. For instance, A borrows the means to finish the building of his house; he obtains certain goods which he inserts into his structure, and gives a promissory note to B for its repayment, secured by a pledge of his property in the form known to the law as a mortgage. The note and the mortgage are merely the legal methods adopted to make repayment more certain; they are not essential in the credit itself. The real importance should be put on the transfer to A of means returnable to B in the future. Legal and customary forms intended to secure repayment have created different devices in the same community, while the prevailing habits of different countries have given rise to varying methods of obtaining the same result. In one situation, for instance, a book entry, in another a bill of exchange, in another a promissory note is found most suitable. In short, the circumstances of the loan, the opinions and convenience of the parties to the contract, and the like, may bring into use a great variety of legal forms, all resulting from the primary transfer of goods. The undue insistence upon legal forms arising out of credit draws attention away from the economic processes essential and intrinsic in

it to the nonessential and external forms outside of it. The familiar case of a bank loan illustrates this truth: there is the essential element in the transfer of capital to the borrower on an obligation to return an equivalent value at a fixed future time; but the evidences of the transaction, whether in the form of a book entry as a deposit, or the passing of the bank's own notes, or the giving of a cashier's draft for the sum, are secondary matters, or consequences, arising out of the original credit operation. As said before, the latter merely form the machinery for obtaining greater or less security with a view to repayment.

6. THE BASIS OF CREDIT

There has been a long-continued discussion over the basis of credit operations, that is, the reasons why credit is extended by one person to another. One party to the controversy has stoutly insisted that confidence is the basis of all grants of credit; that if one did not have confidence that a borrower would repay a loan he would never think of making the loan, unless perchance for personal or philanthropic reasons. Others have held that property, rather than confidence, is the basis of all genuine credit transactions. Without attempting to analyze the causes for this apparent difference of view, a tabular exhibit of the points usually investigated before credit is extended by up-to-date business concerns will show that while confidence must exist before a loan will be granted, such confidence is based in part on the borrower's property and in part on his personal characteristics.

The customary matters investigated may be grouped in two general classes as follows:

It will be apparent that these points are not entirely unrelated. A man of excellent business ability, for instance, would have his business properly organized, and on the other hand, if it were found that a business was poorly equipped and managed, it would be certain that the man's business experience or business capacity was strictly limited. Investigation of these two kinds, however, usually serves to furnish a more adequate basis for a sound judgment of the risks involved. Perhaps one may conclude from this analysis that before deciding to extend credit one should at any rate have confidence in two points: (1) in the ability of the borrower to pay as promised; and (2) in his willingness or intention to pay. One is a matter of property and business ability; the other a question of honesty and business reliability.

7. THE VARIOUS KINDS OF CREDIT

The modern world has been called a credit society. The Germans, for instance, classify the stages in the evolution of industry as follows: barter economy; money economy; credit economy. The mechanism of credit would therefore appear to be the center and core of modern industrialism. While this characterization may well be pushed too far, it is certainly true that credit today is found in practically every variety of business transaction and is in fact the basis for the great mass of commercial exchanges. The divisions of credit have been classified as follows: Public Credit; Capital Credit; Mercantile Credit; Individual or Personal Credit; and Banking Credit.

By Public Credit is meant chiefly the borrowing operations of governments, whether national, state, or local, through the issue of interest-bearing securities. The government promises to pay interest on a bond from year to year and to repay the principal at some stated future date. The purchaser of the bond accepts the government's promise of intention to pay and has faith in its ability to keep that promise. The government by means of its credit is therefore able to secure funds for present needs. An issue of paper money by the government is another example of a credit operation. Even without any fund for redemption purposes an issue of paper money will not for a time depreciate to worthlessness; a promise of ultimate redemption will give it some value so long as faith in the word of the government is not entirely shattered. At any rate, a partial reserve in coin,

as in the case of our greenbacks at present, will maintain the value of paper currency. To the extent of the uncovered issue we have a pure credit currency.

By Capital Credit, or Corporation Credit, to employ another term, is meant the credit used by corporations in procuring the necessary capital required in their business operations. The corporation agrees to return to the purchasers of its bonds at some future date the equivalent of the funds borrowed, with interest. The bondholder thus extends funds to the corporation because he believes the credit of the corporation is good. The purchaser of stock, also, trusts his funds to the managers of a corporation, and it is understood that he is to receive dividends in the future (if earned) and ultimately, if the business is liquidated, a return of his share of the capital. There is the obvious difference between a holder of stock and of bonds that one is an owner and the other a creditor, that the returns to the one are wholly contingent, and to the other definite, in so far as the mortgage is adequate. But credit, through the entrusting of one's funds to a third party, is an essential element in both.

It is the usual practice to exclude from Capital Credit investments made by individuals in a business partly or largely their own, such as a partnership. The difference between this sort of investor and the purchaser of securities, says Prendergast, is this: "Where a few men invest their funds in a business, those funds invariably represent their entire available means of wealth. They are working for themselves alone, and the profits of the business, whatever they may be, go to the owners alone. These owners . . . have placed all they possess at the risk of the business. . . On the other hand, the general investor, who is seeking merely a nominal or reasonable interest upon the funds invested, is careful to so place those funds that his investments will be very well distributed," with a consequent lessening of the total risk. To use the economic terminology, the one is primarily a risk-taker and after profits, while the other is, as far as possible, a risk-avoider and is satisfied with interest alone. A better distinction between the two types of investment, however, is that credit, so far as fixed capital is concerned, is almost negligible in the case of the partnership, while with the purchaser of securities credit is the very basis of the tran action.

Mercantile Credit is the credit used by producers, wholesalers, commission merchants, retailers, etc., in connection with the manufacture and sale of commodities, that is, with the movement of goods