purchase and sale from the original producer to the hands of the ultimate consumer.

9. THE IMPORTANCE OF INVESTMENT CREDIT

The importance of investment credit has often been underestimated by writers on the subject of credit. Nevertheless it plays quite as important a rôle in the world of business as does commercial credit. By means of government credit the individuals who purchase bonds receive interest on funds that might otherwise be either unemployed or less safely or remuneratively invested, while the government, on its part, is enabled to build a Panama Canal, wage wars of self-defense or conquest, construct public roads and buildings, street railways, electric lighting plants, etc. In so far as a government can perform certain services for society more effectively than can private business, there is clearly a direct social gain arising from the uses of this form of credit.

By means of capital or industrial credit the surplus funds of individuals are turned back into the channels of productive industry; they are transferred from non-productive to productive employments, thereby increasing the wealth and productive power of society. These private funds are converted into railroads, factories, shops, and farms which would not yet have come into existence without the use of investment credit.

An idea of the enormous extent of investment credit may be gained from the statistics of the bonds and stocks listed on the New York Stock Exchange. The principal of the bonds listed on the exchange amounts to a total of $14,310,553,000, classified in groups as follows:

Government and municipal, including foreign.
Railroad.

Public utility and street railway.

Manufacturing, industrial, and miscellaneous.

$3,357,379,849

8,213,374,750

1,475,567,590

1,264,232,950

The face value of the listed stocks amounts to $13,084,073,923. It is estimated that for the country as a whole the bond houses every year market in the neighborhood of $2,000,000,000 of bonds. The significance of these enormous figures may be realized when one considers that the total wealth of the entire nation is estimated at about $120,000,000,000.

IO.

THE COMPLICATED SYSTEM OF COMMERCIAL CREDIT It has become almost a trite saying that credit is the very lifeblood of commerce and that without its wonderful assistance the enormous business of the modern world would be quite impossible. It is a commonplace, also, that the credit structure is a very uncertain mechanism, one that periodically breaks down, involving hundreds of businesses in financial ruin and indirectly demoralizing the commerce of an entire country. The precise manner, however, in which this credit structure is built up, with its intricate and complicated interrelations, is often not clearly understood. It is the purpose of the following analysis to trace these intricate relations and show the complicated interdependencies in the fabric of commercial credit.

Commerce relates to the movement of goods from the hands of those who perform the first operation in production to their final resting-place with the ultimate consumers. Commercial credit connects itself, therefore, with the various purchases and sales that are made in the extended process of marketing commodities. The nature and place of credit in this marketing process may perhaps best be made clear by assuming first a society that does business on a cash basis only.

To illustrate the process, let us begin with some raw materials in the form of iron ore and coal which are to be manufactured into farm machinery for sale to farmers. These raw materials normally pass through the hands of the following classes of business men: (1) the manufacturer of machinery; (2) the wholesale dealer; (3) the retail merchant, from whom they are purchased by the farmer. In the absence of credit the producer of raw materials would have to possess enough capital to defray the cost of producing these materials. Let us assume he sells them for cash to the manufacturer, who pays for them with ready money. In turn, the manufacturer, after converting the materials into finished machines, sells them in a new form to the wholesale dealer, who pays for them out of funds accumulated for the purpose. The wholesaler next passes them on to the retailer for cash, and the retailer disposes of them to the farmer for cash. In each case cash accumulated and in hand ready for payment is the significant feature. We have thus far, however, but half completed the commercial circle.

The farmer does not purchase the machinery as an end in itself. With it he produces crops for sale. He sells his annual produce to a

local dealer for cash; the local dealer sells these products to the commission merchant for cash; the commission merchant passes them on for cash to a retail store; and the storekeeper sells them for cash to his customers, who happen to be, let us assume, the laborers in the mines of iron and coal who were the original producers of the raw materials that went to the making of farm machinery. Thus we have the complete round of production.

In the foregoing analysis we have assumed each sale to be for cash; no one waits for his payments, and all keep the slate clear as they go. With such a method there is little danger of a general breakdown. If a purchaser has not the cash with which to pay for goods, he is refused the sale. Hence the seller is never dependent upon the future solvency of his purchaser. Sales may be restricted by a slackening of the industrial process; but there are never maturing obligations to meet and there is never a chain of failures, each due to the previous one. Let us now introduce credit into the system as outlined above.

It is evident that the farmer who buys the farm machinery is the ultimate demander of the raw materials purchased by the manufacturer. In the final analysis the farmer's cash pays for the labor of the workers in the mines of iron and coal. Or, traveling around the circuit in the opposite direction, it is the laborer's cash that really pays for the crops that have been produced by the farm machinery. Without credit, however, it is impossible for the precise cash paid by the farmer to the retailer to be used by the latter in paying the wholesaler, and so on up to the producer of the raw materials. In introducing credit into this system it will be necessary to assume for the moment a situation that does not represent the actual state of affairs. The corrective will be given in the paragraph following.

Let us assume that the producer of raw materials possesses enough cash to produce $10,000 worth of raw materials, paying his laborers in advance. Now let us assume that he sells these materials to the manufacturer on twelve months' time; that is, he agrees to wait twelve months for his pay. The manufacturer in the course of three months converts these raw materials into finished machinery and sells the machines on nine months' time to the wholesaler. In a month the wholesaler disposes of the machinery, letting the retailer have eight months in which to pay. In another month the retailer sells the machines to a farmer, agreeing to wait seven months Four months later the farmer sells his crops on three months' time to a local dealer,

who sells them in a month to a commission merchant on two months' time, the commission merchant in turn selling on one month's time to a retail store, and the retailer disposes of them within a month to the laborers who work in the mines, for cash received by them for producing raw materials. Cash would thus be paid to the retailer of farm produce just twelve months from the date of the first sale of the raw materials; and if this cash should be passed on promptly through the hands of the commission merchant, local dealer, farmer, retailer, wholesaler, and manufacturer to the original producer it could liquidate all the obligations as per schedule.

In actual practice, however, twelve months would be a long time for the producer to wait for his payment. Similarly, the periods of nine, eight, and seven months would be too long for the others to wait, for further production would be more or less halted meanwhile. In practice, therefore, credit extension is for much shorter periods, usually from one to four months, whether it be to the producer of raw materials, the manufacturer, or the middleman. How is this made possible?

The manufacturer, for instance, may give his note to the producer for three months and pay as soon as he sells to the wholesaler. The question now is, Where does the wholesaler get the funds with which to pay? Does he not have to wait until the retailer has disposed of the goods? This is where the banks come to the assistance of commerce. The wholesaler sells to the retailer on time, but instead of delaying his payment to the manufacturer, he procures a loan from his bank, giving as security therefor either his own note or the notes received from the retailer. With this loan the wholesaler may pay the manufacturer at once. The loan from the bank is repaid when the retailer settles with the wholesaler. Therefore the bank instead of the dealer undertakes the waiting.

In the foregoing illustration it was the wholesaler who procured the loan from the bank. It may, in fact, be any one or several in the chain of buyers and sellers. The manufacturer, for instance, instead of asking the wholesaler to pay cash could accept a promissory note instead, and then sell this note to a bank for cash, that is, have

The practice in this country has commonly been for the wholesaler to sell on open account, requiring no note, the retailer paying shortly in cash obtained by borrowing on his own note. Both wholesalers and retailers, however, have occasion to borrow from the banks.

it discounted. Or the retailer might borrow from a bank and pay cash to the wholesaler. Similarly, on the other side of the circle, the commission merchant may pay cash to the local dealer, borrowing from a bank for the purpose; and the retailer of the foodstuffs may sell to his customers on credit and borrow from a bank while waiting for his returns. It is quite immaterial which party procures the assistance of the banks, though in practice it usually becomes the custom for only certain ones in the chain to do so regularly.

The commercial structure which we have thus outlined is seen to be very closely interrelated; and it is because of this interdependence of factors that a "credit breakdown" has such far-reaching consequences. The credit circle cannot be broken at any point without more or less seriously disrupting the entire system. Suppose, for instance, that a long drouth or heavy rains ruin the agricultural produce and render it impossible for the farmer to pay the retailer as promised. This affects the retailer's ability to pay the wholesaler, and in turn the wholesaler's ability to pay the manufacturer, or his bank, and so on around the entire circle. Or suppose a strike in the manufacturing establishment should prevent the manufacturer from filling his selling orders. It becomes impossible for him to pay the producer on time; and the latter in turn is unable to meet his obligations as they fall due. The halting of the manufacturing process may compel the producer to restrict his output of raw materials, and hence discharge laborers. This affects the sales of the retailer of the farm produce, and hence his ability to pay the commission merchant, and so on around the circle. Obviously numerous other examples of this sort might be enumerated.

Whenever there is a break in the delicate structure at any point, there is always an attempt to stop the gap by calling upon the banks for assistance. Whoever finds himself unable to pay on time rushes to his banker for a loan. Indeed, if there is but a well-grounded fear that difficulties are likely to come, dealers often go at once to the banks for loans in anticipation of trouble to come. Without here going into an analysis of the responsibility thus placed upon the banking institutions, it should be emphasized that the success with which a community may pass through a period of disrupted credit operations depends upon the ability of the banks to expand their own credit sufficiently to tide the commercial world over the emergency.