The Theory of Money and Credit

To comprehend the significance of fiduciary media, it is necessary to examine the nature of credit transactions.

Acts of exchange, whether direct or indirect, can be performed either in such a way that both parties fulfill their parts of the contract at the same time, or in such a way that they fulfill them at different times. In the first case we speak of cash transactions; in the second, of credit transactions. A credit transaction is an exchange of present goods for future goods.

Credit transactions fall into two groups, the separation of which must form the starting point for every theory of credit and especially for every investigation into the connection between money and credit and into the influence of credit on the money prices of goods. On the one hand are those credit transactions which are characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does—the forgoing of immediate power of disposal over the exchanged good, or, if this version is preferred, the forgoing of power of disposal over the surrendered good until the receipt of that for which it is exchanged. This sacrifice is balanced by a corresponding gain on the part of the other party to the contract—the advantage of obtaining earlier disposal over the good acquired in exchange, or, what is the same thing, of not having to fulfill his part of the bargain immediately. In their respective valuations both parties take account of the advantages and disadvantages that arise from the difference between the times at which they have to fulfill the bargain. The exchange ratio embodied in the contract contains an expression of the value of time in the opinions of the individuals concerned.

The second group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party. Thus the difference in time between fulfillment and counterfulfillment, which is just as much the essence of this kind of transaction as of the other, has an influence merely on the valuations of the one party, while the other is able to treat it as insignificant. This fact at first seems puzzling, even inexplicable; it constitutes a rock on which many economic theories have come to grief. Nevertheless, the explanation is not very difficult if we take into account the peculiarity of the goods involved in the transaction. In the first kind of credit transactions, what is surrendered consists of money or goods, disposal over which is a source of satisfaction and renunciation of which a source of dissatisfaction. In the credit transactions of the second group, the granter of the credit renounces for the time being the ownership of a sum of money, but this renunciation (given certain assumptions that in this case are justifiable) results for him in no reduction of satisfaction. If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him. He could confer credit in this form free of charge, if we disregard the technical costs that may be involved in the issue of notes and the like. Whether he is paid immediately in money or only receives claims at first, which do not fall due until later, remains a matter of indifference to him.3

It seems desirable to choose special names for the two groups of credit transactions in order to avoid any possible confusion of the concepts. For the first group the name commodity credit (Sachkredit) is suggested, for the second the name circulation credit (Zirkulationskredit). It must be admitted that these expressions do not fully indicate the essence of the distinction that they are intended to characterize. This objection, however, which can in some degree be urged against all technical terms, is not of very great importance. A sufficient reply to it is contained in the fact that there are no better and more apt expressions in use to convey the distinction intended, which, generally speaking, has not received the consideration it merits. In any case the expression circulation credit gives occasion for fewer errors than the expression emission credit (Emissionskredit), which is sometimes used and has been chosen merely with regard to the issue of notes. Besides, what applies to all such differences of opinion is also true of this particular terminological controversy—the words used do not matter; what does matter is what the words are intended to mean.

Naturally, the peculiarities of circulation credit have not escaped the attention of economists. It is hardly possible to find a single theorist who has devoted serious consideration to the fundamental problems of the value of money and credit without having referred to the peculiar circumstances in which notes and checks are used. That this recognition of the individuality of certain kinds of credit transactions has not led to the distinction of commodity credit and circulation credit is probably to be ascribed to certain accidents in the history of our science. The criticism of isolated dogmatic and economico-political errors of the Currency principle that constituted the essence of most nineteenth-century investigation into the theory of banking and credit led to an emphasis being placed on all the factors that could be used to demonstrate the essential similarity of notes and other media of bank credit, and to the oversight of the important differences that exist between the two groups of credit characterized above, the discovery of which constitutes one of the permanent contributions of the Classical School and its successors, the Currency theorists.

The peculiar attitude of individuals toward transactions involving circulation credit is explained by the circumstance that the claims in which it is expressed can be used in every connection instead of money. He who requires money, in order to lend it, or to buy something, or to liquidate debts, or to pay taxes, is not first obliged to convert the claims to money (notes or bank balances) into money; he can also use the claims themselves directly as means of payment. For everybody they therefore are really money substitutes; they perform the monetary function in the same way as money; they are “ready money” to him, that is, present, not future, money. The practice of the merchant who includes under cash not merely the notes and token coinage which he possesses but also any bank balances which he has constantly at his immediate disposal by means of checks or otherwise is just as correct as that of the legislator who endows these fiduciary media with the legal power of settling all obligations contracted in terms of money—in doing which he only confirms a usage that has been established by commerce.

In all of this there is nothing special or peculiar to money. The objective exchange value of an indubitably secure and mature claim, which embodies a right to receive a definite individual thing or a definite quantity of fungible things, does not differ in the least from the objective exchange value of the thing or quantity of things to which the claim refers. What is significant for us lies in the fact that such claims to money, if there is no doubt whatever concerning either their security or their liquidity, are, simply on account of their equality in objective exchange value to the sums of money to which they refer, commercially competent to take the place of money entirely. Anyone who wishes to acquire bread can achieve his aim by obtaining in the first place a mature and secure claim to bread. If he only wishes to acquire the bread in order to give it up again in exchange for something else, he can give this claim up instead and is not obliged to liquidate it. But if he wishes to consume the bread, then he has no alternative but to procure it by liquidation of the claim. With the exception of money, all the economic goods that enter into the process of exchange necessarily reach an individual who wishes to consume them; all claims which embody a right to the receipt of such goods will therefore sooner or later have to be realized. A person who takes upon himself the obligation to deliver on demand a particular individual good, or a particular quantity of fungible goods (with the exception of money), must reckon with the fact that he will be held to its fulfillment, and probably in a very short time. Therefore he dare not promise more than he can be constantly ready to perform. A person who has a thousand loaves of bread at his immediate disposal will not dare to issue more than a thousand tickets each of which gives its holder the right to demand at any time the delivery of a loaf of bread. It is otherwise with money. Since nobody wants money except in order to get rid of it again, since it never finds a consumer except on ceasing to be a common medium of exchange, it is quite possible for claims to be employed in its stead, embodying a right to the receipt on demand of a certain sum of money and unimpugnable both as to their convertibility in general and as to whether they really would be converted on the demand of the holder; and it is quite possible for these claims to pass from hand to hand without any attempt being made to enforce the right that they embody. The obligee can expect that these claims will remain in circulation for so long as their holders do not lose confidence in their prompt convertibility or transfer them to persons who have not this confidence. He is therefore in a position to undertake greater obligations than he would ever be able to fulfill; it is enough if he takes sufficient precautions to ensure his ability to satisfy promptly that proportion of the claims that is actually enforced against him.

The fact that is peculiar to money alone is not that mature and secure claims to money are as highly valued in commerce as the sums of money to which they refer, but rather that such claims are complete substitutes for money, and, as such, are able to fulfill all the functions of money in those markets in which their essential characteristics of maturity and security are recognized. It is this circumstance that makes it possible to issue more of this sort of substitute than the issuer is always in a position to convert. And so the fiduciary medium comes into being in addition to the money certificate.

Fiduciary media increase the supply of money in the broader sense of the word; they are consequently able to influence the objective exchange value of money. To the investigation of this influence the following chapters are devoted.

• 3See Macleod, The Elements of Banking (London, 1904), p. 153.