Mr. Merchant: Mr. Banker, a moment ago you said that the loan to Mr. Farmer, apart from his personal standing, was not the safest kind of a loan to make. Just what did you mean by that?
Mr. Banker: I am glad that you asked that question, for it should be explained right here. Suppose that you, Mr. Merchant, should purchase $4,000 worth of pork and beef in the barrel, at some distant point, and should come to me for the money to pay for it. In all probability I should ask you for the bill of lading covering the shipment, and also insist upon your getting an insurance policy on the goods before giving you the money. In this case, I am loaning money upon the necessities of life, consumable commodities, and unless the insurance company fails, and the goods are destroyed, I cannot possibly lose a cent. I have, humanly speaking, eliminated all chances of loss. You will observe that if I should hold the bill of lading and the insurance policy, I have the title or ownership of the pork and beef, in any event. In such cases, comparatively speaking, the rate of interest ought to be the lowest possible, as far as the risk goes.
Mr. Manufacturer: But this kind of a transaction constitutes a comparatively small part of the commerce of the country.
Mr. Banker: Yes, that is true, and if credit was limited to such transactions, credit crises would be very few, indeed, probably never would arise as a result of over trading under such circumstances; trade would be greatly hampered, and business curtailed to a destructive degree.
Mr. Manufacturer: That is certainly true. You men all know that I am a manufacturer of high class clothing. I want to give you an illustration of how business is being carried on today in the way of multiplying credit.
A manufacturer of woolen goods at Lancashire, England, sold to a wholesale merchant on the other side, $10,000 worth of goods on three months' time. The wholesale merchant sold the goods for $12,000 to an English exporter on three months' time. The English exporter sold the goods to an American importer for $20,000, duty paid; the importer sold them to an American jobber for $22,000; the jobber sold them to me for $24,000. All these sales occurred within thirty days, and not a single man paid a cent of money on account of his purchases. By way of payment, this is what happened. I gave my note due in ninety days to the jobber, and he discounted it at his bank. The jobber gave his note due in ninety days to the importer, and the importer discounted it at his bank; the English exporter sent over a draft upon the American importer at ninety days sight, and he accepted it and it was returned to England, where the exporter discounted it at his bank. In the meantime, the wholesaler drew a draft on the exporter at ninety days sight, and he accepted the draft, whereupon the wholesaler discounted the draft at his bank. At the same time the manufacturer drew on the wholesaler at ninety days sight, and the draft was accepted by the wholesaler, and was discounted by the manufacturer at his bank. Thus we see that goods which sold originally for only $10,000 went through five different hands and became the basis upon which credits were granted for $88,000, and debts were created for $88,000. Every single debt was sold just as though it was so much woolen goods. Every man had his money and not one of them had paid his debt, and yet every transaction was legitimate and in the ordinary course of business.
Within sixty days I shall have turned these goods into clothes and sold and delivered them, giving my customers in turn credit upon my books, or will have accepted their promissory notes, which I may discount at my bank if I should need the money in my own business. Now mark and note this. If I should deliver to the American jobber my check today, and he should send his check to the American importer and the American importer should send a draft to the English exporter, and the English exporter should deliver his check to the wholesaler, and the wholesaler should send his check to the manufacturer, debts amounting to $88,000 would have been paid and credit amounting to $88,000 would have been canceled; and yet not a single cent of cash in the form of coin or currency has been used.
Every one of the checks, notes or drafts taken in the transaction is property, just as much as the note taken for a single sale of the goods would have been property. Indeed, every one of the five notes or drafts was just as much property as the goods themselves were, and could be bought and sold just as well as the goods themselves could be bought and sold. Now it must be evident to all of you that in the production, transportation and distribution of commodities, credit performs exactly the same function as money. So far, therefore, credit is in all respects equivalent to money. So long, therefore, as the operations through credit are successful, everything goes well.
Mr. Banker: Precisely so, Mr. Manufacturer, so long as the operations are successful, everything goes well; but it is the sudden breaking of the chain of credit that brings or precipitates a disturbance.
MacLeod uses this language in referring to the destruction of confidence: "It is the sudden failure of confidence and extension of credit which produces what is called in commercial language, 'a pressure on the money market' and which causes money to be 'tight.' When money is said to be scarce, it does not mean that there is a smaller quantity of money actually in existence than before; there may be more, or there may be less in the country; no one can tell what the amount of money in existence is, but a great amount of credit which serves as a substitute, and was an equivalent of money, is either destroyed altogether, or is suddenly struck with paralysis, as it were, and deprived of its negotiable power, and therefore, practically useless. A vast amount of property is expelled from circulation, and money is suddenly called upon to fill the void."