Currency and credit

Front matter

CORNELL

UNIVERSITY

LIBRARY

Preface

To add yet another to the legion of books which have been written on Currency is an act which almost requires an apology. But extensive and complex as the subject has always been, every year that passes brings new developments which add to its extent and its complexity. A subject which grows in this luxuriant fashion opens up a corresponding variety in the methods of theoretical approach. The present work is not intended to set up one particular method to the exclusion of all others. Still less does it exalt any single practical measure as a panacea of currency disorders. Its purpose is rather to present a systematic analysis of currency and credit movements, and especially to avoid that phrase, "other things being equal," by which it is so fatally easy for theory to step straight from premises to conclusion.

Scientific treatment of the subject of currency is impossible without some form of the quantity theory. Two forms of this theory, both rigorously true, will be found enunciated in Chapter III. But the quantity theory by itself is inadequate, and it leads up to the method of treatment based on what I have called the consumers' income and the consumers' outlay — that is to say, simply the aggregates of individual incomes and individual expenditures. This method has been employed throughout the succeeding pages.

vi PREFACE

It will be found that pre-war institutions and conditions are often referred to in the present tense. This is no more unreal than to speak of them in the past, as things of the past. Even now the war is not technically over, and in the prevailing obscurity it is impossible to say what can or cannot be regarded as normal or actual.

Chapters XV. to XIX. are occupied with illustrative examples drawn from a variety of periods and countries. I am indebted to the editors of the " Economic Journal " for bringing out the greater part of Chapters XV. and XVI. in the issues of the Journal for September and March, 1 91 8.

R. G. HAWTREY.

Contents

CHAPTER

I. Credit Without Money

II. Metallic Money .

Chapter I. Credit Without Money

Money is one of those concepts which, like a teaspoon or an umbrella, but unlike an earthquake or a buttercup, are definable primarily by the use or purpose which they serve. The use or purpose of money is two-fold : it provides a medium of exchange and a measure of value.

According to the classical doctrine of money, mankind, in order to avoid the intolerable inconvenience of the direct barter of one kind of commodity or service for another, has learnt to choose one standard commodity to be offered by every buyer and accepted by every seller. Whether this standard commodity is established by law or custom, the seller willingly accepts it in payment because he knows that it will be accepted in turn by those from whom he wants to buy. The practice which makes the selected commodity the common medium of exchange almost inevitably makes it also the common measure of value. A market which priced each commodity separately in terms of every other would be impossibly complicated ; the use of one standard commodity as money enables us to express all -p«ees- in terms of this one commodity.

If we approach the subject in this way, we naturally assume that the use of some selected commodity as money is the only alternative to a state of barter. To show what part the use of money plays in society, and how great a difference it makes, we are invited to turn to remote and benighted communities which have never learnt the use of it, or to conjecture what must have been the economic condition of mankind before money was originated at all. Such comparisons may well exaggerate the importance of money. In order to see it

I in its true proportion we ought rather to take a completely organised and civilised society, with all the modern developments of commerce and industry, and to examine to what extent such a society might have existed just as it is without the use of money, or which of its characteristics would be necessarily sacrificed. In other words we have to find not the historical but the logical origin of money.

Suppose then that society is civilised, and that money does not exist. Goods are brought to market and exchanged. But even though there is no medium of exchange, it does not follow that they must be bartered directly for one another. If a man sells a ton of coals to another, this will create a debt from the buyer to the seller. But the buyer will have been himself a seller to some one else, and the seller will have been himself also a buyer. The dealers in the market can meet together and set off their debts and credits. But for this purpose the debts and credits, which represent the purchase and sale of a variety of goods, must be reduced to some common measure. In fact a unit for the measurement of debts is indispensable. Where a commodity is used as money, it naturally supplies the unit for the measurement of debts. Where there is no money, the unit must be something wholly conventional and arbitrary. This is what is technically called a "money of account". Even when money is used, it may occasionally happen that the unit for the calculation of debts ' diverges in some degree from exact correspondence with the money in circulation. In that case the distinction between money and money of account immediately becomes a practical one. The value of the standard coin will be quoted in terms of the money of account, and varying amounts of the standard coin will be needed to pay a given debt. This is an approximation to the state of affairs which we are assuming.

But however conventional and arbitrary the unit may be, once it is established as the basis of the debts and prices and values of a market, it is bound to assume a certain continuity. If the bargains of a day were completed within the day, and everyone could exactly balance his debts against his credits the next day's business might start with an entirely new unit'

as arbitrary as the other and having no relation to it. But in fact this balancing of debts and credits is impossible ; each day's transactions will leave a residue of indebtedness to be carried forward to the next. The same unit will therefore necessarily be used from day to day. Each day's business starts with the record of the previous day's closing prices calculated in the unit. Each dealer in the market calculates his own command of wealth in the same unit ; it affords the basis for his valuation both of what he wants to buy and of what he wants to sell, and he looks for only such divergence from the previous prices as varial^ions of supply and demand will justify. The total effective demand for commodities in the market is limited to the number of units of the money of account that dealers are prepared to offer, and the number that they are prepared to offer over any period of time is limited according to the number that they hope to receive. Therefore, arbitrary as the unit is, capricious variations in its purchasing power will not occur.

Inconvenience would undoubtedly be caused by the absence of any. generally recognised medium for the discharge of an outstanding balance of indebtedness. As between dealers balances can for the most part be carried forward from day to day, but immediate payment will sometimes be required, and in case of dispute there is no recognised " legal tender " in which a court of law can order the debtor to pay. How this problem might best be solved by the dealers we need not stop to inquire. This question of the payment of debts is a wider one than that of the settlement of balances among dealers in a market.

In the processes of production a service rendered creates a debt from the person to whom the product belongs to the person who renders the service. Most people derive their incomes from services rendered either by their personal exertions or by the use of their property in production. The practice which we have attributed to the dealers of setting off one debt against another may be described as the use of credit as the means of payment. As H. D. MacLeod insisted, Debt and Credit are different names for the same thing. That which to the debtor is a debt, is to the creditor a credit.^ Can credit be used as the means of payment not only between dealers, who are all men of business, but between employers and employees ?

An umbrella-maker might pay wages by creating a debt from himself to his workmen, but, in order that his workmen may spend their wages, the liability must be transferred to other shoulders than those of the umbrella-maker, for he can sell them nothing but umbrellas.

The solution of this difficulty is to be found in the intervention of some one who deals in debts. The umbrella-maker can sell to this " dealer in debts " the debts due to him for the umbrellas which he has sold, and in return the "dealer in debts" can take on himself the liability for the umbrellamaker's debts to his workmen. If every creditor assigned his rights as against his debtors to the dealers in debts, the setting off of debts against one another would be enormously facilitated.

/"A dealer in debts or credits is a B anker. ^Th.^ debts of the wKrle community can be settled by transf«s in the banker's books or by the delivery of documents, such as bank notes, representative of the banker's obligations. So long as the bankers remain solvent, their obligations supply a perfectly adequate means for the discharge of debts, because a debt can be just as well cancelled against another debt as extinguished by a payment of money. Of course it is still true that if the banker himself is sued in a Court of Law, there is no legal tender in which he can be ordered to pay. But if he is solvent, he can obtain a credit from another banker. In fact, the natural test of the solvency of a private trader would be his power of obtaining sufficient bank credits to meet his liabilities, and the test of the solvency of a banker would be the ready convertibility of his obligations into the obligations of other bankers.

But, it may be asked, is not this to give away our whole hypothesis ? We postulated a state of society without money.

iThe antithesis is between a debt and a credit. Credit, the noun of quantity, means the stuff of which debts (or credits) aie made.

Yet if a man can go to his banker and cash a cheque in bank notes, is not this to admit the existence of something which is money in all but name? It is true that we are accustomed to think of bank credits as money. But this is only because for the practical purposes of every day the distinction between bank credits and money is rarely of any importance. And for all that a bank credit is merely a debt, differing from other debts only in the facilities allowed by the banker for transferring it to another creditor. No one imagines that a trade debt is money, though it may be as good an asset as a bank credit.

Having found in the bank credit the means of making payments, how far have we provided for a standard of value ?

The money of account provides a unit for the measurement of debts. It must also provide a unit for the measurement of prices. For when a price of any commodity is quoted in a market, this constitutes an offer, the acceptance of which creates a debt from the purchaser of the commodity to the vendor. The function of the price is to determine the magnitude of this debt.

But the unit for the measurement of prices is inevitably the unit for the measurement of values. The relative values of all commodities (in the economic sense of values) are measured by their relative prices. And the price of each commodity measures its value relative to the unit. What then is the value of the unit ? So long as value means value in exchange, the value of anything, whether it be a commodity or the monetary unit of account, must always be ^proportion — a value in terms of something else. Just as every commodity has a value in terms of the unit, so the unit has a value in terms of each commodity. It may be the equivalent, say, of a pair of trousers, or of a ton of coals.

Now in some sense or other the chief requirement of the unit of value is stability. But what do we mean by stability ? It is all very well to say that the value of the unit must not vary, !»ut there is no single interpretation of the value of the unit. Its value in coals may be stable, while its value in trousers may rise or fall. This problem is not peculiar to the conception of a money of account. It arises equally where the monetary unit is defined as the equivalent of a prescribed quantity of a selected commodity, such as gold. We still want to know whether the value of gold in terms of other commodities varies.

The significance and the measurement of a rise or fall in the unit of value will engage our attention later. Here it is enough to say that if we can point to a tendency for all prices of commodities, reckoned in the unit, to rise together, that means that the value of the unit is falling ; and a tendency for all prices to fall means that the value of the unit is rising.

Will the continuity in the use of the unit from day to day be of itself sufficient to prevent its value in commodities varying in either direction unduly, even though it be unrestrained by equivalence to any specified commodity? If every one who received a credit immediately spent it on commodities, the function of the banker would be reduced to that of settling up every one's books at the end of the day. He would be a humble accountant, remunerated by a moderate commission or in some other suitable manner. Without doubt, however, just as every one in the economic societies we know keeps some ready money in hand, so in that which we are postulating every one would keep some unexhausted credit in hand to meet the payments, foreseen or unforeseen, which will have to be made in the near future. These reserves of unexhausted credit in the hands of the public are of course the counterparts of undischarged debts due from the bankers. As the reserves always exist, the bankers are perpetually indebted to that extent to the public. And as the public retain these reserves of credit of their own accord and for their own convenience, the bankers do not have to pay interest upon them, or, at any rate, do not pay interest at the full rate.

Now the bankers are merely dealers in credit. They do not take over liabilities except in consideration of receiving equal assets. The umbrella-maker who wishes to pay his employees in credits on a banker, must purchase these credits out of the proceeds of his umbrellas. But a banker is not willing to deal in umbrellas and will not buy them himself. It is of the essence of the banker's position that he sells credits to all sorts of producers and dealers, so that his credits may be accepted in payment by all sorts, ^e will find it more convenient (as actual bankers do) to Wid his credits rather than to buy goodsy His assets will consist mainly of advances made to producers and dealers, who will employ the credits advanced in their respective businesses and will pay interest upon them out of the profits so made.

The great credit-machine will work very much as it does in the actual world. An order is given by a merchant to a manufacturer to supply a certain quantity of goods. The manufacturer borrows from his banker a sufficient credit to meet the necessary expenses of manufacture, including the cost of raw material, for the period which will intervene before the goods can be delivered and payment received from the merchant. When the goods are delivered the merchant in turn borrows their value for the period for which they are likely to be on his hands. The goods may pass from one manufacturer to another and from one dealer to another several times before they are finally disposed of piecemeal by the retail dealers to the consumers. Each manufacturer or dealer will probably be indebted for a part at any rate of their value so long as he holds them. A debt, as it were, is attached to the goods so long as they are being dealt in — that is to say, bought with a view to being sold. This debt is only finally paid off when the goods are sold, not to be dealt in, but to be consumed. But each manufacturer or dealer is quit of the debt when he is quit of the goods. He borrows to meet the expense of making or buying the goods, uses the proceeds of his borrowing to pay the people employed in manufacturing them, or to defray the purchase price ; then, when he disposes of them, applies' the proceeds to pay off the sum borrowed, and retains any balance as his own profit. Thus new credits, as distinguished from those created merely in replacement of old ones, are created to pay the profits, remuneration, interest, etc., of those who contribute, either by their personal services or by the use of their property, to production.

The borrowing is done by traders — by those, that is, who either produce or buy goods, etc., with a view to subsequent sale. The stocks of goods in course of production, in transit or awaiting sale, are the property of the traders, and at any moment there is a stream of goods passing from trader to trader through all the successive stages. Simultaneously the corresponding credit operations are taking place. Any individual trader may be both making and receiving payments. His actual borrowing and repaying operations may have no definite relation to any individual buying and selling transactions, but will only represent the net result after his receipts and payments are set off against one another — that is to say, when his outlay on the production or purchase of goods exceeds his sales, he borrows ; when it is less, he repays. His indebtedness rises and falls with his stock in trade.

Consider what happens in a particular week. Production is increasing the traders' stocks ; sales to the consumer are diminishing them. Those of the traders who are engaged in production are paying out such part of the expenses of production as come in course of payment in the week. The retailers are receiving the sums that the consumers spend in the week. These consumers are to a great extent the same people who receive payment from the producing section (though of coursfe there are some classes of the community, such as landlords and domestic servants, whose incomes do not come from businesses that require to be " financed ").

Between the retailing and producing sections of traders stands the wholesale section, the merchants.

The wholesale merchants fill a very important place in the trading system. They judge demand and regulate supply. The outlook of the retailer is local and limited (except where wholesale and retail dealing are combined, and the differentiation of function is lost), and he cannot make a comprehensive survey of the prospects of demand. It devolves therefore on the wholesale merchant to set the machinery of production at work by giving orders to the producers, and incidentally to start the machinery of credit. This is especially true of manufactures and the production of raw materials. In agricultural production supply is a matter of opportunity and demand is

CREDIT WITHOUT MONEY g

comparatively steady, and there, consequently, the functions of the merchant count for much less. The production of fixed capital is different again. The order is given not by a merchant but by a promoter, who makes it his business to procure savings to cover the cost. Money invested is of course speni ; it is spent on fixed capital. The demand for fixed capital is made up of people's savings in just the same way as the demand for consumable commodities is made up of their expenditure on their present needs. In this process the need for temporary borrowing comes in at two points. The contractor, who engages to construct the new fixed capital, may borrow to meet the expenses in anticipation of the payments he is to receive from the promoter. And the promoter himself may have to borrow in anticipation of the savings he hopes to collect from the investor.

. When a banker lends, we say that he grants or creates credit or " a credit ". This is a loose way of describing a double transaction. The banker assumes an immediate ob- \ ligation to his customer, in exchange for the customer's ob- ; ligation to him at a future date. The banker's obligation or " bank credit " meets the customer's need, because it can be assigned away as a means of payment. The customer's obligation, since it yields interest or discount for the period before it becomes due, supplies the banker's profit. Thus two credits or debts are really created, though only one of them is destined to be used as a means of payment.

In our selected week there will be determinate market rates of wages, salaries, etc., and determinate market prices of commodities. The merchant, in deciding at what price he will order goods, must be guided by the then prevailing market prices ; the manufacturer, in deciding what price he will accept, must be^uided by the then existing costs of production. To a great extent the incomes which the consumers have to spend, and which constitute the demand for commodities, are the component parts of those same costs of production, it being understood that the traders themselves are included among the consumers and their profits among the costs of production.

The consumers' purchasing power is therefore largely supplied out of the credits which the traders borrow from the banks. Credit originates in production and is extinguished in consumption. The supply of purchasing power is thus regulated by the transactions which require to be financed. It starts from the giving of an order to the producer, and the quantity of purchasing power brought into being when the producer borrows to carry out the order depends upon the price at which it is placed. The capacity of the productive resources of the community is limited, and, at any rate when this limit is approached, continuity in prices implies continuity in the supply of purchasing power.

Every borrower in fact has to take account of conditions that limit the amount which he borrows, and this very limitation of borrowing tends to confine the income and consequently the expenditure of the consumer to their previous limits.

Nevertheless it is obvious that this principle of continuity is incomplete. There is room for variation in the volume of orders, the rapidity of their execution, the quantity of credit with which they are financed. If we are to prove that the monetary unit will be a stable standard of value, we must show that if exposed to any disturbing cause the unit will tend to return to its former value, or at any rate that it will arrive at a new and relatively stable value not differing much from the old.

Suppose then that the routine of the credit machinery is interrupted. This routine depends upon the new borrowing being on the whole sufficient and not more than sufficient to replace the advances paid off. The credit created must be equal to the credit extinguished. Granted this, the stability of every other part of the machine follows.

First consider the case where there is a curtailment of new borrowings. It may be, for instance, that the merchants have given fewer new orders to the manufacturers, or perhaps that borrowers have been applying to the reduction of their indebtedness credits which they would otherwise have spent. In the latter case, expenditure being diminished, sales will fall off and the stock of commodities in the hands of the dealers will be less drawn upon than usual, and the dealers will give smaller orders to the manufacturers for the replenishment of those stocks. Thus in either case a slackening in the creation ot new credits means a diminution of orders to the manufacturers. But the result of this will be that the labour and plant of the community are no longer fully employed, and the total amount of wages and profits will be diminished. Consequently the expenditure of the public will begin to fall off. But this will react on the sales of the retailers and merchants. They in turn will further restrict their orders for fresh supplies of goods, and so the original restriction of credit will tend to repeat and reinforce itself A corrective tendency will, however, early be at work. The restriction of credit means a restriction of the bankers' business. HThe bankers will not willingly acquiesce in the consequent shrinkage of their profits, and they will try to tempt their customers 40 borrow. They will in fact reduce their charge for interest. /

It should be observdd that, quite apart from any deliberate action by the bankers, there is in any case an important influence at work to lower the rate, of interest. As we have seen, the curtailment of credit occasions a flagging of the demand for commodities. This flagging of demand will produce a fall of prices. The merchants will find that their stocks of goods lose value while they hold them, and this loss of value will diminish the profit out of which they pay interest on the loans with which these stocks are financed. Falling prices of themselves therefore make borrowing less attractive and reduce the rate of interest which borrowers are willing to pay. The bankers must reduce their charges of interest accordingly before they can even induce their customers to continue borrowing on the diminished scale which their turnover of goods will justify, and, if these customers are to be tempted to increase their bormwing, the rate of interest must be reduced even below this low level.

If, as is not impossible, the bankers fail to encourage borrowing in this way, the restriction of credit and consequent depression of trade will go on until disappointed merchants are driven to borrow on terms which they do not hope will be remunerative, merely to keep their businesses alive. This will prevent credit-operations from dwindling down to nothing, and the circulation of the credits so created will presently revive the old routine. But in the meantime the volume of credits in circulation and the nominal amount of wages and prices paid out of them (calculated in the conventional unit of value) may have been enormously reduced. In other words the value of that unit, expressed in services or commodities, may have been enormously increased. Nor is there any tendency for it automatically to return to its former value, i Indeed a new disturbance may be initiated in the form of a new curtailment of credits, and after a new period of restricted trade may end in yet a further appreciation of the unit of value.

The probability of a contrary variation, an expansion of credits and a depreciation of the unit of value, is, however, at all times much greater. And this movement is even more unlimited in scope. Self-interest prompts both the enterprising trader ever to borrow more, and the enterprising banker ever to lend more, for to each the increase in his credit operations means an increase in his business. Suppose some of the merchants, in the hope of extending their business, give increased orders to the manufacturers. The manufacturers will forthwith borrow more than usual from their bankers. They will urge on the business of manufacture, will pay more to their employees, and will receive greater profits in proportion to their greater output. They and their employees will have more to spend ; the retailers will dispose of more goods, and will take over more from the merchants ; the merchants will give yet further orders to the manufacturers. The manufacturers, finding their productive capacity overstrained, will quote higher prices to the merchants ; the merchants, being unable to supply the retailers fast enough or to maintain their stocks of goods, will raise prices to the retailers, and the retailers will raise prices to the public. The general rise of prices will involve a proportional increase of borrowing to finance a given output of goods, over and above the increase necessitated by the increase of output. This increase of borrowing, meaning an increase in the volume of credit, will further stimulate trade. Where will this process end? In the case of the curtailment of credits the self-interest of the bankers and the distress of the merchants combined to restore the creation of credits, though not to its pre-existing level. But in the case of the expansion of credits there is no such corrective influence at work. An indefinite expansion of credit seems to be in the immediate interest of merchants and bankers alike.