Principles of Political Economy

by Arthur Latham Perry

(3) Attention should be called to a third distinction of the same general nature, as between relations very different in themselves and yet extremely liable to be confounded with each other. Let us take a common instance: a customer of a bank takes a package of valuables of any kind to his banker, such as bonds and bills payable and jewels and plate, and asks him to take care of it for the present in his vault, subject of course to a return to him or any one else to his order at any time: no property in these valuables passes over to the banker, it is not a deposit in the ordinary banking sense, the relation of debtor and creditor does not arise as between banker and depositor, the banker becomes Trustee or Bailee of the package, and is bound to exercise common vigilance in the care of it, but if it be burned or stolen extraordinarily the loss is the customer's and not the banker's. But now, on the other hand, when a customer deposits in the banking sense money or bills payable with his banker, the property in the money and bills passes over to the banker instantly, the relation of debtor and creditor arises, the depositor receives a credit on the banker's books in return for the money and bills rendered, the exchange as a mere case of value is consummated to the profit of both parties, but the return-service to the depositor is the right to demand equivalents of the banker at some future time. In other words, it is a case in Credit.

(4) As this general distinction is vital, we shall lose nothing in the end if we make even a fourth exemplification of it. The United States Treasury receives silver dollars of its own minting from any person who chooses to place them there, and gives out in token what are called "Silver certificates" to the same amount, entitling the bearer to take out the dollars again at will, and thus the certificates being more convenient than the dollars and just as valuable become a part of the money of the country. The Treasury is bound to exercise due care in the keeping of these silver coins, and to return them to the holders of certificates on demand, just as the elevator and railroad companies are under legal obligations to show diligence in keeping and transporting the wheat of our former example; but the United States is not debtor to the holders of these certificates any more than the elevator company is debtor to the wheat shipper, and consequently there is no element of Credit in these certificates. Just so of the later gold certificate. On the other hand, the so-called greenbacks issued by the United States are also a part of the money of the country, but they are credit-money, inasmuch as they are a promise to pay to the bearer some time in the future so many dollars. The Treasury has never kept up any special fund of gold and silver, with which to redeem the greenbacks. They rest back for their value on the good faith of the country. The United States is debtor to the bearers, and these in turn are creditors, and the legal-tender quality of the greenbacks does not alter their character as a form of pure credit. Both the elements of good faith and future time inhere in the greenbacks, as they do also in the bonds of the United States, while in the certificates neither of these elements appears.

However, circumstances easily conceivable and which were actually realized in the case of the famous Bank of Amsterdam, founded in 1609, might make the United States a debtor and the holders of the silver certificates creditors in the commercial sense of those terms. The Directors of the Bank of Amsterdam, towards the close of the second century of its beneficent existence, loaned out to the Dutch East India Company and to the City of Amsterdam large parts of the bullion, on which its certificates ("bank money") were based, unknown to the public, which felt unlimited confidence in the bank, and the result was in 1795, when the French invaded Holland and the facts became known, that bank money which had previously borne a premium of 5% fell at once to a discount of 16%, although the bullion that remained and the debts due the Bank were fully equal to redeem the certificates and were used for that purpose. So, if the United States should use, clandestinely or otherwise, the silver dollars for other purposes than to redeem the certificates on demand, the latter would undoubtedly both in law and fact be transformed from mere token-money (as now) into credit-money valid as against the United States as debtor, like the greenbacks at present.

Have we now compassed our first object? Do we fully understand, from the foregoing descriptions and distinctions, the Nature of Credit? If so, we are prepared to look narrowly into its Forms.

2. Credit-rights are commonly, but not always, recorded upon paper; but it is important to observe, that the paper-document is the mere evidence of the right, and not the right itself, which lies back of the paper as substance to shadow, and persists intact even were the paper lost or destroyed. These paper instruments of Credit are commonly contemplated as of two kinds, Promises to pay and Orders to pay, but there is not at bottom any radical difference between these, the Right as between two persons is not affected by this superficial difference, as we shall see, and the present enumeration of credit-forms will proceed independently of it.

a. Book Accounts. A charge in a trader's books is both a current and a legal evidence that the person charged has received a certain service, and has virtually promised to render the sum charged as a return-service. Book accounts are the most common of the forms of credit; and if the person charged fails of his own accord to complete the exchange thus commenced, the law, in the absence of any proof to make the charge suspicious, collects it, if possible, and forcibly completes the exchange. The convenience of this form of credit is so great, that it is not likely ever to be disused; and as between people who deal much with each other is very useful, inasmuch as their respective book accounts are set against each other in settlement, and only balances are required to be cancelled in money. It is for the benefit of both creditors and debtors, however, even when the same parties are both creditor and debtor, that such credits should be short in time and such settlements frequent, since in book accounts there is no interest on charges however long they run, and since in this way only can the creditor realize the full gain of the exchange, and the debtor keep fair his mercantile name. If it be difficult or impossible to follow strictly the excellent financial maxim, "Pay as you go," the next best thing to that is, "Go and pay." The gains of an exchange are lessened, or its terms become more onerous, just in proportion as delay in its completion is experienced or expected. Book accounts are subject also to this disadvantage as compared with other forms of credit, that their number and amount as against any person are less likely to become publicly known, and therefore he is more likely to be trusted in this form by others beyond the point of his solvency and their safety.

b. Promissory Notes. These differ from Book accounts in that they are always either expressly or virtually on interest, and are consequently negotiable. They are issued by individuals, corporations, and Nations. If the principal be deemed secure, that is, if there be a thorough trust on the part of the holder in the maker of the note, the time of the payment of the principal becomes a matter of comparative indifference, because the interest is compensation for delay, and is often the motive on the part of the holder for rendering that service of which the note is evidence. Indeed a long obligation, other things being equal, is commonly preferred to a short one, and bears a higher price. When a note is sold (negotiated) by the original holder it becomes payable to the purchaser, or to each subsequent purchaser in turn, and thus may run a devious round, may play a part in many commercial transactions, may be set off by the transient holder against a debt owed by him and thus cancel that, and when itself is cancelled by ultimate set-off or by any other mode of payment the last holder takes the return for the service originally rendered by the first holder. The promissory notes of individuals are frequently discounted by Banks in a manner to be presently explained. These are always for short times, and are debts bought by banks on the personal security of the names upon the notes. The notes are founded on the relation of debtor and creditor, which is always a personal relation, and so differ in their nature from a mortgage, which is a qualified title to a specific piece of property, usually real estate. A note secured by a mortgage is, as it were, absorbed into the mortgage, and becomes another thing from a common promissory note, or commercial paper, as it is called. A mortgage rests therefore on other grounds than a commercial trust in the good faith of a person.

Corporations also issue promissory notes, and as such issuers become in a sense moral persons entitled to confidence according to the character and purposes of the individual corporators and the financial means and methods of the corporation itself. It is an old saying, that "corporations have no souls"; economists as such have no need to pronounce on that proposition; the fact is enough for them, that the short notes of corporations are often discounted by bankers on the same ground as the notes of individuals are discounted; and that their long-time obligations, commonly called Bonds, are all the time bought and sold in the market like commodities. Many of the Railroad bonds, of which immense quantities are in the markets of the world, rest back also for their security upon Mortgages of the real estate of the corporations made over to Trustees to hold for the assurance of the holders of the bonds. The personal obligation of the corporators is thus reinforced, much as a common mortgage reinforces the note or bond, to secure which the mortgage is executed. Whenever all the real estate of a railroad company becomes subject to a mortgage, when there are previous partial mortgages or liens, these latter take precedence in due order of any subsequent pledges or bonds secured by what is properly called the consolidated mortgage. Such a mortgage has recently been executed by the Northern Pacific Railroad Company for $160,000,000. Railroad Bonds so fortified in proper and legal terms possess the highest possible credit-security to their holders. When no such consolidated or "blanket" mortgage has been put on the property, first and second and third mortgages sometimes support bonds of primary and secondary and tertiary validity; and sometimes so-called Income-bonds are issued, with or without mortgages behind them, for the payment of the interest on which bonds the net earnings of the corporations are specifically pledged. Frequently also simple long-time bonds resting on corporation security only are negotiated without difficulty.

It must be constantly borne in mind, that certificates of Stock in railroad and all other similar corporations are not credit-documents at all, but are mere evidences of so much proportional ownership in the corporate property. They are not interest-bearing documents at all, although they may draw interest or rather dividends, if the property be prosperous. They are somewhat like deeds to land, in which no element of credit inheres.

Nations too are moral persons in the same loose though binding sense as corporations, and as such often issue promissory notes on interest, commonly called in this country Bonds, in Great Britain Funds, and in some countries Stocks. These are always pure credit. Nations give no mortgages. Yet they often borrow at a less rate of interest than the most solvent individuals or corporations can, as is seen by the fact, that British consols carry but 3%, and yet bear a premium in the present market. The term, "consols," is a popular contraction of "consolidated annuities," the Act to create which at 3%, out of a then confused mass of public debts at various rates of interest passed Parliament in 1757. The maximum of the British debt was $4,500,000,000 in 1815, and has now decreased to $3,467,787,960.