reference was made to the fact that under modern conditions a considerable proportion of commercial transactions is performed by means of credit and credit instruments. Having now considered the nature, functions and operations of credit and credit instruments we may examine the question of the effect of credit upon prices. Some writers maintain that credit has no influence whatever on prices; that the general level of prices is determined by the supply of and the demand for standard money; that credit transactions are based on the price level thus determined; and that the credit instruments arising from such transactions are finally cancelled without having exercised any influence on prices. Others assert that credit, which virtually means purchasing power, influences prices exactly as money does. Credit undoubtedly increases the supply of purchasing power and so may seem to have the same effect on prices as an increase in the quantity of money. The price of an article put up for sale is affected quite as much by the offer of a man of undoubted credit who asks to have it charged to him or who gives his promissory note in payment as by a cash offer. But it must be remembered that credit merely postpones the payment of money. Sometime the credit obligation must be liquidated in money, and money used for this purpose will not be available for other transactions. If all credit transactions cancelled each other automatically and completely, making it unnecessary to use any actual money, credit would be a perfect substitute for money and as such would act upon prices just as money does. In practice, however, no such complete and exact cancellation takes place. Against the uncancelled balance a reserve of money must be kept, the amount of which will vary with business conditions and customs and various other factors. This demand for money to settle uncancelled balances measures the real influence of credit on prices. Since most credit transactions are based upon bank loans, banks must keep a reserve of money sufficient to liquidate credit balances and thus to maintain confidence in the ulti mate payment of credit obligations. How much money is needed as a basis of credit only experience can tell. It varies in different countries and in the same country at different times. It must always be sufficient to maintain confidence, which is the cornerstone of credit. The amount of money thus set aside as a reserve reduces the total available for actual cash transactions and so tends to lower the price level.1 Credit, therefore, exerts the same kind of influence upon price as money, but to a lesser degree, owing to the fact that "a portion of its ideal efficacy as a substitute for money is lost through the necessity of keeping on hand a reserve for which no substitute can be employed."2 In so far as credit and credit instruments dispense with the use of actual money, they affect prices in the same way that money does. Credit lessens the demand for money as a medium of exchange and as a store of value. If, for example, banks should refuse to honor checks under $100 it is clear that everyone would be obliged to carry much more cash than at present, and the demand for money would vastly increase. If the supply of government currency or bank notes were not correspondingly increased the value of money would rise and prices would fall. The use of credit money and credit in the form of checks and drafts reduces the amount of currency needed for pocket and till money, and legal tender money serves as well as money itself for bank reserves. Credit money, like every other form of credit, by economizing the use of money, lessens the demand for it and so lessens its value. When people have perfect confidence in the ability of the government to redeem its notes and they are made legal tender and available for bank reserves, an increase in government credit money tends to raise prices in the same way as an increase in gold itself. Bank notes, too, serve as substitutes for money and by lessening the demand for money 1 Kinley: The Use of Credit Instruments (Nat. Mon. Comm.), pp. 213-214. 2 Seligman: Principles of Economics, p. 552. tend to raise prices. Credit does not increase the supply of money, but it does increase its efficiency, enabling a country to get on with a smaller supply of money than would otherwise be necessary. An expansion of credit, therefore, exerts the same upward tendency on prices as an increase of the money supply.1 In view of the fact that credit is so elastic and that its influence in raising prices is naturally cumulative, its use must be carefully guarded if over-expansion and speculation are to be avoided. As prices rise in response to the increased credit demand for goods, the owner of the goods finds that he can get larger credit at his bank, for the goods are worth more. With confidence and buoyancy in business, this process may be repeated until prices reach a dangerously high level. The total amount of credit based upon goods at these inflated prices may become so great that the uncancelled balance may be too large for the money reserve to sustain. If before this stage is reached credit is not contracted or reserves increased, a money stringency, possibly a crisis, will result, causing great loss to the business community by a rapid fall in the price level.2 The influence of credit upon prices, therefore, operates through its effect on the demand for money, and especially on the proportion between money in circulation and that required as a reserve for credit transactions. READING REFERENCES Cleveland: Funds and Their Uses, Chs. III, IV. Hagerty: Mercantile Credit, Chs. I-V. Herrick: Rural Credits. Hobson: Gold, Prices and Wages, Ch. VII. : Laughlin Principles of Money, Ch. IV. : 1 Johnson: Money and Currency, p. 63. 2 Kinley: Money, p. 223. Moulton: Principles of Money and Banking, Pt. II, Chs. II-III, IX. Phillips: Readings in Money and Banking, Ch. X. Scott: Money and Banking, Ch. VI. Taussig: Principles of Economics, Bk. I, Ch. 31. Wall: The Bankers' Credit Manual. PART II. BANKING CHAPTER VIII ORIGIN AND DEVELOPMENT OF BANKING 63. Early banks. The authorities are not agreed as to the origin of the term "bank." Some trace it to the "banc" or bench where the early money changers kept their coins and plied their trade. Others claim that it is derived from "banck, the German name for a joint stock fund, which was converted by the Italians into "banco," meaning a heap or accumulation of money or stock.1 In colonial days in Massachusetts the issue of paper money was referred to as "raising a Banke," the word bank meaning the money rather than the institution which put it in circulation. The modern banker, as has previously been shown, is primarily a dealer in credit. Originally he dealt in money, his business being to exchange one form of coin for another, both domestic and foreign. Early, however, the Athenian and Roman bankers began to receive deposits of money, to make loans, sometimes based on valuables, and even to transfer money and credits. "Traces of credit by compensation and by transfer orders are found in Assyria, Phoenicia, and Egypt before the system attained full development in Greece and Rome. The books of the old Sanskrit lawgiver, Manu, are full of regulations governing credit. He speaks of judicial proceedings in which credit instruments were called for, of interest on loans, of bankers, usurers, and even of the renewal of commercial 1 MacLeod: Theory of Credit, Bk. I, p. 315. |