The Stock Market, Credit and Capital Formation

CHAPTER I

COMPETITION IN THE CREDIT MARKET

1. The various types of borrowers, who compete for the limited supply of credit, evoke very different sentiments among critical observers of the economic system. The class of borrowers which is least sympathetically regarded by the critics is that which uses the purchasing power, put at its disposal, on the stock exchange. This is not surprising considering the attitude adopted by a large section of the community towards stock exchanges, towards the business that is transacted thereon, and towards the people who frequent them. In so far as this is the mere expression of the resentment of the general public toward the “easy” and “effortless” gains of traders on the stock exchange, or the contempt of the moralists for “unscrupulous” speculation1 or even the lack of respect of naïve economic politicians for every kind of activity which is unproductive in a technical-physical sense, there is no scientific problem involved. But there are serious scientific problems involved in the arguments of many economists who have come to take sides with or against particular classes of borrowers.

Antipathies exist against stock exchange credit.

2. It is a fundamental proposition of the theory of value and prices, and one which is to be found without exception in every introductory text to economics, that under conditions of perfect competition the available supply of any commodity will go to those buyers who offer the highest price for it. Whether we take the popular example of the horse market, or the orange market, or any other textbook example, there are always “excluded buyers” who are squeezed out of the market because other buyers outbid them. The pricing mechanism works in such a way as to distribute the limited supply among those who offer most, and to restrict the quantity demanded to the quantity supplied.

The weaker bidder is squeezed out of the market.

This explanation of the exchange mechanism constantly called for treatment of the problem of the comparability of the intensity of wants of different persons; otherwise it was open to question whether the result might not be to satisfy “less important” wants while leaving “more important” wants unsatisfied. It was only when the impossibility of measuring the needs of different individuals came to be recognized that most economists decided to be content with a general prefatory reservation and to assume, for all practical purposes, that the amounts of money offered were the measure of the importance of wants.

Writers often regard effective demand as a measure of wants—

It is a common experience to find that objections which have been disposed of in the early stages of an analysis, obstinately re-emerge at later stages. The same objection which was dealt with and turned away in building the foundation of a structure is liable to reappear, often in another guise, a story higher, where it requires to be dealt with anew. Thus the objection that economic importance or urgency should be measured in terms of indices other than the monetary expression on the free market, makes its reappearance in connexion with the controversy on productivity, where it takes the form of the question whether the distribution of productive factors in the exchange economy does actually tend toward securing the maximum product. A systematic adherence to the basic assumptions of pure theory led to the conclusion that the “productivity objective” was realized by pursuing the “profit motive.” It appeared to those who had previously disposed of the difficulty of ranging economic ends in order of importance, that it was impossible to construct a productivity concept which was divorced from the concept of profit and which was at the same time unobjectionable from a methodological standpoint; and that pure economic theory must be satisfied with the profit standard.

—and profits as a measure of productivity.

But even those economists who accept this thesis have new pangs of conscience when they come to treat specialized problems, and again find themselves doubting the rationality of the results established by the working of the free market. And so they begin to re-examine exchange transactions from the standpoint of whether it would not be “better for society” if a different set of people were successful in obtaining what the market had to offer.

This is essentially what lies at the heart of the problem of the distribution of the available supply of credit among the various borrowers. When at certain times a large part of the credit supply is “taken up” by the stock exchange, because it is the strongest bidder on the credit market, critical observers remark that “it is a shame that the stock exchange should have secured credits of which industry could have made much better use.”

The stock exchange may be the strongest bidder for credit.

The adherent of laissez-faire economics may decline from the beginning even to examine the question whether “industry” “is entitled to” credits in preference to the “stock exchange.” He may avoid considering the motives, conclusions and false deductions of the critic, by having recourse to the argument that it is absurd both, theoretically and practically to combat the results of free competition for credit. The adoption of this attitude precludes all discussion before it has begun. The reasoning behind would run somewhat as follows: “If the credits were taken up by the stock exchange, the stock exchange was obviously able to outbid the other potential borrowers by paying a higher rate of interest, and it was undoubtedly enabled to do this by reason of its more profitable opportunities for employing the borrowed purchasing power. The employment of credit on the stock exchange being more profitable than elsewhere, it follows that the credit is being put to its most productive use, and any further argument is beside the point.”

No problem is left for a laissez-faire stalwart.

There are several reasons why the present author’s intention is not to dispose of the problem in this simple manner, but to examine it in detail. First, it has to be recognized that the thesis that the productivity concept can be interpreted in terms of the profit principle is no longer universally accepted by pure theorists and still less by politicians. Secondly, the logic of the conclusions should be tested no matter whether or not the premises appear acceptable. Finally, the main problem is linked up with a whole series of subsidiary problems whose detailed treatment is both important and interesting.

Examination of the problem is necessary.

3. There is added reason for studying the problem of the distribution of the available supply of credit even for one whose faith in the working of free competition is unshaken. One of the most important data in the whole problem, the supply of credit itself, is in fact partly determined by political factors, and thus is not the result of the play of free forces. The modern organization of money and credit is such that it enables the banks to “create” credit (i.e., to grant credit in excess of the proceeds of intended savings) and thus makes the credit supply partly dependent on considerations of a politico-economic nature. But if the supply of credit is manipulated quantitatively, why should not its distribution among various classes of borrowers be manipulated also?

We have, then, to examine the economic arguments against a particular distribution of credit, and especially against the granting of credit to the stock exchange. The problem of the granting of credit to the stock exchange is but one aspect of the important group of questions which are usually dealt with under the heading “quantitative versus qualitative” control of credit. The examination of these problems will of course necessitate reference, at many junctures, to the elements of credit theory. It is, moreover, of the nature of credit theory that it links up with the theory of capital formation on the one side, and the theory of money on the other. In dealing with these topics we shall be dealing with crucial problems of trade-cycle theory.

The problem is one of qualitative v. quantitative control of credit.

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