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.

It is in the effects resulting from the transference of capital from those who are willing to lend to those who are desirous to borrow that we must seek for the advantages derivable from credit. All the operations supposed to be carried on by its agency, how extensive and complicated soever they may seem, originate, in fact, in a change in the actual holders or employers of capital. Nothing, indeed, is more common than to hear it stated that commodities are produced, and the most extensive operations carried on, by means of credit or confidence; but this is an obvious mistake. Wealth cannot be produced, nor can any sort of industrious undertaking be entered upon or completed, without the aid of labor and capital; and all that credit does, or can do, is, by facilitating the transfer of capital from one individual to another, to bring it into the hands of those who, it is most probable, will employ it to the greatest advantage. A few remarks will render this apparent.

It is plain that, to whatever extent the power of the borrower of a quantity of produce, or a sum of money, to extend this business, may be increased, that of the lender must be equally diminished. The same proportion of capital cannot be employed by two individuals at the same time. If A transfers his capital to B, he necessarily, by so doing, deprives himself of a power or capacity of production which B acquires. It is most probable, indeed, that this capital will be more productively employed by B than by A; for the fact of A having lent it shows that he either had no means of employing it advantageously or was disinclined to take the trouble; while the fact of B having borrowed it shows that he conceives he can advantageously employ it or that he can invest it so as to make it yield an interest to the lender and a profit for himself. It is obvious, however, that except in so far as credit may thus bring capital into the possession of those who, it may be fairly presumed, will employ it most beneficially, it can contribute nothing to the increase of wealth.

The most common method of making a loan is by selling commodities on credit, or on condition that they shall be paid at some future period. The price is increased proportionally to the length of credit given; and if any doubt be entertained with respect to the punctuality or solvency of the buyer, a further sum is added to the Adapted from Principles of Political Economy (1843), pp. 121-25.

I

price in order to cover the risk that the seller or lender runs of not recovering the price, or of not recovering it at the stipulated period. This is the usual method of transacting business where capital is abundant and confidence general.

When produce is sold in the way now described, it is usual for the buyers to give bills to the sellers for the price, payable at the expiration of the credit; and it is in the effects growing out of the negotiation of these bills that much of that magical influence that has sometimes been ascribed to credit is believed to consist. Suppose, to illustrate this, that a paper-maker, A, sells to a printer, B, a quantity of paper, and that he gets his bill for the sum, payable at twelve months after date: B could not have entered into the transaction had he been obliged to pay ready money; but A, notwithstanding he has occasion for the money, is enabled, by the facility of negotiating or discounting bills, to give the requisite credit without disabling himself from prosecuting his business. In a case like this both parties are said to be supported by credit; and as cases of this sort are exceedingly common, it is contended that half the business of the country is really carried on by its means. All, however, that such statements really amount to is that a large proportion of those engaged in industrial undertakings do not employ their own capital, but that of others. In the case in question, the printer employs the capital of the paper-maker, and the latter employs that of the banker or broker who discounted the bill. This person had, most likely, the amount in spare cash lying beside him, which he might not well know what use to make of; but the individual into whose hands it has now come will immediately apply it to useful purposes, or to the purchase of the materials, or the payment of the wages of the workmen employed in his establishment. It is next to certain, therefore, that the transaction will be advantageous. But still it is essential to bear in mind that it will be so, not because credit is of itself a means of production, or because it can give birth to capital not already in existence, but because, through its agency, capital finds its way into those channels in which it has the best chance of being profitably employed..

The following extract from the evidence of Mr. Ricardo before the committee appointed by the House of Lords in 1819, to inquire into the expediency of the resumption of cash payments by the Bank of England, sets the principle we have been endeavoring to establish in a very clear point of view:

"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 CREDIT1 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 futuAdapted from Principles of Money, pp. 82-85. (Charles Scribner's Sons,