It is easy to draw legal distinctions in all these cases, but to show that definite and uniform economic consequences flow from these legal distinctions is quite impossible. Rather, it is easily possible to show that uniform or certain economic consequences do not, in general, flow from them.
I shall refrain from the effort to give a general, fundamental definition of credit. I shall rather discuss certain of the more important types of what have been called credit, with a view to seeing what bearing they have on the problems with which this book is concerned; the value of money, and prices. The general class of transactions to which the name, credit transactions, has been applied may be roughly designated as transactions in which the consideration on one side, at least, is the assumption of a debt, running in terms of money (though not necessarily to be paid in actual money), payable either at a future time or at another place. Objections can be found to this definition. It does not meet the fundamental test of a definition that, for the purpose in hand, it should seize upon the essential and unique characteristic of the things marked off. I am not sure that it meets the tests of inclusiveness and exclusiveness even for those transactions which we call credit transactions. Thus, if A and B go to the bank together, and A there buys B's horse, standing in front of the bank, giving B in return a check, which B immediately cashes in the same room where the check is drawn, the idea of different time or different place is not realized in any but a technical sense. A, in drawing the check is, of course, assuming a debt. The check, if repudiated by the bank, becomes a note, which A must pay. A, moreover, is paying B, not with money, but with the transfer of a claim on the bank, and the fact that his check, if unpaid, becomes a note is not the main fact about the check. Understanding our definition of credit to cover this case also, however, and attaching no fundamental importance to the definition save as a means of marking off a class of more or less related phenomena which we mean to discuss, the definition will serve.
Thus defined, we have in credit a concept susceptible to quantitative treatment. Debts, in terms of money, can be summed up, and we may have the concept of the "volume of credit" as the sum of such debts at a given time, or through a given period of time, or as an average through a period of time. We may distinguish credit transactions from credit, defining credit as the volume of debts, and credit transactions as transactions in which the debts are passed in exchange. This would be to broaden the notion of credit transactions beyond the usual conception, since it would include transactions in which A sells ("without recourse") B's note to C. It would also include cases where bonds are sold. It would exclude cases where stocks are sold, since they are not legally debts. Some would prefer to limit the notion of credit transaction to transactions in which there remains some contingent responsibility on the part of the one who uses the credit instrument, but this would be to deny the name, credit transaction, to cases where bank-notes or government paper are used in payments, as well as to deny it to the case where bonds are sold. It is not important, for my purposes, to draw a sharp line about the concept, credit transaction, however. And about the concept credit itself I have drawn a line resting on a legal, rather than an economic, distinction.
Within the field of credit, thus defined, we may single out for especial consideration certain forms of demand or short time credit, particularly bills of exchange, bank-notes and bank-deposits, and merchants' book-credit. We shall also have something to say regarding long-time credit, including bonds, and mortgage-notes that have no general market.
All these debts in terms of money, to which, in the aggregate, we have given the name, volume of credit, have grown out of exchanges. Exchange is here used in a wide sense, and is not confined to the case where goods or services are bought and sold. It is an exchange, if a man gives his note to a banker in return for a deposit credit. But, on the assumption that exchanges are made only when gains are to be realized, it follows that all debts, and so all credit, have been created in view of anticipated gains (or to avert anticipated losses). In a society where everything is in equilibrium, a "static state," where there are no "transitions" to be effected, where there is no occasion for speculation, and where exchanges of lands, etc., are negligible, the volume of all exchanges, including those where debts are passed in exchange, would be small. The occasion for the creation of the debts which make up the volume of credit would not be nearly so numerous as under dynamic conditions. The volume of credit, in other words, is largely a function of dynamic conditions, even though credit would exist in a static condition of economic life. The bulk of credit, as the bulk of exchanging, grows out of dynamic conditions, transitional changes, and the like.
This will be clearer when we raise the question as to why debts are created, as to what function debts perform in economic life. Why should a man borrow? Let us suppose that a farmer has 600 acres of land. He wishes to sell 100 acres, and use the proceeds in buying equipment for his farm. But he finds it difficult to sell the 100 acres. There is no ready market. He can sell it immediately only at a great sacrifice. By waiting, and looking industriously for a customer, or by engaging a real estate dealer to do so, he could finally find a buyer, but the thing is slow and uncertain, and he wishes to get the equipment at once. He borrows, therefore, giving his farm as security, or a part of the farm as security. He exchanges a claim on the future income of the farm for present money, and with this he can buy the equipment he needs. The net result has been that the credit transaction has transformed his unmarketable quantum of value into a marketable form of value. He has been able, by an indirect step, to do what he could not do directly—to trade a part of the farm (which in its economic essence is a prospect of future income) for the equipment. In this illustration, credit has functioned as a means of increasing the marketability or saleability of non-pecuniary forms of wealth. Credit is primarily a device for effecting exchanges that could not otherwise be effected, or for effecting exchanges more easily than they could otherwise be effected. This means that credit transactions are a part of the productive process, and that they increase values. It is the function of credit to universalize the characteristic of money, high saleability. It is the function of credit to "coin," so to speak, rights to goods on shelves, lands, etc., etc., into liquid rights, bearing the dollar mark, which are much more highly saleable than the rights in their original form were, and which often become as saleable as money itself, functioning perfectly as money.
Credit thus tends to universalize that characteristic which Menger[507] considers the unique characteristic of money. By means of credit transactions, a man borrows up to 50% of the value of the farm, makes his farm in effect, 50% saleable or fluid. The man who owns livestock may not be able, on a given day, to market them without loss, but he can use their value in the market, up, say, to 75%, by a loan. The man who owns a hundred shares of United States Steel may not be able, at a given time, to market them to his satisfaction—though in the case of articles and stocks dealt in the speculative markets saleability is very high indeed, and in the case of United States Steel, in particular, the "spread" between "buying price" and "selling price" is very narrow—but he can borrow, with the stock as security, up to 80% of its value. On a bond of the United States government, he may borrow up to 100%.[508] The process of creating credit is a process of transforming rights from unsaleable to saleable form. Often this means the subdivision of rights, preferential rights to a portion of the value of a piece of wealth being more saleable, because of greater certainty, than the total right to the whole. Another reason why partial rights may be more saleable is that the value represented by each partial right is smaller. It is easier to market things worth a thousand dollars than things worth fifty thousand, as a rule. In any case, a chief economic function of credit is,—the chief function for our purposes—to make fluid and saleable articles of wealth other than money; to universalize the quality of saleability.
This justifies us in our contention made before that all corporate securities, whether stocks or bonds,[509] are, in economic nature, alike. Driven to a legal concept for a definition of credit, we were obliged to exclude stocks from our rough definition. But corporate organization does precisely what the various other transactions that we have called credit transactions do. Lands and buildings and machinery, or the roadbed and rolling stock of a railroad, are highly specialized, often unfit for use in any form other than that in which they now appear. As concrete instruments of production, they would be highly unsaleable. In their totality, as a going concern, they are highly unsaleable, because in the aggregate so very valuable. Grouped together, however, but still subdivided, the objects of many thousands of partial rights, represented by stocks and bonds, they become saleable in high degree.
As objects other than money gain in saleability, they tend to gain in value, also. This is not necessarily true, always. If wealth is already in the best place, at the proper time, and in the proper hands, no point is involved in further exchanges. Additional saleability—or an increase in the qualities that make for saleability—could make no difference. But when objects could be employed to greater advantage if in different hands, if, in other words, there is occasion for exchange, then whatever adds to the saleability of a good adds to its value. What would otherwise have gone into the trouble and expense of marketing now is saved. In general, items of wealth tend to gain in value as they gain in saleability—though not in any definite proportion.
Further, as objects of value other than money gain in saleability, money tends to lose its differential advantage in this respect, and so tends to lose that part of its value which comes from the money-uses. If all things, including gold, were equally saleable, there would be no raison d'être for money, and gold would have only the value that comes from its commodity functions. In so far as credit-arrangements give to partial rights to wealth the capacity to serve as a medium of exchange or for other money purposes—and this is true to a high degree of bank-credit—this tends to cut under the sources of value of money. Credit thus, from two angles, tends to raise prices; it raises the values of goods; and it tends to lower the value of money. The limits on this, however, are reached when gold ceases entirely to function as money, and when all items of value are perfectly saleable. Then credit has done its perfect work for prices, and can do no more. No incentive remains for further borrowing, if all items of value that need to be exchanged are perfectly saleable.