CHAPTER XXII
CURRENCY, BANKING, AND CREDIT
The purpose of this chapter is to explain what money is, what purposes it serves, how banks conduct their business, and how credit facilitates trade.
The Origin of Money.—The use of money is one of the marks of civilization. In primitive communities money was unknown. Buying and selling was by barter, the exchange of one commodity for another. The man with too much corn exchanged corn for cattle or for a boat or for skins with which to clothe himself. But exchange by barter is a slow and clumsy method because it means that two persons must be found each of whom wants exactly what the other has to sell, a thing which does not easily happen. With the growth of trade, accordingly, it became necessary to find a medium of exchange, in other words some single commodity which is so readily exchangeable for all other commodities that it can be used to facilitate buying and selling. Some of the Indians of North America used the ends of shells, or wampum, for this purpose. The early colonists in Virginia chose tobacco as a temporary medium of exchange, it being in universal demand. People accepted tobacco in exchange for things which they wished to sell, and gave tobacco for things which they desired to buy. This was not because they wanted tobacco for their own use but because of all commodities in the colony tobacco was the most easy to exchange for other things at a moment’s notice. No ordinary form of merchandise, however, makes an entirely satisfactory medium of exchange and all of them in time gave way to the precious metals, gold and silver, which are now everywhere used for this purpose.[191]
The Functions which Money Serves.—Money, however, serves not only as a medium of exchange but as a standard of value and a measure for future payments. Money is the common denominator by means of which we express the value of different commodities. If money were not in existence, how could we state the value of anything? It would be of little avail to say that a suit of clothes is worth ten hats, for this would merely beg the question: How much is a hat worth? Money performs the function of providing a uniform scale into which all values can be translated. When we say, therefore, that a suit of clothes is worth forty dollars and that hats are worth four dollars apiece we are measuring both commodities according to the same standard of value. Money also facilitates the use of credit by providing a measure for deferred payments. People cannot well agree to indefinite future obligations; they must know exactly what a debt amounts to. The use of money enables men to borrow today with the understanding that they will repay the same amount at some future date.
Characteristics of Money.—Gold and silver are best adapted to facilitate exchange because they possess, in high degree, certain qualities which money must have in order to fulfil its functions properly. What are these qualities? |1. Value.| To serve acceptably as money a substance must have, in the first place, some value in itself; it must therefore have utility as a basis of value. A worthless substance, which nobody wants, would not do. |2. Stability.| Second, it must not only have value but stability of value. To serve efficiently as money a metal must not be subject to wide and frequent fluctuations in what it is worth. A substance which might be worth much today and little tomorrow would not be satisfactory. Gold and silver, being produced in limited quantities, are more nearly stable in value than any other metals, gold being particularly so. |3. Convenience.| Third, the metal used as money must possess relatively high value in proportion to its bulk so that it can be easily passed from hand to hand. There was a tradition in ancient Greece that Lycurgus compelled the Lacedaemonians to use iron money in order that its weight might deter them from overmuch trading. If iron were used as currency today a dime would weigh more than a pound.[192] In a word the metal used as money must be portable, easy to carry around. |4. Durability.| Fourth, it must be relatively indestructible, not subject to rapid decay or rusting. Gold and silver satisfy this requirement, for time does not destroy their value nor do they suffer much wear and tear through handling. It is believed that some of the gold which is in the coinage of European countries today served as money in the time of the Romans. |5. Uniformity.| Fifth, it must be homogeneous, that is, it must not vary in quality, otherwise equal amounts of it would not have the same value. In order that we may reckon things in terms of money the units must be equal and similar so that twice one will always make two. If we were to use diamonds as money, it would not always happen that two stones would be worth exactly twice as much as one. |6. Divisibility.| Sixth, it must be easily divisible without loss of value, for we need small units of money as well as large ones. One great difficulty which primitive people found in using the skins of animals as money was that they could not be cut into portions without destroying their value altogether. Nobody would take, for example, a quarter of a skin in payment for a basketful of corn. But gold and silver can be divided at will and yet retain an exactly proportionate value. |7. Cognizability.| Finally, it must be a metal or other substance the genuineness of which can be easily determined. If every person who receives money had to scrutinize, weigh, and test it, the processes of trade would be intolerably delayed.[193] Gold and silver may not themselves be readily cognizable by the uninitiated, but they are easy to stamp into coins with a stamp or design and this impression cannot be easily counterfeited. The various countries of the world adopted gold and silver as their chief media of exchange because these metals fulfil in the largest degree the foregoing requirements. For small units of currency nickel and bronze are utilized because subsidiary coins of gold and silver would be too small.
The Coinage of the United States.—In the United States gold is the standard of values. This does not mean that gold is circulated from hand to hand in every transaction, but merely that all economic values are expressed in terms of gold coin. The actual payments may be made in paper notes, or in silver, nickel, or copper coins. The monetary system of the United States is based upon the decimal system, which was adopted in 1784 at the suggestion of Thomas Jefferson. This means that we reckon in fractions and multiples of ten—ten cents one dime, ten dimes one dollar, and ten dollars one eagle. For convenience there are also additional coins, such as nickels, quarter dollars, half dollars, and half-eagles. No gold dollars are now coined, as they were found to be too small for convenience.[194] The mint has also ceased coining quarter eagles but continues to make five, ten, and twenty dollar gold pieces although these coins remain for the most part in the banks where they are held as reserves. Very little gold coin is in circulation anywhere in the world today. The coining of money is wholly within the jurisdiction of the national government; no state is allowed to make or issue coins. |The United States mints.| The making of coins takes place at four mints, which are located at Philadelphia, New Orleans, Denver, and San Francisco.[195] If you look at the reverse side of a recently minted coin, you will find, near the base, a small letter indicating the mint at which the coin was struck; if there is no such letter, the coin was minted at Philadelphia.
The Controversy over Bimetallism.—In 1792, when the first American mint was established, Congress provided by law that there should be two monetary units, the gold dollar and the silver dollar—the ratio between the two, in terms of weight, being fixed at fifteen to one. Any person bringing gold or silver bullion to the mint was entitled to have it made into coins at this ratio, which corresponded to the relative market value of the two |In 1792.|metals in 1792. Silver eventually cheapened in relation to gold, however, and in time only silver bullion came to be coined. |In 1834.| So Congress in 1834 reduced the weight of the gold dollar and made the ratio sixteen to one. This, in turn, proved to be an under-valuation of silver, and no silver now came to the mint to be coined.[196] |In 1873.| In 1873, after silver dollars had practically dropped out of circulation Congress abolished the free coinage of silver altogether.[197] Presently, however, there was a popular demand for a resumption of silver coinage and the minting of silver dollars was recommenced,[198] |In 1893.|but only on a limited scale; and in 1893 it was once more abandoned.[199]
This action on the part of Congress raised a great hue and cry in certain sections of the country, especially in the South and West. Free coinage of silver was desired not only by owners of mines who had silver to sell but by large numbers of farmers who believed that gold was becoming too scarce to serve as the sole standard of value. Scarcity of gold meant scarcity of money, and scarcity of money meant low prices for wheat. If money were plentiful, prices would go higher, and the way to get more money was to coin into dollars all the silver that would come to the mint. That was the farmers’ argument.
The “Cross of Gold” Campaign.—The leaders of the Democratic party took advantage of this widespread agricultural grievance. At the national convention of that party, held at Chicago in the summer of 1896, Mr. W. J. Bryan swept the delegates off their feet with his denunciation of the “few financial magnates who corner the money of the world” and his plea for the poor man’s dollar. “You shall not press upon the brow of labor this crown of thorns”, he declaimed. “You shall not crucify mankind upon a cross of gold.” The delegates, amid tumultuous cheering and enthusiasm, thereupon nominated the young orator from Nebraska as their candidate for President and made the free coinage of silver at a ratio of “sixteen to one” a fundamental part of the Democratic platform in the election campaign. But Bryan was overwhelmingly defeated and the clamor for free silver soon subsided. |Final settlement of the question in 1900.| In 1900 Congress passed the Currency Act, which declared gold to be the sole standard and directed the secretary of the treasury to maintain all other forms of currency at a parity with gold. This means that every silver dollar, whether the silver which it contains be worth a dollar or not, is guaranteed by the national government to be worth a gold dollar.
Paper Money.—Our experience with paper money goes back to colonial days when bills of credit were issued by Massachusetts to pay the costs of the expedition against Quebec in 1690. But no great amounts were issued until the Revolutionary War; then the various state governments as well as the Continental Congress printed and issued notes to the par value of nearly half a billion dollars. In the earlier years of the war this paper currency circulated at its face value although there was no gold or silver reserve behind it; but as the struggle dragged on and notes by the million kept being issued they began to depreciate until eventually this continental paper currency was worth only a fraction of a cent per dollar. Hence the origin of the slang expression “not worth a continental”. The notes for the most part were never redeemed; they merely became worthless and passed out of circulation.
Naturally this experience made the people averse to paper money and when the constitution of the United States was framed it contained a provision that “no state shall emit bills of credit (or) make anything but gold and silver coin a tender in payment of debts”. It was strongly urged that the national government should also be prohibited from issuing paper money, but in the end it was decided not to make any express prohibition, so the constitution is silent as regards the authority of the national government to emit bills of credit. It neither gives this power nor denies it. In due course, however, Congress authorized the issue of legal-tender notes or greenbacks, and the Supreme Court upheld its right to do this on the ground that the constitution expressly gives Congress the power to borrow money and that the issue of paper money is a reasonable method of borrowing. But although the national government has itself the legal right to issue paper money, either with or without a reserve behind it, most of the paper money now in circulation is issued by the federal reserve board or by the federal reserve banks under authority granted by Congress.
Paper Notes now in Circulation.—There are several kinds of paper notes now in circulation.[200] These include silver certificates, gold certificates, treasury notes, and greenbacks issued directly by the national government, national bank notes, federal reserve notes, and federal reserve bank notes. The provisions for the redemption of these different types of paper money vary greatly, and each is protected by a different reserve, but in actual fact the holder of any unit of paper money can obtain gold for it if he so desires. This is true even of the silver certificates which, strictly speaking, are redeemable only in silver dollars. The arrangements under which the national banks, the federal reserve banks, and the federal reserve board are permitted to issue paper money will be discussed presently.
Why do we have paper money? Chiefly because it is, in many respects, more convenient for use than metallic money. In large amounts it is not so bulky as silver or gold would be. There is also the advantage that when paper money wears out it can be cheaply replaced. If gold coins were continually in circulation from hand to hand, they would gradually wear down and the monetary loss would be considerable. Hence it is better to keep the gold in the bank vaults and circulate the paper, which represents gold, in its stead. But a sound system of paper money should always provide for the redemption of the notes, which means that the notes should have an adequate reserve behind them. This reserve should be in gold or in the equivalent of gold. |Inconvertible paper money.| Unredeemable paper money, issued without an adequate reserve behind it, leads practically always to depreciation and thereby to heavy losses on the part of the people who have taken the money in good faith. That was what happened in the case of the assignats of the French Revolution, the continental currency in the American Revolution, and the paper money of several European countries during the World War.[201] It is folly to try to finance a war or any other national enterprise by issuing fiat currency, as it is called, which is paper currency with only the word of the government and no substantial reserve behind it. Better tax the people outright than make them take money as legal tender which is not worth what it purports to be.[202]
Radicals sometimes say: “Let us do away with money altogether”. Instead of money, they say, we might use “labor checks”, each check representing a given amount of labor. One hour of labor, let us say, would then be the standard of value instead of 23.2 grains of gold. This arrangement, however, would not abolish money, but only change the nature of the basis upon which the value of money is calculated. The labor checks would be money in every sense of the word. There is only one way to abolish money and that is to go back to barter.
The Banking System
What Functions do Banks Perform?—Banks are established and maintained to satisfy certain needs which arise wherever men carry on extensive trade with one another. |1. As institutions of deposit.]| In the first place when money is accumulated by people in the course of their business some safe place is needed to keep it. Banks, therefore, serve as institutions of deposit. |2. As agencies for loaning money.| In the second place, as business develops, it becomes necessary for people to borrow money. Banks facilitate this borrowing. Their two primary functions are to receive deposits and to make loans. But in order that they may perform these two primary functions to the best advantage the banks have assumed other subsidiary functions as well. |3. Sometimes also as issuers of paper money.| Frequently they issue bank notes, or the bank’s own promises to pay, for use in general circulation. |4. To transfer funds from one place to another.| They sell drafts or bills of exchange, thus enabling people to transfer funds from one city or country to another without the trouble and risk of sending the actual money. As a rule they provide safe-deposit vaults in which customers, on payment of a small sum, are permitted to keep their valuables. These vaults are fire-proof and burglar-proof. Banks also collect money which may be due to a customer from someone elsewhere. They help the national and state governments to sell their bonds. Frequently they act as trustees, holding property for children until they grow up or for other persons who are unable to look after the property for themselves. Without banks it would be difficult, if not impossible, to carry on the operations of modern business.
The Early American Banking System.—The national constitution contains no mention of banks or banking. Hence it was assumed that the power to charter banks would rest with the states. The states assumed this authority but the national government desired to exercise it also, and during the first thirty years of its existence established two great banks, both of which became unpopular and ultimately went out of existence. The first Bank of the United States, established in 1791, ceased to do business in 1811; the second bank, chartered in 1816, incurred the wrath of President Andrew Jackson and went to the wall in 1836.[203] From this date to the Civil War the state banks, of which a large number were established in all parts of the country, had the field to themselves.
The National Banking Act of 1863.—During the Civil War, however, the national government encountered great difficulty in raising funds. When it issued bonds the people would not buy them readily. The state banks showed very little interest in marketing them. So Congress, in this emergency, decided to establish a system of national banks in order to facilitate the sale of war bonds. The National Banking Act, passed in that year, laid a heavy tax upon the paper money of all state banks, with intent to drive this currency out of circulation. It then provided that any bank chartered by the national government might issue untaxed paper money provided it bought United States bonds to a designated amount and deposited these bonds in Washington as security. In other words the Act of 1863 aimed to provide a uniform system of bank notes throughout the country, these notes to be backed by government bonds. The plan worked well and its main provisions have been retained to this day.
National banks are owned by private individuals who subscribe the capital stock. These stockholders, or shareholders, elect the bank’s officers, who in turn manage the business. The profits go to the shareholders in the form of annual dividends. Each national bank must buy a designated amount of United States bonds and these bonds are deposited in Washington. In return the bank receives an equal amount of paper notes, with its own name engraved thereon, and these notes the bank pays out over its counters, thus putting them in general circulation. If the bank should become insolvent, the government would redeem the notes since it holds the bonds as security. |Their functions.| The national banks receive money on deposit, make loans, and perform the various other banking functions. They are strictly regulated by national law; they must make periodic reports and are frequently inspected by officials from Washington. |Their reserves.| One requirement is that they shall always maintain a certain “reserve” so that they may be in a position to make all payments which may be called for by their customers. The supervision of the national banks is in the hands of an official known as the Comptroller of the Currency, who is appointed by the President.
In addition to the national banks there are state banks and trust companies throughout the country operating under state charters. These institutions do not issue paper money but perform all the other banking functions.[204] Their business is regulated by the laws of the state in which they are located and they are supervised by state officials. The laws relating to state banks and trust companies differ considerably from state to state.
The Federal Reserve Banks.—Although the national banking system worked pretty well for fifty years after its establishment, certain defects came to be recognized. One of these defects, in actual practice, was the necessity of always keeping available a “reserve” amounting to a certain percentage of each bank’s total deposits. It was not necessary to keep this reserve in the bank’s own vaults; a part of it might be placed upon deposit in larger banks where it would draw interest. As matters turned out, a considerable portion of the reserves was usually deposited with large banks in New York City. In times when business was good and money plentiful, this arrangement worked very well, but when periods of business depression arrived and money became scarce every small bank naturally drew upon its reserve deposits in the larger banks, which found difficulty in paying them all at the same time. Moreover, it was found from experience that during times of business prosperity the country needed a large increase in paper money while the national banking system, as established in 1863, proved too rigid to meet the business needs of the country.
In 1913, accordingly, Congress made provision for the establishment of a Federal Reserve system which does not displace but supplements the operations of the national banks. By an act passed in that year provision was made for the establishment of twelve federal reserve districts, with a federal reserve bank in each. The capital stock of each federal reserve bank is contributed by national or state banks within the districts, these contributors being then known as “member banks”. The national government also subscribes a part of the capital stock when necessary. |The Federal Reserve Board.| Each federal reserve bank is controlled by officials, some of whom are elected by the member banks and some appointed by the national government through a body known as the Federal Reserve Board. This board is composed of the Secretary of the Treasury, the Comptroller of the Currency, and five other members appointed by the President.
These federal reserve institutions are bankers’ banks. They do business with banks only, not with individuals. They receive deposits from banks and lend money to banks. The member banks now keep with them a portion of their reserves. In this way the reserves are mobilized at twelve different financial centers where they can be readily drawn upon.[205] The Federal Reserve Board has authority to increase or decrease the percentage of reserves which the member banks are required to maintain, thus giving the reserve system a large degree of flexibility. Whenever a member bank needs additional paper money for circulation it goes to the federal reserve bank of its district and deposits any sound “collateral”, that is to say, any acceptable security, and receives federal reserve notes of like value in return. This collateral may be in the form of government bonds or it may be, and more often is, “commercial paper”. |How they give flexibility to the whole banking system of the country.| By commercial paper is meant the notes or other obligations of corporations and individuals which have been given to the member banks in return for loans made to such corporations and individuals. The federal reserve banks are authorized to issue federal reserve notes, to an unlimited extent on the security of this collateral provided they also keep a gold reserve amounting to forty per cent of the total notes issued. In addition they are empowered to issue federal reserve bank notes secured by United States bonds in the same way as national bank notes are secured. It is expected that in time the national bank notes will go out of existence altogether, their place being taken by these federal reserve bank notes.
Since their establishment in 1913 the work of these federal reserve banks has been of great value. They have enabled the banking operations of the country to expand and contract in accordance with changes in business conditions, thus obviating serious danger of financial panics. In helping the government to float the various Liberty Loans they rendered great service. There is no doubt that the system has improved and strengthened the banking facilities of the country.[206] This will appear more clearly when the relations of banking and credit are discussed a few pages further on.
The Practical Operations of Banking.—There are some elementary things connected with the practical operations of banking which everyone ought to know. Generally speaking, there are two kinds of banks, commercial banks and savings banks; or, in some cases the same bank may have two departments, a commercial department and a savings department. Both commercial and savings banks receive deposits; the former may or may not pay interest according to the amount of the deposit and the length of time it is left in the bank; the latter always pay interest if money is left on deposit a prescribed length of time. When money is deposited in a commercial bank the depositor is said to have an “account” and he may issue checks up to the amount of his deposit. |Bank checks.| A check is an order, addressed to the bank, and calling for the payment of a designated sum. This check may be cashed at the bank on which it is drawn, or the person who receives it may have it cashed at the bank where he has his account. Banks cash checks for their own customers no matter what bank the checks happen to be drawn upon.
One result of this is that every bank at the close of each day’s business will have on hand a large number of checks drawn against other banks. |The clearing house system.| It receives payment on these checks through the medium of the “clearing house”, an institution which is maintained by the banks in every large city. To the nearest clearing house a clerk takes each morning all the checks on other banks that have come in during the previous day. These are sorted out and exchanged for checks drawn on the bank itself which are held by other banks. Whatever difference there happens to be is paid in cash.
When any person desires to borrow money from a bank he gives his note, which is a promise to repay the bank at a designated time. The bank may ask the borrower to obtain an endorsement upon his note, that is, to have some responsible person put his name on the back of it, which means that the endorser assumes liability for the amount of the note if it is not paid by the maker on time. Or the bank may ask the borrower to deposit “collateral” as security for the payment of the note. This collateral may be in the form of bonds, stocks, mortgages, or any other intangible property that has sufficient value. The bank holds this collateral until the loan is repaid.
When a bank lends money and takes a man’s note, with or without collateral, it is said to discount the note. It gives the borrower the face value of his note less the interest, whatever it is, calculated at the current rate. Thus if the rate is six per cent and the person gives his note for one thousand dollars payable in six months, the bank would hand him $970 in money. Business men obtain large sums of money from the banks by getting their notes discounted; they borrow money in this way to buy goods and then pay off their notes when the goods are sold. Such notes are called “commercial paper”.
Now the federal reserve banks help the member banks by “rediscounting” this commercial paper for them. Suppose a small bank has loaned on notes all the money it has to spare. Then it receives applications from its customers for more loans. What does it do? It takes a bundle of business men’s notes, or commercial paper, from its vaults and sends this to the nearest federal reserve bank. The latter does just what the member bank did in the first instance; it deducts the discount at current rates and gives the balance to the member bank in money, that is, in federal reserve notes. The member banks are enabled, in this way, to loan a great deal more money than would be the case if there were no way of getting their commercial paper “rediscounted”.
Drafts or bills of exchange are used to make payments at distant points. If a person lives in San Francisco and wishes to pay a small bill in New York, he will probably go to the post office and buy a postal money order; but if the amount is large, he may find it more convenient and cheaper to go to a bank in San Francisco and buy a draft on some New York bank. This draft he then sends to New York in payment of his bill. A draft payable in a foreign country is usually called a bill of exchange. From any American bank one can buy a bill of exchange payable in Paris, Madras, Hong Kong, or elsewhere. When the money of one country is worth more than that of another, as is the case throughout the world at the present time, allowance is made for this difference. Bills of exchange are “cleared” through the great clearing houses in London or New York, and any balances are paid by the shipment of gold.
The Credit System
What is Credit?—Credit is simply the giving and taking of promises in place of money. The most common form is “book credit”, which means that wholesalers and retail merchants give out goods with nothing but charge accounts on their books to show for it. These accounts are merely the records of credit which has been extended to customers. But in many transactions something more than a book record is desired, in which case the person giving the credit may ask for a “promissory note”. This is a written promise to pay a designated sum either on demand or at a definite date. Bank checks are also instruments of credit; so are drafts and bills of exchange. Anything that expresses or implies a promise to pay a sum of money is an evidence of credit.
The general relation between the amount of money in circulation and the course of prices is shown by the two statistical diagrams on the other side of this page.
It will be noticed that per capita circulation began to decline in 1921. Prices also commenced to fall during that year, and if the table of prices were extended to cover the last year or two it would show the price-lines moving downward. The data for continuing the lines of the lower diagram may be found in the publications of the United States Bureau of Labor Statistics.
MONEY IN CIRCULATION PER CAPITA (Figures for first day of month)
COURSE OF WHOLESALE AND RETAIL PRICES[207] IN THE UNITED STATES
JANUARY, 1913, TO MAY, 1920
[Average Prices, 1913 = 100]
The Relation of Credit to Money.—A large part of the world’s business is done on credit. If all debts had to be paid tomorrow, there would not be enough money in the world to pay one cent on the dollar. But all debts do not fall due at once, and a huge credit system is able to stand with comparative safety upon a relatively small amount of gold. |There is a limit to the expansion of credit.| There is a limit, however, to the expansion of credit and this limit is roughly determined by the amount of gold available to be held as a reserve. Hence it is that when the volume of gold increases, credit usually expands also. With their reserves full to overflowing the banks are more ready to lend money on notes, and the rate of discount goes down. Conversely, as the volume of gold declines, credit usually contracts. The rate of discount then goes up and business men find it harder to borrow money upon commercial paper. In the one case we speak of an inflation or expansion in money and credit; in the other we speak of a contraction or deflation.
Credit and Prices.—The general level of prices depends upon the value of money. The price of a thing is merely its value expressed in terms of money. To say that prices have gone up is to say exactly the same thing as that the value of money has gone down.[208] The general level of prices, to put the matter in another way, is determined by the demand for goods on the one hand and the supply of goods on the other. The demand for goods, however, is represented by the amount of gold currency available plus the amount of credit which is built upon this gold. The credit, as has been seen, bears a definite relation to the gold. |How the general level of prices is determined.| Hence it can fairly be said that the amount of gold is an index of demand for goods or services. So, if the supply of goods remains approximately the same, any large increase in the available amount of gold would send prices up; and conversely, if the supply of goods is greatly increased, while the available amount of gold remains approximately the same, prices would go down.
This is the so-called quantity theory of the relation between money, credit, and prices and it holds good in a general way although it does not work out as simply as it reads. The adjustment of supply and demand sometimes takes place very slowly. The volume of credit which can be built upon a given reserve of gold is not absolutely fixed, moreover; in some circumstances it may be more extensive than in others. |Defects of the quantity theory as shown by recent experience.| During the World War, for example, credit ran away from the gold reserve in all the European countries. Enormous amounts of paper money were issued with very little gold in reserve to protect them. Due to reduced production, the supply of ordinary goods sharply declined. A combination of these two things, inflation of credit (i. e., potential demand for goods) and decreased production, sent prices sky-high.[209] In the United States credit was also inflated during the war and prices went up, though not to the same extent as in Europe. Since 1920 the process of “deflating” credit has been going on. This process of deflation is guided by the federal reserve banks, which are able to contract the volume of credit by charging higher rates for rediscount.
The Advantages and Dangers of Credit.—It is probable that at least two-thirds of the buying and selling in the world is done on credit. Nearly all large transactions are put through by the use of credit for short or long terms. Credit affords many advantages to modern industry and commerce; without it, indeed, our whole economic system would break down. |Four functions which credit permits.| A few of these advantages may be mentioned: (a) It economizes the use of gold and silver, by doing away with the necessity of passing gold and silver coin from hand to hand at every transaction. (b) It enables large payments to be made at distant points without an actual shipment of metallic money. (c) It permits men to engage in business operations beyond their own means by borrowing capital and using it productively. (d) It enables people to invest their savings (by depositing in savings banks, lending money on mortgages, buying bonds or stocks, etc.) so as to secure a profitable rate of interest without great risk.
But there are also some disadvantages. The credit system often encourages extravagance in that people are tempted to buy goods which they eventually find it hard to pay for; it tends to encourage speculation which frequently results in heavy losses; and it sometimes enables promoters to obtain capital when there is little or no chance of their being successful. By strict governmental supervision, however, the advantages can be retained and most of the dangers eliminated.
The Stock Exchange.—A word should be said about the place where instruments of credit are most commonly bought and sold, namely, the stock exchange. As its name implies, this is a market in which men buy and sell stocks, bonds, and other securities.[210] There is a stock exchange in every large city. The buying and selling is done through brokers, who are members of the exchange and who receive a small commission for their work, this commission being paid by the persons for whom they buy or sell. A broker, at your request, will buy or sell on the exchange any security that is listed there. The amount of the purchase may be paid in full, or, if the buyer desires, a partial payment of five, ten, or twenty per cent may be made. |Trading on margin.| This is called “buying on margin”. The current prices of all securities are kept posted on the exchange; they go up and down from day to day in keeping with market conditions. Shrewd investors try to buy when prices are low and to sell when prices are high, but in this they are not always successful. Many fortunes have been made—and lost—on the stock exchange.
F. W. Taussig, Principles of Economics, Vol. I, pp. 227-235 (Coinage); 236-251 (Quantity of Money and Prices); 265-273 (Bimetallism); 348-359 (Banking Operations); 375-385 (The Banking System of the United States);
Isaac Lippincott, Economic Development of the United States, pp. 550-580;
H. R. Burch, American Economic Life, pp. 336-371;
W. A. Scott, Money and Banking, pp. 1-116;
W. S. Jevons, Money and the Mechanism of Exchange, pp. 3-41;
Marshall, Wright, and Field, Materials for the Study of Elementary Economics, pp. 443-546;
C. J. Bullock, Introduction to the Study of Economics, pp. 224-246;
D. R. Dewey, Financial History of the United States, especially pp. 383-413;
Everett Kimball, National Government of the United States, pp. 460-479;
Horace White, Money and Banking (5th edition), passim;
F. A. Fetter, Modern Economic Problems, pp. 31-163.