CHAPTER II. Credit and its Influence on Prices. Definition of Credit. Credit is a power to borrow. If the credit of an individual is good, it is because there is general confidence in his ability to pay, and therefore he can borrow at a low rate of interest. If the credit of an individual is bad, he is not able to borrow except at a high rate of interest, because his ability to pay is doubted. The credit of different people in the same age and country can be accurately measured by the rate of interest which they pay for borrowing. When it is said in the City article of the Times that the rate of interest is "23 for the best three months' bill," it means that 24 per cent. per annum is paid for a loan by those in whose ability to pay there is perfect confidence; a higher rate of interest is paid at the same time by those whose ability to pay is less undoubted. This remark does not apply unreservedly to the credit of nations. "Ability to pay" of course produces its effect upon the credit of nations as well as upon that of individuals. The credit of Turkey and Spain is exceedingly bad. Turkish bonds for many years paid nearly 12 per cent.; in the autumn of 1875 the government of Turkey announced its bankruptcy by telling its creditors that only half the interest due to them would be paid in gold, and even this half was not forthcoming; some descriptions of Turkish stock are now quoted at a price, which, if they paid at all, would pay nearly £50 per cent. Thus in the Times of July 14, 1880, the price of a Turkish bond for one hundred pounds, nominally paying 5 per cent. interest, was quoted at £10. 2s. 6d. Such a price as this indicates that speculators have no expectation that Turkey will resume paying interest on her debt. Spanish bonds pay about 17 per cent., whilst English funds pay only 3 per cent. But there is frequently a great difference between the rate of interest prevailing in two countries which does not indicate a corresponding difference in their ability to pay. It has previously been explained that the rate of interest is not only affected by the security of property and the amount of risk incurred by the lender, but also by the position of the margin of cultivation. Hence it is not fair to infer that the credit of England is better than that of America because an English government stock pays 3 per cent. whilst American government stock is issued at 5 per cent. A great part of this difference is accounted for by the different position of the margin of cultivation in the two countries. In England money can be borrowed on a mortgage, that is where land is given as a security, at 4 per cent., whilst in America money cannot be raised on a mortgage for less than 7 per cent. The credit of a nation cannot therefore be accurately measured by the rate of interest which it pays for loans. Although confidence in a country's "Ability to pay" always produces its effect on the rate of interest, yet different rates of interest prevail in different countries whose financial prospects are equally sound, owing to the different position, in the scale of productiveness, of the margin of cultivation. The expression "Credit is Capital" is meaningless. It is sometimes asserted that "credit is Capital." A little consideration of the meaning of words shews that this expression is nonsensical. Credit has already been defined as "the power to borrow," and it has frequently been explained that capital is that part of wealth which is set aside to assist future production; it supports the labourers and furnishes the tools, materials, and shelter that their work requires. Now it is evident that a power to borrow can do none of these things. Credit will not feed and clothe labourers, nor can it furnish the implements of their industry. The power to borrow, if exerted, will procure capital, just as muscular strength will, if exerted, enable a man to carry a sack of wheat; but it is as foolish to say that credit is capital as it would be to say that a man's strength is a sack of wheat. Banks. The real service which credit performs is that it enables an increased quantity of the wealth of a country to be used productively as capital. It encourages the productive employment of wealth. Scarcely any one, for instance, retains a considerable sum of money in his own keeping; people keep just sufficient money to pay their daily personal expenses; all their money above this amount is generally deposited in a bank, and is there used for productive purposes. Suppose, for instance, that Mr A. has an income of £1000. He deposits the whole of his yearly income in a bank, drawing it out in small sums as occasion requires. In the meantime the banker is employing a considerable part of this deposit as capital, experience having shewn that a bank need never keep in the form of money more than one-third of the sums deposited with it. Mr A. himself would never have been able to employ any part of his income as capital, but the banker, by accumulating a large quantity of these small capitals, is able, with advantage to all concerned, to employ two-thirds of the total amount deposited with him to assist the future production of wealth. Depositors in a bank in reality lend their money to the banker, on the condition that they shall be able to withdraw the whole or any part of their deposits at any time. In some banks depositors receive interest on their deposits, if they have been left in the bank more than a certain time. In most cases, however, the banker is considered to make a sufficient return to the depositors by taking charge of their money, and by allowing them to withdraw any part, or the whole of it, at a moment's notice. It is evident that a bank could not exist unless the credit of the banker was good. People would not place their wealth at the disposal of a man unless they had confidence in his honesty and in his ability to pay. Joint-stock Companies. Another way in which credit enables an increased amount of the wealth that is saved to be employed productively, is by means of joint-stock companies. Such an undertaking as a railroad requires for its construction an amount of capital such as scarcely any private individual could supply. The necessary capital is therefore subscribed by thousands of individuals. The required amount is determined by the promoters of the company; it may be assumed that this amount is £1,000,000; it is accordingly arranged to raise this sum in 20,000 shares of £50 each. Any individual, therefore, who has saved £50, and who buys one of these shares, becomes what is called a shareholder in the railway; he is in fact a partner in a great commercial enterprise; this small capital of £50 is employed in assisting the future production of wealth, whereas if there had been no such things as joint-stock companies, it would probably have been consumed unproductively. It is evident that the success of a joint-stock company depends upon the credit of its promoters and directors. They have frequently not deserved the confidence reposed in their honesty, but this has nothing to do with the present subject. If their credit had not been believed to be good the companies could never have been started. From these illustrations it is perceived that the capital of the country is practically augmented by the means of credit, because it offers great facility for the productive employment of wealth. But besides those just described there are forms of credit performing other functions, which very materially facilitate the exchange of wealth, and which produce a very great influence on the prices of commodities. The forms of credit to which we refer are bills of exchange, bank notes, cheques, and book credits. Bills of exchange. It was said in the preceding chapter that foreign commerce did not involve a constant exchange of gold and silver money between the two countries trading with each other. It is evident that if the English merchants who purchase French goods had to send the price of these goods in money to France, great inconvenience and risk would be incurred. The necessity of the constant transit of gold and silver money is obviated in the following way. Let it be supposed that an English merchant A. sells £1000 worth of coal to the French merchant B., and that a French merchant C. sells £1000 worth of wheat to the English merchant D. If there were no such things as bills of exchange, the result of these transactions would be a transit of £1000 in money from B. (in France) to A. (in England), and also a similar transit of £1000 in money from D. (in England) to C. (in France). Now it is evident that the same result could be attained without any transit of money at all, if A., the English seller, received £1000 from D., the English buyer, and C., the French seller, received £1000 from B., the French buyer. This result is effected in the following way. B., the French merchant, sends to A. a written promise to pay him the £1000, and D., the English merchant, sends a similar promise to pay £1000 to C. These written promises are called bills of exchange. A. has a bill for £1000 drawn on France, and C. has a bill for £1000 drawn on England. If they exchange these bills both debts will be discharged. Bill discounting. Merchants do not usually effect these exchanges themselves; they are generally undertaken by a third class of individuals, called bill brokers or bill discounters. These persons undertake to buy the bills drawn on different countries. In the case just described, A. and C. would not exchange their bills; A. would sell his to a bill discounter in London, paying him a small sum as commission; and C. would sell his to a bill discounter in Paris. Thus a London bill discounter might collect £1,000,000 worth of bills drawn on France, whilst a French bill discounter might collect £1,000,000 worth of bills drawn on England. They would then proceed to exchange the bills. The transit of money is as entirely dispensed with as if barter were the recognised medium of exchange between the two countries. Bills of Exchange perform many of the functions of Money, and they therefore produce an effect on General Prices. Bills of exchange are very largely used in domestic as well as in foreign commerce. It is very unusual for one merchant to pay another in money; the debt is usually discharged by means of a bill of exchange; that is, a written promise to pay at the end of a certain time. A three months' bill is a promise to pay at the end of three months, and so on. Now this bill, up to the time when it falls due, performs many of the functions of money. The person who receives it perhaps wants to make a purchase himself: we will suppose that the bill is for £1000, and that its present owner, A., has received it from B. A. now wants to purchase £1000 worth of goods of D.; he obtains the goods and gives to D. the same bill |