The Value of Money Part 20

First, objection will be offered to the doctrine that all credit is merely rights to wealth, that credit rests on wealth. It will be urged that many loans are made without collateral, or mortgage security, that the "personal credit" of the borrower is the only security, and the only basis of the loan. This objection is not serious. There are, doubtless, loans which are disguised benevolences, where the lender gets nothing good in return for his loan. I abstract from such cases. Quant.i.tatively they are not important, and qualitatively they are not really commercial transactions. In general, when a good merchant borrows at the bank on his personal note, the bank knows very well what goods he has in stock, what prospects he has for marketing them, what other debts he has, what his "net worth" is. And the bank knows that it has legal claims, even though not preferred claims, on his wealth. When a young business man borrows capital from a neighbor, giving no security because he has no marketable wealth which would serve as security, he is, none the less, exchanging a valuable right for the loan. He is giving the lender a right to a preferential share in his future income. The lender has considered the young man's abilities as sources of income, in conjunction with the capital lent. Incidentally, the lender retains rights, preferential rights as against the young man himself, in the quantum of value he has turned over to him. If a young man borrows the resources with which he buys a farm, the lender takes a mortgage on the farm itself. Transactions of this sort frequently have in them the element of benevolence, and the considerations are not always strictly commercial. In the case of a young man of unusual ability, however, who insures his life for the benefit of the lender, such transactions may be perfectly good commercial transactions, value balancing value in the exchange. The thing traded is commonly present money (or its equivalent) for rights to future money income.

Public loans present no exception to our rule. They represent the transfer of present wealth for the future income which the government, by virtue of its public domain, or, more commonly, its taxing power, may expect to receive. With a strong government, this future income may be a very substantial part of the total income of the people. Public loans may often be for commercial purposes, as when munic.i.p.alities borrow to build or extend munic.i.p.al enterprises. In cases of this sort, the market frequently will consider the prospects of commercial success of the enterprises in fixing the value of the munic.i.p.al bonds. Where the proceeds of the loan are for non-commercial purposes, as war, the question of the future income of the government will still, ordinarily, be a dominant factor in determining the value of the securities. Often, however, there is the direct action of patriotic fervor, etc., enhancing the values of government securities. We have seen this in the case of government money. It is no part of our theory to maintain that men's calculations are always rational, or that the whole of the value of a long-time income-bearer rests on the antic.i.p.ated income. But this is no peculiarity of credit phenomena. The same thing is true of lands, for example. Capital values often get independent in part of their "presuppositions," as we have seen in the chapter, _supra_, on "Economic Value." War security issues often represent the effort of the government--as at the present time--to bring into the present every possible bit of future values, as a means of increasing their power in a desperate struggle. The high prices of goods in such a situation represent the concentration of future values into the present, an increase in the motivating power which stimulates the people to unwonted exertions. In war time, moreover, many _ideal_ values,--those whose fate is dependent on the outcome of the war--enter into and increase the values of those goods which are needed for carrying on the war. This leads to larger sacrifices of future income than would ordinarily be tolerated. It is not so much a case of present goods rising because of extra credit, as of extra credit because present goods are more valuable.

A second objection would be raised that in many cases, the values pledged by the borrower could not exist if the lender did not make the loan. This would be particularly the case with credit granted for the starting of a new or novel enterprise, which as yet exists only in idea.

The established merchant, with goods on his shelves, or with a bill of lading for goods which he has sold, has a very tangible, concrete basis for a loan, whose value is independent of the decision of any given banker. If my doctrine is to be taken as holding that all credit rests on concrete physical goods, very many exceptions indeed could be found.

But this is not my doctrine. It is that credit rests on valuable _rights_. These rights may be rights to existing concrete goods; they may be rights to future incomes. In any case, it is the values, rather than the physical quant.i.ties, that are significant. Witness cotton before and after the outbreak of the World War. Ultimately, in general,[510] economic values come from the "primary values" or "first order" values of consumption goods and services. These values are reflected back, by the imputation processes, to the various "factors of production" which have made the existence of the goods and services possible, in accordance with well-known laws which need not be here elaborated. But the category of "factors of production" is far from exhausted when we have named land, labor, and produced instruments of production! Some writers have rejected the notion of "factors of production" largely or altogether, and prefer such a term as "agents of acquisition."[511] I certainly have no intention to give to the term, factor of production, any ethical connotation. Even though a factor of production be, like land or labor, a _sine qua non_ of production, it does not follow that the owner of that factor gets his proper, or ethically just share, under the laws of economic imputation. Many of the "factors of production," in the sense of factor which derives a value from the economic laws of imputation, may well be parasitic from the angle of ultimate social welfare. The only test is as to whether, under existing social arrangements, a portion of the income _of a given establishment_ would cease to exist if that factor should disappear, or be reduced. From the angle of this test, monopoly power, trade-marks, established trade connections, the big idea of an entrepreneur, a dynamic personality, capacity for winning other men's confidence and good will, and sometimes that brutal selfishness which makes other men shrink from conflict, or the reputation of being a dangerous and vindictive man, may be equally "factors of production" with land, labor, and produced instruments of production. In Part IV of this book, "The Reconciliation of Statics and Dynamics," we have discussed the "intangible capital items" of this cla.s.s, and have indicated that many of them perform really important and necessary social functions. Others are doubtless pernicious. Production involves leaders.h.i.+p, organization, the making and maintaining of "interst.i.tial connections," as well as the technology of muscle and machine. But credit is based on values, rather than on concrete goods as such, and if these "intangibles" have value, they may have credits based upon them.[512]

That some of these values exist only by virtue of the fact that credit is granted is no marked peculiarity. The granting of credit is an exchange of the rights of the creditor for rights to the future income of the borrower. If the exchange were not made, in certain cases, the borrower would have no future income to which he could give rights. The entrepreneur with a big idea cannot actualize that big idea unless he can bring it into conjunction with land, labor, capital, and a market for the products. The exchange of rights to the value of the products for the banker's deposit-currency, or the private lender's money is merely one of many necessary exchanges required to bring about the combination which will create the products. If there were no possibility of marketing the products, he would be equally helpless, and his idea be equally valueless. The general range of values, under our present system of division of labor, private property, private enterprise, etc., depend on the possibility of exchange. Men produce for the market, rather than for their own consumption, or for the consumption of a communist society. Without exchange, many values would persist, but most values would at least be diminished. Exchange is part of the productive process. The only peculiarity in the case under discussion is that the man getting credit for the exploitation of a big new idea commonly has a very limited market--is dependent on the decision of one bank or lender, or at most of one out of a few possibilities. The narrower the market, the more dependent are the values of things that must be exchanged upon the decisions of a few men. Wheat is free, virtually, from individual caprices, though even there a big operator may organize a pool and temporarily affect the value very greatly. But the immediate power of a few men on values is increasingly great as we get closer to those things which are unique, which are capable of only specialized employment, and which call for the cooperation of elaborate and expensive systems. And, of course, the influence of individual caprice, or individual decisions, on all values grows greater as wealth and power are concentrated.

Economic social value is an inst.i.tutional value, specially weighted and controlled by individuals, cla.s.ses and inst.i.tutions.[513]

Joseph Schumpeter, in his _Theorie der wirtschaftlichen Entwicklung_, has made much of the role of the banker in economic evolution. He sees in the banker a creator of "_Kaufkraft_," by means of which an entrepreneur, a dynamic man who has a new idea which he wishes to actualize, is able to wrest from the unwilling "static economic subjects" their land, labor and instrumental goods for the purpose of putting his new plan through. This new _Kaufkraft_ is the true _Kapital_ which the new enterprise requires. Capital, thus defined, is not an acc.u.mulation of goods, is not embodied in goods. It is an _agent_, a _power_, which the banker creates. It makes dynamic change possible.

Schumpeter is particularly anxious, in clearing the way for his new theory of interest, to get rid of all the notions of saving, acc.u.mulations of stocks of goods, etc., which have commonly been made prominent in the discussion of capital and interest. We need not here discuss his theory of interest.[514] He maintains that the new dynamic credit, credit granted by a banker for a really new enterprise, as yet not concretely in existence, represents something new in the world, anomolous from the angle of static values, and static credit. Indeed, he regards credit as unessential for the static a.n.a.lysis, and banishes it from the "_Wesen_" of his static state. But this new credit is different from such credit as there may be in the static state, because, he holds, the new credit does not rest on goods, and has no _Deckung_. Schumpeter himself calls these doctrines "heresies." They become less dangerous, however, when we learn that by "saving" Schumpeter means mere trenching upon accustomed expenditure, so that the entrepreneur who saves part of unusual profits is really not saving at all, and when one discovers that his contention that there need be no acc.u.mulation of goods prior to the starting of a new enterprise means merely that there need be no special acc.u.mulation of goods _ad hoc_. Of course if saving means trenching upon accustomed expenditure, it is banished by hypothesis from the static state, but there may still be plenty of capital (in the ordinary sense of acc.u.mulated produced means of production) for Schumpeter's entrepreneur to get hold of by means of his new _Kapital_. His contentions that the new credit does not rest on goods, that it has no _Deckung_, and that we have a new thing in the world since in dynamic credit we have a case of temporal discrepancy between the making of obligations and the ability to pay them, calls for further a.n.a.lysis.

It is true that there is a time during which the new credit has no basis in concrete goods. Very speedily, however, the new credit is exchanged for concrete goods, and the enterprise is started. Further, the banker commonly insists on a margin at the start. Further, the claims of the borrower on the banker are themselves, prior to their expenditure for the things needed in the enterprise, a.s.sets to which the banker may look as a basis for his confidence in the goodness of the entrepreneur's promise to pay him. There is never a moment when the new credit does not rest on _values_. The loan by the banker to the borrower is, essentially, like the case of the purchase of any bearer of future incomes, say a machine, or a factory. The machine is, after all, in economic nature, merely a "promise" of future goods and future values, as an Austrian economist should be quick to recognize, and machines are almost as frequently poor performers as borrowers--indeed, most commonly, the borrower's inability to repay comes from the failure in the value of the goods which his physical equipment produces. The _raison d'etre_ of the new credit is the new values which have come into existence: the new plan of the entrepreneur, _validated by the banker_, attains a value equal to the present worth of the extra products which it promises. I repeat that it is values which are significant as the basis of loans, that values are not all embodied in physical goods, and that value is essentially a psychological thing.

The banker's validation of the plan may be an essential factor in its value. _Belief_ is often an essential factor in values. The new value, and the new credit, have a large element of belief in them. The value of the new plan rests proximately in the belief of the banker, manifested by his granting of credit. But the value of the _bank-credit_ rests ultimately in the _prestige_ of the banker, which is a fact of social psychology, resting in a ma.s.sing of belief on the part of the public in him, in the validity of his bank-notes and deposit-currency, coupled with support from legal and other inst.i.tutions. But this is to antic.i.p.ate the discussion of the nature of bank-credit. The point involved is sufficiently ill.u.s.trated by the case where a man who is not a banker lends his money to an entrepreneur of a new undertaking. Here again the enterprise is impossible without the loan. Here the loan is made on the basis of an antic.i.p.ated income. Here again the antic.i.p.ated income is made possible only by the loan; one of the values that enters into the exchange exists only because the exchange is possible. None the less, the credit rests on value. It is a right to an antic.i.p.ated income.

The man who has made the loan has his security in the value which he has lent, plus the present worth of the extra income which the new idea is expected to create.

Now a great practical difference is made in the course of economic life by the decisions of lenders to lend to men who plan new things, instead of to men who plan old things. It makes an enormous difference whether or not new plans appeal to the imaginations of those who control the economic resources of society. It makes a great difference whether static values (the capital values of incomes to be created in familiar ways) or dynamic values (capital values of incomes to be created in novel ways) win out in the compet.i.tion for loans from those who have loans to make. But _as values_, the two are of the same psychological stuff and substance: futurity and belief are essential elements in both of them.

Stable belief, and strong belief, are easier to evoke in the case of the established and the familiar. New ways of creating wealth must promise larger returns, and make more dramatic appeals to the imagination, than old ways. Schumpeter indicates that it is the essential function of the banker to give preference to the new ways, that the ma.s.s of men are "static" in their att.i.tude, and that, for some reason which he does not clearly indicate, the banker is not. This has not been our American experience, on the whole. The contrast which Schumpeter makes between the timid, static ma.s.ses, and the few highly important dynamic entrepreneurs, holds very much less true in America than in Continental Europe. There it is doubtless true that new industrial enterprises have had their main encouragement from bankers. Here, such enterprises have appealed largely to the ma.s.s of men, to the investing and speculative public. Our commercial banks have lent largely upon stock exchange collateral, which means that, indirectly, bank-loans have gone to finance industry. The extent of this is enormous, as will later appear.

However, the banks, as banks, have not been large _buyers_ of stocks.

They have guarded themselves by requiring "margins" from those to whom they have lent on such collateral. Seasoned bonds have been bought in great volume by our commercial banks, but few stocks. Even the underwriters and investment bankers have been primarily intermediaries, expecting to pa.s.s on to private buyers the securities they hold temporarily. My point here is, merely, that there is nothing in the distinction between static and dynamic credit, when by that is meant the distinction between credit for new enterprises and credit for old enterprises, to mark off a peculiar or essential province for bank-credit. The need for bank-credit does arise out of dynamic conditions, primarily, but it is not the need for credit to _start_ dynamic changes, even though bank-credit may do, and does do, that. The chief reason for bank-credit is to enable economic society to readjust itself quickly and readily to dynamic changes, by putting through without friction the necessary exchanges that such readjustment requires, and by holding in liquid form a fund of rights which can meet the emergencies and unexpected occurrences which dynamic conditions involve. To this we now turn.

Bank-credit is the debt of responsible inst.i.tutions, payable on demand in money. It may take the form of notes, or of the right to draw checks.

Long evolution has begot a system of legal relations.h.i.+ps, and of banking technique which makes these promises easily performed. The same process of development has led to social reactions toward banks and bankers which give them enormous prestige. Legal regulation, in the case of many banks, requiring adequate capital, and, in this country, requiring minimum cash reserves, have added to that prestige. The promise of the bank is commonly so liquid and saleable that the banks are not called upon to fulfill it by the actual payment of money--the promise alone is an object of value which is perfectly saleable, which runs in terms of money, and which functions as a perfect subst.i.tute for money in almost every use except for very small retail transactions. Even there, it is very much used.

Among the features of banking technique to which we must give especial attention are the following: (1) the banker has substantial resources of his own, his "capital," which const.i.tutes the "margin" of protection which he offers to those who give him valuable things in return for his promises to pay money on demand; (2) the banker exchanges his promises to pay on demand, as far as possible, for those things which have a high degree of "liquidity," _i. e._, for those things which he can quickly dispose of for cash, or for the promises of other bankers which are the equivalent of cash. Farm mortgages are not good a.s.sets for a banker to hold in large amount. They are long-term obligations, with a very limited market, and they will not help him in emergencies to meet his obligations to pay on demand. Agricultural loans, and other mortgage loans are made in considerable volume by our State banks and trust companies. All cla.s.ses of commercial banks make many non-liquid loans, as we shall later see. But all of them get as high a proportion of liquid loans as they can. Bills of exchange, running ten, thirty, sixty or ninety days, growing out of commercial transactions which automatically terminate themselves in the payment of cash or the promises of other bankers, const.i.tute admirable a.s.sets. In return for these, the banker may give his promises freely. This is especially true where there is, in the banking practice, a wide "rediscount market," in which he can sell these bills before maturity if he wishes to get even more liquid a.s.sets. Promissory notes, for short periods, thirty, sixty, or ninety days, growing again out of commercial transactions, which, like those for which the bills of exchange were drawn, automatically bring in cash or the promises of other banks, are in many respects like the bills of exchange, even though the rediscount market for such notes has not been so highly developed as the market for bills of exchange in Europe. Whether such notes are as available for rediscount as bills of exchange is a question of technical banking which we need not here discuss in detail, though I venture the opinion that bills of exchange are superior decidedly for this purpose, especially "doc.u.mentary" bills.

The element of personal credit is commonly larger in the promissory note, and that limits the market. Banking organization, and particularly our new Federal Reserve System, may greatly reduce the disadvantages of the promissory note from this angle, but it seems not unlikely that the bill of exchange may be a factor of increasing importance in our internal banking arrangements. The general test, however, of what is available for a banker's a.s.sets depends on varying conditions, and is not to be answered by a simple formula. A bank in a rural region which loads up heavily with the safest local bonds is little better off than with farm mortgages. For neither is there a quick market in an emergency. A city bank, near the stock exchange, may very safely buy in large amounts highly saleable as a profitable subst.i.tute for part of its cash reserve. Even country banks may, and do, safely own such bonds.

Short loans on stock and bond security, const.i.tute the most important single type of bank-loan in the United States, as we shall later see.

(3) The third feature of banking technique to which attention must be given is the reserve policy. The banker must keep some actual money on hand (how much we have in part considered in Part II, and shall again discuss).

I shall give attention to these points in what follows. The first point needs little discussion. Large "capital" for a bank gives prestige and security. Some capital is a _sine qua non_ for a bank which expects its notes or deposit currency to have general acceptability.

It will be well to consider further the circ.u.mstances determining the form which a bank's a.s.sets shall take. Though commercial banks own enormous quant.i.ties of high grade bonds, it is rare for commercial banks in America to buy stocks of corporations.[515] They will often lend to owners of such stocks with the stocks as collateral, up to a high percentage of the value of the stocks, but they will rarely trade their demand obligations for the stocks directly. In general, a bank wishes to have its a.s.sets in the form of obligations of other people, expressed in terms of dollars, and having a definite term to run (or callable on demand).

One reason for this is a bookkeeping reason. "Par value" of stocks has little meaning any more. Market-prices of stocks, even the best stocks, are not absolutely fixed. They fluctuate, even though within narrow limits. This fact presents complications to the bookkeeper! Of course, the bank's buildings and fixtures, listed among its a.s.sets, fluctuate also, in value, and in the price that could be obtained on a given day, but the bookkeeper can abstract from that, since the bank has no intention of selling its buildings and fixtures. The notes and bills held in the bank's portfolios also in fact fluctuate in value, and in the price at which they might be sold on a given day, but they are expressed in terms of dollars, and the bookkeeper commonly has no need to look beyond the figures written on them. At irregular intervals, a small percentage of them may be marked off the books as "bad," but usually the minor fluctuations are abstracted from. The bank does not like to have a.s.sets whose published prices fluctuate. But this is, I suppose, not the main objection which banks have to stocks as a.s.sets since it does not prevent their buying bonds. I abstract from the legal restrictions that prevent many banks from buying stocks. The fundamental reason is to be found elsewhere. The point is to be found here: the transaction whereby property rights in roadbed, rolling stock, etc., were collected into property rights in a going, organic whole increased the saleability of all these rights; the further subdivision of these rights into many thousands of equal parts enormously increased the saleability of these rights, especially when coupled with listing in an organized market; the further transaction, by which a preferential claim upon these subdivisions of rights is embodied in a collateral note still further increases the saleability of the value of these rights.

The whole of the value embodied in a share of stock has not the certainty and saleability which a banker wishes for his a.s.sets. It might not be possible to market the stock on a given day without loss. But a collateral note, embodying 80% of that value, with provision for additional collateral in case the margin is reduced, is highly liquid and the banker has no doubt that, with watchfulness, he can always realize the full face value of such a note. It becomes saleable enough for his purposes. The transaction by which this note is exchanged for the banker's demand obligation gives the drawer of the collateral note a perfectly saleable form of value with an almost universal market, which he can convert without loss into practically anything that money can buy. We have here a series, a scale, saleability of rights growing steadily greater, through a series of transformations and exchanges, till at last the virtually perfect saleability is reached. Again we are reminded of Menger's a.n.a.lysis[516] of the methods of primitive barter, whereby the man who possesses a good of low saleability, through successive exchanges, gradually gets goods of higher and higher saleability, until he finally reaches his goal. Bank-credit, this most highly saleable of all forms of rights except the rights to actual money in hand, and in general not inferior to money, cannot usually be had by direct offer to the bank of crude property rights. These must be refined and distilled, till a central core of highly saleable value emerges, and then they may enter the bank's a.s.sets in return for bank-credit. The best bonds likewise offer such a central core of highly saleable value.

A further point is to be noticed about this scale of saleabilities. At each stage of the exchanges of less saleable for more saleable rights, the holder of the less saleable rights must make concessions to the holder of the more saleable rights. And the degree of his concession is, in general, correlated with the lack of saleability of what he offers.

Commonly this takes the form of giving up a right which has a higher yield for one which has a lower yield. Or, viewed more fundamentally, from the angle of the capitalization theory, income-bearers of low saleability are capitalized at a higher discount rate than income-bearers of higher saleability, with the same yield. Farm lands may be capitalized on a 10% basis. (There will be great differences between regions in this, depending in considerable measure, often, on the activity of farm sales. I would refer here to the facts mentioned in my chapter on "The Quant.i.ty Theory and International Gold Movements,"

contrasting Ca.s.s Co., Iowa, with Yazoo Co., Mississippi. Of course, the risks of agriculture count heavily, also, and the prestige of owning land as compared with other forms of property.) The farmer's mortgage note may bear 7%. A merchant who holds that note may use it as collateral, with a margin, backing his own note, and get accommodation for three months at 6%. The bank may rediscount the note of the merchant, giving it its own endors.e.m.e.nt, on a 4-1/2% basis. The coal mine owned by a small company may yield 12%; sold to a large iron company, which combines mining and smelting and manufacturing, that mine may be represented by 7% stock; a collateral loan, for sixty days, based on 80% of the value of the stock may be had for 4%; the demand liability of the bank given in exchange for the collateral note will either yield nothing at all, or else yield a low per cent, one, one and a half, or 2%, on large checking accounts. If the collateral note be a call note, the rate will be lower, in general, than on a time note. I here refer to what was said in the chapter on the functions of money with reference to the relation of short loans, especially call loans, to the "bearer of options" function of money. Part of the yields of these loans is in the bearing of options. This function grows out of the uncertainties of a dynamic market. It would disappear if uncertainties, "friction," and dangers disappeared.

The importance of liquidity and saleability in the a.s.sets of a banker needs little discussion. It has been reiterated by virtually every writer on the subject. Its connection with the need for meeting demand obligations is obvious. The point that I would here emphasize is, however, that this, too, grows out of dynamic changes, uncertainties, etc. An economic life in "normal equilibrium," in static balance, with all things going smoothly, in antic.i.p.ated ways, could dispense in large measure, or wholly, with such liquidity. Obligations which matured at the time that the holders of the obligations had maturing obligations, would serve their purpose perfectly. Again I would emphasize the fact that the theory of money and bank-credit is essentially a dynamic theory, and that the notion of "normal equilibrium" which underlies the quant.i.ty theory has no bearing whatever on these fundamental matters.

The market where fluid bank-credit is exchanged for less fluid rights has been given the name, "the money market." The prices fixed in this market are "money-rates," figured as percentages on the amounts of bank-credit exchanged for the less fluid rights. It is, of course, strictly speaking, not a money market. Money, as the term has been used in this book, has been taken to mean gold coin, subsidiary coin, government paper, and for the United States, bank-notes. In a country where much bank-credit is elastic bank-notes, it is better to distinguish money from bank-notes. The term, money, is not one easily defined in a logical manner. A good logical definition should seize on some essential characteristic of the object defined, should include all the objects of that cla.s.s, and should exclude all others. We can meet the tests of inclusiveness and exclusiveness in a definition of money, but we can hardly meet the first test. The differences between gold money, for example, and gold bullion are less than the differences between gold money and government paper. The differences between bank-notes and bank-deposits are less than the differences between bank-notes and government paper, or bank-notes and gold. The term, money, covers a group of more or less miscellaneous things, concerning all of which few general laws are possible. Gold, or other standard money, in particular, may obey different laws from other forms of money.

I have been careful, in the foregoing, to avoid the danger of letting the argument rest on any ambiguity in the meaning of the term, however, and for the present shall not attempt further definition. For the present, we shall use the term, "money market," in its familiar sense, as meaning that market in which bank-credit is exchanged for less fluid rights. An organized money market commonly appears only in larger cities. In smaller places, relations.h.i.+ps between banks and customers are much more personal, and indeed, even in larger cities, regular business houses have particularly intimate relations with special banks. A fluid, impersonal market, to which men may repair without reference to anything but the marketability of the collateral they have to offer, is a distinctively metropolitan affair. Only large dealers commonly have relations with more than one or two banks. Larger houses in the big cities often do sell their "commercial paper" through brokers, and some of the big New York mercantile houses have had their paper scattered a good deal throughout the country. The lack of protection which houses which sought such credit faced during the Panic of 1907 tended to check the practice in some measure, but it has revived, and even increased.[517] In the matter of a wide market for commercial paper, however, an impersonal market, with great fluidity, we are well behind not only England, but also Continental Europe. The London acceptance house has especially contributed to an impersonal market. The American money market is _par excellence_ a New York market, and the primary type of paper discounted in the American money market is stock exchange paper, and foreign bills of exchange. For commercial paper, however, there are innumerable more personal, more restricted, markets, and commercial paper const.i.tutes a very considerable part of banking a.s.sets, though much less than is often supposed. But this we shall discuss in the next chapter.

CHAPTER XXIV

CREDIT--BANK a.s.sETS AND BANK RESERVES

In traditional discussions of banking, the impression is given that commercial paper is the normal and dominant type of banking a.s.sets.[518]

To one accustomed to this view, the figures of the Comptroller of the Currency for banking investments in the United States for 22,491 banks of all kinds (State, national, private, and savings banks, and trust companies) in 1909,[519] will occasion dismay:

(000,000 omitted) Loans on real estate $ 2,505 Loans on other collateral security 3,975 Other loans and discounts 4,821 Overdrafts 69 United States bonds 792 State, county and munic.i.p.al bonds 1,091 Railroad bonds and stocks 1,560 Bonds of other public service corporations 466 Other stocks, bonds, etc 703 Due from other banks and bankers 2,562 Real estate, furniture, etc 544 Checks and other cash items 437 Cash on hand 1,452 Other resources 111 -------- Total Resources $21,095

These figures, however, call for further a.n.a.lysis. They include figures from inst.i.tutions which should not be counted with commercial banks. The percentage of real estate loans, especially, is too high to represent the workings of commercial banks, a very high percentage of real estate loans being held by stock and mutual savings banks. The other items, however, are not much changed by the inclusion of savings banks and private banks. It will be well to draw some conclusions from these aggregate figures for all cla.s.ses of inst.i.tutions, before taking up a more detailed a.n.a.lysis of State and national banks, and trust companies.

Where, among these items, does one find "commercial paper"? In the reports of the metropolitan papers, giving daily variations in interest rates, it is usual to find "commercial paper" listed as a separate category, coordinate with "sixty day paper," "ninety day paper," etc.

Recent periodical discussion has gone elaborately into the question as to what should be called "commercial paper," from the standpoint of the policy of the Federal Reserve Banks. I think it safe to say that no two markets, at present, in the United States will use the term in precisely the same way, and that all would restrict the term to a small portion of the "other loans and discounts" listed above. The most general definition of "commercial paper" would be paper bought through note-brokers. Despite the decided increase in loans and discounts which our war prosperity has involved, there has been very frequent complaint of the scarcity of "commercial paper." I shall use the term, "commercial paper" in a much more liberal sense than the American money market does, and shall mean by it all loans of a really liquid character, made by banks to merchants and others to pay for the purchase of goods in antic.i.p.ation of a resale within the term of the loan which will enable the loan to be repaid at maturity. From this should be excluded, however, loans made to speculators. With this liberal, and not very precise, definition of commercial paper, we raise again the question as to where it may be found in the items above given.

Virtually all of it, I think, must be found in the item, "other loans and discounts"--an item which, in all, is slightly less than 23% of total banking a.s.sets.[520] But not all of this "other loans and discounts" is commercial paper. Very much indeed represents loans of a non-liquid character, regularly renewed, which manufacturers and others have put, not into moveable goods, but into fixed forms of capital-goods, as machinery, and even buildings. One case in New York, which the writer is informed by a business man well acquainted with both banking and business in many sections of the country is typical of many cases, is as follows: a New York bank is at present lending to a small manufacturer of automobile supplies about $30,000. Of this, about $10,000 is liquid, periodically covered by "bills receivable," and if the bills receivable should fail, in the period in question, to cover the $10,000, the bank would insist on a reduction of the loan. The remaining $20,000, however, is not liquid. It was spent for non-moveable equipment; the bank expects to renew the notes for this loan periodically, and is well aware that it could not force collection without bringing the business to a close--or else forcing the factory to get accommodation elsewhere. The $10,000 that is liquid is by no means all spent for goods, but is spent, in part, for wages. _None_ of the $10,000 is spent for goods which are to be resold without being transformed by manufacture. None of the $30,000, therefore, is, in the strict sense, "commercial paper." It is manufacturer's paper. Part of it is virtually as liquid as commercial paper; two-thirds of it is not liquid.

A very large part indeed of bank-loans are of this character. A large part of the loans made to farmers are in no sense liquid: when the loan is made, for, say, six months,[521] it is perfectly understood by both bank and borrower that a renewal will be asked for and granted. It is impossible to say what fraction of this $4,821,000,000 of "other loans and discounts" is really liquid commercial paper, or liquid paper of any kind, in the sense that it can be automatically paid off at maturity. I venture the statement with entire confidence, however, that the proportion of liquid paper is not one-half of the amount. I should question if more than one-fourth of it is truly liquid, in the sense in which that term is commonly used: meaning that the loan is made to put through a transaction which will be completed during the term of the loan, and permit the loan automatically to be paid off. I do not mean by this merely that the banks could not reduce this item by one-fourth suddenly. Even in a market made up wholly of highly liquid paper, an arbitrary refusal to renew one-fourth of the loans, with the effort to reduce loans and discounts by one-fourth, would occasion great embarra.s.sment and even disaster. The test of liquidity here applied relates to the items separately, on the a.s.sumption that other things are not radically changed. Even in this sense, however, viewing each loan transaction separately, it may well be questioned if the banks in the United States could find among their "other loans and discounts" items exceeding a fourth of the total (in value) which they could refuse to renew, at least in large part, without disappointing reasonable expectations, and embarra.s.sing good business men.[522]

Of this paper, not truly liquid, no doubt a good deal is advanced to wholesale and retail merchants, and is, in this sense, commercial paper.

The terms, "liquid paper" and "commercial paper" by no means run on all fours! As will later appear, the bulk of liquid banking a.s.sets are not commercial paper at all. And only that part of a bank's loans to a merchant may be called "liquid" which can be paid off by the merchant without disappointing his reasonable expectations,--causing him to seek other banking connections.

There is, however, another item in which we may find some commercial paper, and this is the item, "loans on other collateral security." This has commonly been supposed to be virtually all stock exchange loans.

Thus, Conant[523] cites the growth in this item in New York as evidence of the growth of loans on stocks and bonds. For New York, loans on stocks and bonds do make up the great bulk of this item. Even in New York, however, there are other factors in it, absolutely, even though not relatively, important, and in the country outside, the other elements are not at all negligible, even though for the outside country the part secured by stocks and bonds is the major part, and even though the growth of this item in our total banking a.s.sets is, in general, fairly indicative of the growth of loans secured by stocks and bonds.

Figures for the other items are not available for State banks, trust companies or savings and private banks. They are not till very recently available for national banks. In 1915,[524] however, the Comptroller separates the item, "loans on other collateral security," for national banks, into two parts, (1) loans "secured by stocks and bonds"

($1,750,597,273), and (2) loans "secured by other personal securities, including merchandise, warehouse receipts, etc." ($882,749,812). Is there any commercial paper in this last, not inconsiderable, item?

Let us locate the item, in the effort to find out. The percentage runs highest in Chicago, where this cla.s.s of collateral loan exceeds the loans on stocks and bonds. The inference is strongly suggested, therefore, that much of it, there, at least, represents advances to live-stock, grain and produce traders and speculators on the Board of Trade, at the stock yards, etc. The inference is strengthened by the fact that St. Louis, where there is a good deal of grain and commodity speculation, shows more than twice as much of this kind of paper as does Boston, where this kind of speculation is unimportant--despite the fact that Boston's aggregate collateral loans of all kinds greatly exceed such loans in St. Louis. In New York, where there is a great deal of coffee and cotton speculation, and some other commodity speculation, the amount of this paper, though relatively small, is absolutely greater than in any other city. No doubt, in New York, which is the country's centre for foreign commerce, a fair amount of the paper secured by "other personal securities, including merchandise, warehouse receipts, etc.," is really commercial paper, representing advances to importers and exporters--though the difficulties of giving this kind of security where goods are in transit would prevent most of our foreign trade being financed in this manner. The total of this kind of paper in New York--all these figures are for national banks alone--was only 113 millions on June 23, 1915.[525] It may be doubted if very much of this paper, in the great cities, represents goods in transit. With the caution that the view here expressed is based on inference, and not on actual knowledge of what the large city banks are doing, the writer concludes that probably the bulk of this paper, in large cities, represents loans to speculators rather than to merchants. It is liquid, but it is not commercial paper.

What of such paper in the country districts? Nearly one-half--$436,000,000 out of $882,000,000--of these national bank-loans on "other personal security, including merchandise, warehouse receipts, etc.," are in the country, outside the Reserve and Central Reserve Cities. Much of it is in the South. Much of it in the grain and live-stock producing regions. What do such loans mean?[526] Much of it is loans to farmers and planters. In the South, much of it is on crop liens. The loans on cotton warehouse receipts, at least in the country parts of the South, are not as great as is commonly supposed. In the North and West, there are a great ma.s.s of farmers' chattel mortgage loans, including loans on horses, grain in cribs, hogs, sheep, cattle, mules, etc. The use of this type of paper for financing the breeding and feeding of live-stock, particularly hogs, cattle and sheep, is very extensive. Virtually all loans to farmers and feeders for these purposes are secured by such chattel mortgages. It seems improbable that a great deal of this paper could represent ordinary commerce. Neither wholesalers nor retailers can easily handle merchandise on which chattel mortgages have been given. The usual method of granting credit to them is to advance loans on one and two name paper, unsecured. Not many loans to retailers and wholesalers will fall in the category under discussion.

To what extent are the loans of this type to farmers liquid? Well, the crop lien loans in the South have a natural term, and, though commonly longer loans than bankers have in mind when speaking of liquid paper, are liquid in the sense that they are automatically paid off at maturity. Loans on work-animals need not have a natural term. Loans on animals being fed for the market have such a natural term, and are truly liquid. Loans, however, on breeding animals are not thus liquid, such loans are commonly regularly renewed at maturity, and the banks do not count on them in emergencies. It is the opinion of Dr. J. E. Pope that fully two-thirds of the aggregate loans on live-stock chattel mortgage security are to breeders rather than to feeders, and hence are not liquid. Of course, none of these loans are commercial paper.

I conclude, therefore, that the thesis with which we started that the overwhelming bulk of commercial paper is to be found in the item, "other loans and discounts" is correct. I see no reason to suppose that an a.n.a.lysis of the loans of State banks and trust companies would show a different conclusion. We lack the figures for breaking up the collateral loans of State banks and trust companies into the two cla.s.ses, "secured by stocks and bonds" and "secured by other personal securities, including warehouse receipts, merchandise, etc." We have merely the gross figures for collateral loans. As the State banks are in large degree country banks, it is probable that the percentage of commodity collateral as compared with stock exchange collateral for State banks would be larger than for national banks. However, the total of collateral loans for State banks is relatively small--559 millions, for 1909, as against "other loans and discounts" for State banks in that year of 1,112 millions, and as against a total of collateral loans of all banks reporting in that year of 3,975 millions. On the other hand, the collateral loans of the trust companies are very large: 1,222 millions for 1909, as against "other loans and discounts" for the trust companies in the same year of 460 millions. As the trust companies are chiefly city inst.i.tutions, and as the concentration of trust company loans and capital in New York City is relatively very great, it would seem pretty clear that taking both State banks and trust companies into account would substantially lessen the percentage of loans "secured by other personal security, including merchandise, warehouse receipts, etc.," to total collateral loans. As the amount of commercial paper in this cla.s.s of loans for national banks is probably small, it may be expected to be still smaller in the aggregate of collateral loans.

The following figures, for State and national banks, and trust companies, only, will, in the light of the foregoing, give us basis for some further conclusions regarding the character of banking a.s.sets in the United States. As before, the year 1909 is chosen:

(000,000 omitted)[527]

_State _National _Trust _Aggre- _Resources_ Banks_ Banks_ Companies_ gate_

Real estate loans 414 57 377 848 Collateral loans 559 1,939 1,222 3,720 All other loans 1,112 2,966 460 4,538 U. S. bonds 5 740 3 748 State, county and munic.i.p.al bonds 65 156 155 376 Railway stocks and bonds 75 351 362 788 Bonds of other public service corporations 50 148 168 366 Other bonds, stocks, etc 95 208 769 1,072 Total of items here listed 2,375 6,565 3,516 12,456 ----- ----- ----- ------ Total Resources 3,338 9,368 4,068 16,774

This table makes clear that the figures for real estate loans given in the table for all banks, a few pages preceding, were much too high. It leaves the relations among the other items, however, not greatly changed. "All other loans" increase from slightly less than 23% of total a.s.sets to 27%. If we concede that one-half of the "all other loans"

represents liquid "commercial paper"--a very liberal estimate, as we have previously concluded--we get about 13-1/2% of the a.s.sets of these inst.i.tutions in the form of "commercial paper," an increase over the 11-1/2% to be a.s.signed on the basis of the other table. The figure is the roughest sort of approximation. I attach little importance to the exact percentage, and the argument which follows is not dependent on any exact figure here. The proportion of collateral loans to total resources is changed also, and even more: collateral loans are 18% of total bank resources when all kinds of banks are included, and are over 22% of total bank resources when only State and national banks and trust companies are counted. If the foregoing is correct within very wide limits of error as to the amount of commercial paper, collateral loans very substantially exceed commercial paper. If all the "all other loans"

should be counted as commercial paper, collateral loans are still not far behind them--22% as against 27-1/2%.