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produced by labor, machinery, and raw materials; and if these are to be employed in one place, they must necessarily be withdrawn from another.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

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

12. THE MONETARY FUNCTION OF COMMERCIAL CREDIT By J. LAURENCE LAUGHLIN

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

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Adapted from Principles of Money, pp. 82-85. (Charles Scribner's Sons,

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

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

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

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

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INSTRUMENTS OF COMMERCIAL CREDIT

Introduction

Credit instruments probably originated soon after, if not simultaneously with, the development of credit itself, for an obligation entered into upon a credit basis would appear to require almost as a matter of necessity some evidence of the transaction involved. It is of course possible that credit operations may have at one time been extensively conducted without the use of written proof thereof; but there appears to be no historical evidence that such informal credit extension was ever the rule rather than the exception. Without doubt there were always many "character" loans, however, where one's word was as good as his bond, even as now there are between friends informal loans where no note is required. But in all probability some form of note or bill of exchange was generally used almost from the very beginning. There is abundant proof that these instruments were well developed among the Greeks and Romans and even among the Assyrians and Babylonians.

At the present time a great part of credit is evidenced merely by entries in account books, and is known as book credit. Such informal credit extension is quite as significant as any from one standpoint, but from another point of view it is much less important than formal credit. Where a note or bill of exchange arises from a credit operation, we have at hand tangible legal instruments that may be used in a modified way as media of exchange, while in the bank check we have an instrument that in the modern business world has largely superseded the use of money itself in the making of exchanges. Bonds and stocks arising from investment transactions also serve to some extent in lieu of money; but it is only in the instruments of commercial credit that we have a generally acceptable substitute for money.

The adaptability of these instruments to serve as media of exchange has long been recognized, and there has been gradually developed a definite body of law governing their use. The fundamental principle which has given them the wide circulation they now

possess is known as negotiability, whereby one of these instruments may come to have a good title even though there was originally a flaw in it; that is to say, when it gets into the hands of a third party it may, under certain conditions, be a better instrument than when in the possession of the original holder. This principle, so far as our own legal history is concerned, was developed in the English courts to meet the needs of mediaeval trade. In due time it was extended to America, where, in the various states, it developed along similar lines, though with so many local variations that the bar association eventually undertook the securing of identical legislation on the subject in all the states. A uniform negotiable instruments law, however, has only recently been secured.

13. TYPES OF COMMERCIAL CREDIT INSTRUMENTS

A promissory note is an unconditional written promise by X (the maker) agreeing to pay, either on demand or at a definite future date, a sum of money to Y (the payee) or to Y's order or to bearer. It may or may not designate the place at which payment is to be made. Promissory notes may be issued by institutions and governments as well as by individuals. Bank notes, United States notes, certificates of deposit, etc., are forms of the promissory note.

$500.00

No. 246

Due

Chicago Illinois, March 18

1916

Lindy days

after date for value received the undersigned promise to pay to the order of THE NATIONAL CITY BANK OF CHICAGO

Five hundred and for

DOLLARS

at its Banking House in Chicago Illinois, with interest AFTER MATURITY at the rate of seven per cent per annum until paid and with costs of collection and a reasonable attorney fee if not paid at maturity. Presentment and demand for payment, notice of non-payment, protest and notice of protest are each and all hereby waived by the makers, endorsers and guarantors jointly and severally. Any indebtedness owing from said bank or legal holder hereof to the undersigned or to any endorser or guarantor may be appropriated and applied by said bank or legal holder on this note at any time either before or after maturity of this note and without demand upon or notice to any one.

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John Doe

Richard Roe

To indorse a note the payee writes his name across the back of the instrument. This act makes the payee, like the maker, responsible for the payment of the note. Notes may also be indorsed by third parties, thereby adding to the number of those responsible for the payment of the note. Notes which show only one person responsible for the payment are called single-name paper. Those which have two or more signers are called double-name or three-name paper.

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