By W. G. Langworthy Taylor, New York: Macmillan, 1918

Selected Quotations and Interpretations



A unique feature of Taylor's approach to the business cycle is that, instead of building a theory of credit around a foundation that was based on the the theory of money, he assumed that money was a form of credit. Thus, the theory of the business cycle was to Taylor a theory of the effects of a change in the amount of credit. (vii)

T calls his theory evolutionary (dynamic, kinetic) because it considers the economic phenomena within the context of a changing environment. However, he does not define the environment in a physical sense alone. He refers to the environment as "the circumstances under which such promises are made."(v)

The modern theory of economics shows "that considerable expansion of loans may be quite normal. But as a theory it is incomplete, for it fails to account for price fluctuations, because it regards normal credit as incapable of causing them and abnormal credit as unaccountably causing them. [The theory in this book is] that price fluctuation is itself a normal phenomena, depending upon the interacting interests of various orderly groups of producers and financiers, traceable through successive stages...(ibid.: vi-vii)



Evolutionary Point of View in the Study of Credit and First Statement

Different groups in an economy have of the returns they can earn from different types of financial investments: "Productivity thus influences interest and the price-level groupwise."(1)

T sees Austrian economics as the psychology of economics.(2,4) It is a stage in the development.

"[T]he doctrine of evolution is [not] necessarily materialistic...Its method is certainly organic and dynamic, but not inconsistent with an essentially spiritual point of view."(3) "...[T]o imagine an environment...involves a theory of social progress. Financial progress is evidently a department of social..."(5)

"In distribution the cause of value is not necessarily in the valuer."(5)

Credit, interest and prices are the three domains which contact each other.(8) The crucial phenomenon in explaining fluctuations in these domains is not time preference (racial temperament). Although time preference is "doubtless essential to men's prosperity as a wealth-begetting generation, is of no consequence to the daily or annual calculations of the business man."(7) The crucial phenomenon is the value of capital ("immediate prospects from investment"(8)), which changes as a result of changes in business calculations.(7)

"[T]he temporary value [of the circulating medium], which expresses the price-level for those periods which are most interesting in business calculations, is dependent on the state of credit. And credit, in turn, while ultimately without question hedged within severe boundaries by the rate of interest which expresses the racial sense of futurity, is for business purposes dependent upon immediate prospects for investment. It is with these practically pertinent periods that the theory of credit has imminently to do. The theory of general prices in relation to prosperity is the chief branch of the theory of credit and for it interest bulks largely."(8)

"Economy, like organic nature is a congeries of worlds within worlds."(8)

"[D]ifferent stages of production give rise to different sorts of credit, long, short, demand...Thus industry is stratified credit-wise...Thus the profits in each group and the interest for each respective stage of credit are calculated independently of those in other groups. But there is competition or 'arbitration' between the groups, leading to equalization of rent, profits, interest, or other returns or incomes."(9)

Technical guaranty -- the technical processes, plant and materials that are "a material reserve calculated to replace the goods as they become deficient."(9-10)

Banking offers material guaranty for its special form of credit, demand credit (money) -- the "reserve."(10)

"[Men] cannot produce or promise beyond their power to guarantee."(10)

"Reguaranty of credit"(10m)

"[T]he credit compartments successively guarantee each other, until demand credit is reached, which is guaranteed by money. And so the credit system is organized."(10)

The retailer promise money to the banker, the wholesaler promises goods to the retailer; the manufacturer promises goods to the wholesaler.(10)

Definition of a theory (14)

The contrast between subject and object is like the contrast between credit and money.(16m)

"Each credit instrument may thus be shown to stand in a definite relation to a general plan of capitalization, and the mass of such instruments to bind social industry into a whole dedicated to production and guaranteed against willful diversion to wasteful consumption. The great, purposeful, capitalistic machine is thus demonstrated to be a compact of individual volitions. Its dynamic ebb, flow, and control can be appreciated by the student of credit alone."(16)

"[The contrast between subject and object] should begin at and be continued from the fundamental definitions and conceptions of science. In the division of credit, it should at once appear in a clear distinction between credit and money as that between the (psychological) promise, on the one hand, and the (material) guaranty, on the other. It should show that credit is a consistent and all-prevailing manifestation of the organizing and controlling mental forces in industry and commerce; the credit documents indicate what is to be done with material things: for example, that some are consumed and others reproduced."(16-17)

"The ebb and flow of credit is a distinct problem, whose workings must be traced through many stages of industry and many temperaments of producers."(18m)

[In searching for "the reasons for the movements in the tide of credit...the task is not finished till credit has been traced into its physical basis; for the future expectations are rooted in past performances."(17-18)

"...[G]eneral price influences are conditioned from top to bottom in circles which are progressively more material."(18)

"Money affects the price-level when it is employed in making good a financial guaranty. The 'quantity theory' was crudely based on this circumstance."(19m)

"The hypothesis of a credit-using society is more practical than that of a money-using society."(22)


Chapter 1

The Field of Credit

"...a bank affords by anticipation the present use of future funds..."(23)

"Banking differs from other the regulation the banker exercises over traders and manufacturers who seek his guaranty."(23)

"[I]n time of crisis, [b]ank guaranty...alone stands between the business community and reversion to a primitive money or even to a barter economy."(23)

"Questions of prices, crises, and prosperity belong to the broader study of the credit system."(24)

Relationship between the banker and the manufacturer.(26)

The bank as a guarantor (26)

Loanable funds as rights (28)

"...[A] most important point, upon which the whole explanation of price phenomena depends, [is] that purchasing power is a matter of accumulation of guaranties."(28)

When bankers provide merchants and dealers with "present use"(28)," [i]t

is not the promised commodities that are enjoyed, but a share of subsisting, which is proportionate to the claim men have upon future goods."(29)

Footnote on Veblen (p. 29).

The financial has displaced the feudal system.(30)

The banker's reserve is like a throttle. "It can be adjusted through the mechanism of the bank discount rate."(30)

"The banker needs a greater amount of reserve than the merchant, since his must largely suffice for both...his business is so related to the merchant's that, in this matter of purchase and sale, it is the former which regulates the latter."(31) Thus, the banker is a regulator of business.

"...[T]o a large extent the banker has taken the place of the wholesale or other seller of goods to the merchant." "[The banker], therefore, occupies the position of a governor...On the other hand he has undertaken the responsibility...and, therefore, feels especially the ups and down of prosperity."(32)

"To loan on commodities is called a 'Lombard' business."(32)

Bank notes vs. deposits -- 33-35.

"[E]ach promisor-debtor...ascertains those sales or wages due, in the form of an organ generally acceptable, which in times of usual confidence, passes current in preference to money, and frees him from his servitude. A crisis is a time when this privilege is withdrawn and he is called on to pay money...Trade at a standstill and his position is critical...The banker, however, opportunely intervenes. He holds a reserve for this particular contingency....[I]n time of crisis, the bank guaranty is a public salvation." (36-37)

"The hypothesis of a credit-using community is quite typical of everyday experience."(37)

Favorable quote from Maurice Patron, Bank of France.(37-38fn)

"[During a crisis,] the community grasps for some means to carry on its affairs, and returns to the practice of an early epoch."(38)

"The employment of money during a panic is not a return to the righteous and natural medium of circulation; that is the ingenuous fallacy of the street corner. It is rather a reversion to an earlier and more primitive social housekeeping."(38) It is "social atavism."(39)

[T]he proper way is not to explain credit by money, but money by credit. The real thing to be understood, in and of itself, is the exclusively mental process by which exchange may be and is carried on, and the significance of money must be derived from its incidental association with the more highly evolved way of exchanging without it. Money is the alternative, it is, on special occasions [during crises], the substitute for credit; credit is not the substitute for money; and, therefore, its use can be explained only in connection with the usual and normal thing for which it is substituted."(39)


Chapter 2

The Utility of Credit

Chapters I-XI are concerned with prices (in terms of credit money) as an indication of men's expectations about the future or as an indication of the "outlook of the community at large with respect to prosperity."(40)

"...[I]t is as true among men as among animals that progress takes place partly by ruination of individuals." Some people think that men should be protected from ruin and that to achieve this goal, the government should "act on prices." If this was a worthwhile goal, the way to achieve it would be to act upon something anterior to prices; since prices are merely a yardstick, or gauge.(41)

"A disturbance in prices [through the lending of credit money) indicates a rise or fall in the prevalent expectations of the community as to production."(42)

"Organic inflation [is] an indication that men expect an extraordinary amount of wealth to be made available."(42)

"The naive quantity theory is illogical."(42m)

Two functions of prices: (1) rate of exchange; (2) to indicate expectations.(42) Only in a minor sense are they related to a standard of value.(42)

"Prices cannot be regulated directly any more than the pressure on a steam gauge by moving the dial."(43)

By analogy, inflation is a means of varying pressure in boilers by means of fire. If the fire is not removed, once the boom has occurred, an explosion results.(43)

"Orthodox political economy is naively materialistic."(44) History of economic thought passes from the materialism of Mill (although Mill recognized a psychological aspect), to a more general view in which materialism and mental processes are complements. The study of credit is a study of mental process.(44-45) "In credit reside the dynamics of economics. A revolution has been wrought in the student's conception of economy, which may be characterized as one from a static to a dynamic or kinetic point of would seem that the study of credit belongs to the final stage of the movement."(45)

Discussion of market-creation: widening the market, particularly in the context of international exchange -- the process is dynamic.(46-47)

Discussion of equilibrium in terms of statics and dynamics; the equilibrium is upset "by means of money or of credit."(47, 54)

An illustration of the psychic power of credit: how a note ultimately becomes more valuable than gold as it acquires more and more endorsements.(48)

"The difference between credit and economics emerges more clearly: the former has to do with the organization and manifestation of activities in industry; the latter, with its general and especially its ideal conditions."(48)

"There would be no credit in a socialistic state...[because] [o]ne object of credit is to fix responsibility." (48-49)

"[I]t is wrong to assume that the employment of credit, in the majority of cases is open to criticism simply because there have been scandals."(51)

"The materio-mental series...which is indispensable for the full explanation of credit": (1) material goods; (2) metallic money; (3) simple promises (notes and bills of exchange); (4) promises with their increasing grades as signified by endorsements; (5) promises emanating from a credit institution (a suretyship), (6) "titles to whole industrial organizations, connoting all the future goods and temporary promises which may be created or entered into in the course of fabrication."(51)

Sociology -- that branch of study in which the phenomena are human actions based on the conscious realization that the actor is like others. The phenomenon of credit, the characteristic of which is the promise of guaranty, is a sociological phenomenon. To see this, we only need to consider the note that receives increasing endorsements. Some credit ultimately becomes like No. 2 red winter wheat and a replaceable part. The socialization of credit is complete when a single credit instrument can be used for all goods.(52-54)

In discussing a bank's propensity to lend its reserves, T. says: "What was still stigmatized as dishonesty in the eighteenth century became prudent economy early in the nineteenth. Relativity of morals is the only possible ethical standard in finance."(56)

"Deposits are loans."(57)

"The the collector where the surplus [of capital] of a community gravitates, and where in general the nascent capital is to be found."(57)"...A given part of the credit represents a like part of the material capital."(58)

"...[C]onsumption [and luxury spending] cause[s] a cessation of increase, or an actual decrease, in circulating promises."(58) "This principle, which Mill illustrated with the parable of the spendthrift, appears peculiarly conclusive from the credit point of view."(58)

"[The bank] makes the whole operation in which the credit originates more certain. It puts its stamp, its seal, upon the business undertaking..."(60)

"The intercalacating its credit in the series [through discounting], delays payment but hastens liquidation. Thus gold is economized."(60) "The system of set-off or compensation afforded to the public by banks tends to hasten the kind of settlement known as liquidation, but to delay that known as payment (with money)."(40)

"There is a large mass of circulating indebtedness of the country which is not identified with any particular business or industrial process."(61)

"Crises expose the contrast between the environments which they disturb, and illustrate the apparent disregard of individuals which accompanies evolution."(61-62m)

" the course of its progress, passes integrally from one 'zone of characterization' into another. Whenever a financial crisis takes place, a contrast between entourages is evoked, which is not merely a contemporaneous setting-over-against-one-another of previously concordant elements, but is also a temporal and historical. The theory of crises rests fundamentally upon the necessity that society, in its progress, pass from crude to relatively complex conditions, signalized by greater perfection in the economies of the credit system and in the organization of industry. A wider dealing in the securities of corporations is observed. The study of crises teaches that, as in outer nature are found plants and animals endeavoring to survive under the circumstances in which they are placed, a large mass of them perishing, but finally a mode of existence working itself out which is favorable to the survivors and to their successors; in the same way, in industry, enterprisers continually attempt the impossible; the crisis comes and sweeps away the unsuccessful. They are not undeserving, in all cases; their efforts may be for the common weal, even where they appear to be selfish, for failure is the precursor of success. It is, inferentially, necessary that crises take place in order that a better system of industry may be evolved."(61-62)

"Differences between environments may be indicated by the activities of great men."(62m)

Two distinct types of men, or leaders: inventors-enterprisers and the financial type ("banker"). Different meanings of the term banker. Taylor's prefers the continental definition in which banking "embraces also those who carry on many kinds of other financial operations [than purchasing time with demand obligations], such as dealing in stocks and bonds, and underwriting or otherwise gathering funds for business enterprises and large corporations at home and abroad."(62-63)

"Credit is...mathematically the means of circulating goods. What more logical than that the surety agreement which was entered into to guarantee the production of certain commodities, would be the means by which they are exchanged?...It is incredible that in an advanced community, working upon order, marketable services should be exchanged by any other means than by credit. Therefore, metallic money, when used exceptionally for purposes of trade, is presumably filling the secondary role of a substitute for credit. It is the unusual or abnormal goal of commerce."(64)


Chapter 3

Liquidation, Set-Off and Payment

Novation: circulation of a promissory note.(68)

Liquidation: paying off the promissory note.(68)

"International exchange is manifestly a special case [simple example] of the broad principle of novation. It may be appropriately termed, the principle of paying the nearest creditor and of being paid by the nearest debtor."(70)

"Profitable business at home will, in the long run, cause cheap exchange and favor imports."(65)

"Promises are piled upon promises, like Pelion on Ossa, until a financial energy is accumulated that will draw goods from the uttermost corners of the earth and gold from the ground. It is much more efficient than metallic money."(71-72)

On British and French Laws that permitted the holder of a promissory note to collect on it even though he was not the one to which the initial promise was made.(72-73) This was just a recognition of the "law merchant," which had been the practice from the time of the Assyrians, and which allowed "the discharge of distant debts by payment to a neighboring creditor."(73)

"In the case of the banking system...(t)he deposit is the substitute for the note; as often insisted upon in these pages, it guarantees the latter. The public that gladly accepts the bank credit does not know what individual note lies under the deposit assurance. But the latter must be the guaranty of some note lying in the portfolio of some bank."(75)

"(T)he individual note was secured only by a single circle of assignees about which it travelled. Naturally, therefore, the bank deposit has a wider purchasing field."(76)

"The individual notes passing through the portfolio of the bank at a certain rate, determined by the production period of the goods in the course of manufacture, must be met pari passu, in procession, by the deposits as they return from their circle of usefulness in the exchange of goods."(76)

"The note was the evidence that established and identified the ultimate barter of goods against goods."(76)

"In the complex banking system, there is an additional cancellation, namely, of an amount of guaranty-credit or deposit equivalent to the original in the primitive mechanism."(77)

"An additional guaranty, that of the bank, is introduced for the purpose of circulation, while the original note lies in the bank. At the end of the period of credit, two guaranties are cancelled."(77m)

"The individual note lies in the portfolio of the bank, while the deposit is traveling about and doing its work. There is, therefore, no possible inflation."(78)

Reference to Dunbar and Laughlin who showed that there is less probability of inflation from business done upon credit than from that effected through other media.(78)

A discussion of international trade involving interest rates, gold, and long-term securities.(79-82)

"The most noticeable classes of credit have been those in which the intention was to make a contract of payment to be deferred during the transportation of goods. But the most important modern kinds of credit are those which run during the special "transportation" of goods known as "manufacture"; in them the noticeable thing is the time for which the promises are made."(65)

"The international principle of paying the nearest creditor is as active in the case of a discount as in that of foreign exchange, only the word "nearest" must receive a temporal interpretation."(83m)

"The guaranty fund consists of the gold which bankers collect in their reserve to make good their characteristic undertakings."(84)

"The quality which authorizes money to act as a medium of exchange is precisely that it thesaurizes (is stored), though that be but for a little while."(84)

"Credit is manifestly a more important instrument of the two..."(85)

Why gold standard proposals are unrealistic and bad.(86)

"Every deposit is, therefore, or should be, conclusive evidence that some one, some where, has entered upon the construction of useful things which bankers, expert critics of enterprise, are morally certain will result in values."(86)

..."How can paper of diverse antecedents be generalized and rendered homogeneous...In the first place, it is drawn for different lengths of time...for the evident purpose of accommodating unlike technical processes. In the second, so far as production periods do not correspond to those usual times, the producer would, indeed, be compelled to suffer the consequences by paying interest a little longer, or by renewing his indebtedness shortly before his product is marketable, did not the banks purchase the misfits, within a reasonable tolerance, and fill the breaks in the note or bill parallelism by piecing out the deficient credits with those that are excessive...The not reduced idly to hold his hands..."(88)

"The supply of paper is explained by the imperative rule that all business, under individual enterprise, must be held together by a network of contracts"(88-89)

"The system of guaranties is the essential, integral part, and is backed up by a guaranty-fund in the shape of gold to pay obligations which may not offset."(89)

"The organic correlation effected by the structure of debts holds also true for production not upon order but 'for the market'"(89-90m)

T. looks at the iron, textile, farming and planting industries to prove the "proposition...that business furnishes its own "money," which consists essentially of the obligations current in business."(91)

..."[T]he essence of the purchasing power lay in the further obligation to produce."(91m) Reference to Ruskin as a political economist.

"[A] deposit is carelessly called 'money.'"(92)

Because of the convenience of receiving a check rather than money, the creditor is never literally "paid."(92-93) Payment (in gold money) is distinguished from liquidation, which may be defined as the "refreshing of credit with newly tested indebtedness."(93) "Liquidation as distinguished from payment is the substitution of new debts for old."(92m)

"Renewed notes may be more difficult to liquidate than original, for, while they recite the identical individual obligations, they may not correspond to any additional goods manufactured...If [renewed notes] continue to circulate vicariously in the form of bank guaranties, although the cycle of manufacture has not been completed by sale, or even after the finished consumables or vendables nave been turned over again and again for other new notes, there will be a tendency to inflation."(93)

"Credit extended and production not extended spell inflation."(93)

"The principle of correspondence of credit with products is best grasped with the aid of the usual, static, economic hypothesis of normal condition."(94)

The laws ultimate reliance on payment by gold money (resort to "exactions") indicates a reversion to a more primitive environment due to a breaking down of mutual confidence.(94)

The following six chapters are concerned with the clogging or obstruction of sales that occur when someone in the circle refuses to buy what is expected and which leads to an economic crisis.(95-96)


Chapter 4

Investment and the Flow of Credit

The profits earned during each period are held by the banks. These profits are in the form of indebtedness. They are "more likely to linger" in banks than the indebtedness "which simply replaces the body of the capital engaged."(98-100)

"Documents recording indebtedness perform guaranty and circulative services."(98-99m)

"Those promises devoted to meeting expenses of manufacturing or other production are quickly liquidated or otherwise disposed of, while those destined to investment tend to collect and to form a basis for a large part of the bank deposits. Sale of capital goods is correspondingly slow."(97)

The flow of credit "acquires additional guaranties on the route toward the financial center."(97)

Another source of funds consists of the float. But the float is more subject to sudden withdrawal and disaster.(102)

"[I]t is literally true that the resources of the central bank consist of provincial business promises, indorsed by the home banks, and by those of all subsidiary centers through which it may have passed."(103)

How businesses are ordinarily formed: A promoter ("a specialist in finding employment for the catallactic current"--105) typically appeals to a bank for a stock loan or for the bank to underwrite its purchase of materials, labor, etc. Having obtained a stock loan, the promoter proceeds "to advertise the privilege of putting money into a going concern."(107) The guaranty for bank funds may come from a variety of sources.(106) But it often ultimately comes from provincial depositors and "it accumulates purchasing power on the way" to the money centers.(110) "Thus the same surplus which has at first increased the loaning facilities of the country bank, has later augmented the underwriting power of the central."(111) "The conspicuously successful businesses" typically did not start in this way but as small enterprises.(105) The principal actors are the promoter and the underwriter.

By selling securities to permanent holders, the promoter and "central" banker relieve themselves of the claim from the provincial banks.(97)

"The underwriter is enabled to be a guarantor of whole businesses by his possession of small and often distant deposits collected into great capitals, and earns a large remuneration, -- a sort of rent for the use of confidence-inspiring reputation, and at the same time, a premium for risk."(106-107m)

Demand credit (the possibility of obtaining gold on demand) limits excessive underwriting. "Demand credit is the Schoolmaster of Integrity."(107m)

Physical capital is to credit (or money capital) as property is to rights. Popular usage naturally defines capital widely enough to cover rights.(113-114)

"Capital in the legal sense of permanent ownership either of material or credit [as opposed to temporary ownership for the purpose of production] is necessary neither in banking nor in industry, except as a guaranty against miscalculation."(97)

" a temporary control for a specific purpose with a right of marketing. In consumption, it is a right to help or harm one's self...(97)

The income is not received in the form of gold but in the form of promises to pay gold either from consumers or from downstream producers (eg. retailers). The recipients deposit these certificates in local banks which, in turn, send them to banks in the banking centres. (101) To measure the amount of this investment, one should focus on the guarantees.

The unanticipated income is mixed together with other excesses of deposits over pay-outs that local banks happen to acquire. (103-104)

To understand what happens next, one must introduce the role of the promoter (105). The promoter's task is "To set the business actually going: (105) [The conspicuously successful business" were not launched by promoters; they started small and survive. (105) But we are not concerned with them here.]

One must also introduce the role of the underwriter with whom the promoter must collaborate. (106) The underwriter who works for a central bank makes stock loans. [L. discusses various other ways of underwriting beside straight stock loans.] [Until the bank suspension of 1907, the obligation of central banks to local banks was considered saved (107) To avoid bankruptcy or bank suspensions, the central banks may be able to sell stock to the local banks (108-110)].

The "miscellaneous public" ordinarily gains through this process. (111)

"Capital" should refer to social obligation. "the term cannot be confined to the bounds set by treatises what systematically describe the outer environment." (113)

- vs. Hayek and B. Bawerk (Further elucidation on p. 114-115)

L. says that the proper way to treat property rights is as exchangeable obligations. This is the root of his definition of capital. (113-114)

"All in all, the only material liquid capital is in the reserve."(116)

If [a man] borrows from a bank by offering a share of stock listed on the exchange as collateral and then "takes a dollar of that loan into West Street, and buys potatoes with it, is it not literally true, that he has bought them with the promise of the future production of, -- rubber overcoats?"(116)

"It is no exaggeration to say that a purchase made with a check drawn for ten dollars or with a bank note of ten dollars is made with the promise of some future production to that amount."

In a progressive community, it is natural for an estimate of the future to be made in excess of the subjective value of present goods. When this happens, the whole mass of promises must be discounted to the present time.(116-117)

Present goods are purchased with the promise of future goods. (116-118) Quote p.116 Thus the medium of exchange rightly consists of promises of future production. If people came too believed that such promises would not be kept, the amount of the medium would decline substantially. Quote p.118

"Present goods are purchased with future."(117m)

"To say that goods are purchased with credit amounts to saying that they are made capital by contracts for transforming them into final products."(118m)

"Engagements entered into for the future title of goods and services, are a most fitting general [circulating medium]."(118-119)

"If astronomers were to announce that the Earth would be demolished, a year hence, by collision with some vagabond planet, and the prediction obtained general credence, then the large markets for goods would disappear, for lack of a medium of exchange, except so far as barter or fiat money might offer a lame substitute."(118-119)

"Credit stimulates industry because it is the expression of men's calculations about it..."(119m)

"...[T]he bank does more than merely write over current credit in a new form: it endorses it."(120)

"The bank invites the creation of commercial paper by holding out the opportunity of discount."(120)

"The guaranties substituted by banks for individual bills and notes are not individual but general"(120)

Banks regulate the stimulus that credit gives to industry. (119) Quote p. 121-122

Definitions of "liquidation", "offset" and "payment." Liquidation - when loans to businesses are repaid at the end of the production period with different notes (i.e., notes that have different endorsements, and then those notes are used to make new loans. (Quote p.122)

Offset means that the bank makes no new loans with the notes that are repaid so that eventually notes = gold [I think]. Quote p.122.

Paymentmeans that the notes are not repaid by producers and, as a result, depositors demand "payment" in gold (122)

A reiteration of the concepts of liquidation, offset and payment.(122) "The distinction between liquidation, set-off, and payment in necessary to the explanation of the formation and transformation of capital, and of their relation to crises.(122-123m)

A discussion of a crisis in the insurers (124), the Union Pacific-Credit Mobilier failure (125), a hint of how the perfection of the administrative branches of government might reform things (126), where the Granger organization and the silver party came from.(126)

The director of the corporation should be held responsible to the public if, as a result of his actions, banks are not repaid. (125) T. evaluates political action that resulted from current credit abuses and proposes changes in liability and government administration.(125-126)

"Life insurance companies and all financial institutions other than banks are open to abuses arising from lack of obligation for payment on demand."(98)

"Financial corporations have been formed in order to avoid legitimate, personal responsibility..."(98)

"Fixed capital, on the average, is perhaps not worth much more than the circulating capital it can cooperate to create..."(127)

The study of credit "brings into strong contrast the distinction between the future and the present." (128) The "spontaneous logic of long wage" implies that capital refers not to materials alone but to materials controlled by contract. (129-130) L. Cites B. Bawerk's derivation of the word "capital". (129)

"The subject matter of credit is more psychological than that of political economy because it is primarily concerned with comparative estimates of future and present."(128m)

"[T]he mental aspect of industry is brought forward particularly prominently in the study of credit, because it brings into strong contrast the distinction between the future and present."(128)

When credit signifies a capitalistic intention, it is properly called "capital."(129m)

"The spontaneous logic of language has given to this head, financial phenomenon a term that is not materialistic."(129)

The narrow definition of capitalist refers to the "man who has credit-disposal over free goods."(131) He has control over the fund in the banks waiting for investment -- i.e., the profit fund.(130) A rentier (French) is someone who receives a fixed income. He could be called a passive capitalist and is part of a broader definition.(130-131)

The roles of the "capitalist" and the "rentiers". The capitalist "has credit disposal over free goods" [guaranty? or income that individuals did not anticipate receiving?] and uses credit disposal to launch a business. He illustrates the "narrow or intense definition" of capital. A rentier is assumed to be "hereforth relieved of mental stress". He is a coupon dippers who lives off savings.

Free income = Simon Patten's "monopoly fund". 132-133.

"Monopoly is relief from competition, and that is what businessmen severally seek. It is the first and last thought of industrial man."(132)

The fund controlled by the narrow capitalist comes from the excess of revenue over the fixed charges. That is, it consists of "rent" and profit ("the extra value that is obtained by the exceptional persons who are able to extract more utility out of the industry than those who are setting the standards on the lower margins of effort)"(133)

"A capitalist in the narrow sense is a person who seeks to invest his profits. These are free goods seeking a monopolized application."(98)

Similarity and difference between a bank loan and the purchase of a stock (134-135)

"Investment merges short-time credit into long-time."(135m) See ch. 5.

The lender as a guarantor vs. the stock purchaser as a guarantor (135).

The concomitant (?) "careers" of credit and goods quote p. 135-136.

The cycle of credit life: "The promise, then, may be said to start its career in the form of commercial paper, to be endorsed from hand to hand, to be guaranteed by banks, to be utilized in a round of merchant's or other transactions, and to wind up being resolved into a perpetual investment. Simultaneously, the goods start as raw materials, are worked up into elaborate forms, and those of them that are not consumed directly become machines, which are presumed to last forever, and to throw off products for infinite time, with a deduction for wear and tear."(135-136)

"The careers of credit and goods are parallel."(136)

"Commercial paper is created in order to guarantee the production of circulating material capital."(98)

The stockholder as guarantor to the corporation and the market as guarantor of the stockholder (136-137).

Introducing the "consumer's credit."(137)

3 types of credit (137)

(1) long-time paper issued by enterprises

(2) short-time paper -- bills of exchange

(3) consumers credit -- expresses the faith of the general consuming power of the public. (when consumers accept the notes issued by banks, they "promise" to use those notes to but goods?).

On the importance of demand credit. Cash as gold and demand credit.(137)

"Demand credit expresses, through its general and unqualified form, an intention on the part of consumers to purchase. The breaking of that promise is apt to bring on an industrial crisis."(98)

Regarding a crisis, "The transgression of capitalists consists in overproduction, not so much of goods as of promises."(139)

A comparison of two periods (1907-1908): (1) where money is cheap (interest is low), demand for guaranty is light compared with the size of the bank or other reserve; and (2) money is dear (interest is high), there are insufficient reserves because of the inability to offset debts.(140-143)

"In the depression following the crisis [of 1907], the difficulty of offsetting has been cured by the surgery of "weeding out" bad debtors, and now the need is to stimulate a stream of good credit."(141-142m)

The role of credit in financing great enterprises(142-145)

"[I]t is no perversion to say that the real capital is in the credit."(115)

The liquidity of credit, or its general assignability, indorsability, acceptability, and facility of reguaranty constitute the distinctive feature of the capitalistic era."(143m)

How credit helped to build the Panama canal.(144) "[A] great enterprise may receive contributions in minute amounts from the farthest corners of the earth, aggregating large sums, and without the intervention of money.(98)

Equilibrium equals stagnation and would result from isolationism. "Economic life is like a moving equilibrium."(146)


Chapter 5


"The relation between interest and prices...can only be disengaged by means of a careful study of the influences which control the rate of interest. These influences are partly material, partly mental, and act and react upon each other."(148)

The relationship between interest and prices cannot be understood without first studying why people borrow and lend. It is also necessary to understand the connection between profits and interest, since interest cannot permanently exceed the rate of profit.(149) We should also study why a certain rate is made on loans of metallic money. Finally, since metallic money "is, in reality, a promise of future production...why is it that interest is thus simultaneously expressed in future and present goods?"(149-150)

One fact that is important in explaining the connection between interest and prices is derived from recognizing how money emerges. The first person who used money expected to receive a given future amount of goods. Given that his expectations were correct, the difference between the value of the goods he gives up to obtain money and the value of the goods he expects to get with his money is his reward for using money. If he fails to use his money he forgoes that reward. More than that, he contributes to the decline of confidence of producers in their decisions to produce the goods for prospective buyers. Related to this, people regard interest as the penalty for choosing not to spend money.(150)

Metallic money "partakes of the nature of a promise." Because it is "equivocal capital...[i]t does not pay to hoard it."(151)

Isn't it true that if money is appreciating rapidly, one should hold money in order to make a profit? If people did in fact hold money and did not spend it, competition by goods' producers would cause the current prices of goods to fall relative to the future prices, thereby destroying the expectation that money would appreciate.(151-153)

"Interest on bank credit is a fee for the guaranty of a debt."(153m) The size of the profit is determined by entrepreneurship's estimate of the rate of profit in various endeavors, since if the expected rate of profit was higher, the demand for loans would rise, thereby pushing up the rate of interest on bank credit.(154)

When a person buys a stock or a bond, he is essentially a creditor who is "paying up" his guaranty, rather than providing it.(155) His "loan is finally paid off by the public in the stock-market. The price of securities depends on expected income..."(148)

Inflation and excessive valuation of capital should be blamed on investors not the founders of corporations.(156) Taylor discusses the fact that speculation is in the prices of "capital" not in rates or interest on bonds.(156)

Suppose that the original investment in a business is a stock or bond. The investor typically has in mind a short-term investment. However, once the business is formed, the investment takes on a long-term perspective. Stockholders or bondholders expect that the business will last indefinitely and that the values of the stocks or bonds will be maintained. Thus, it can be said that such "[o]riginal bonds or stocks, is practically a merging of short and medium into long term credit, and involves the consequence of perpetual inconvertibility, social speaking, of the capital immobilized in the company."(157) "Hence, in financial parlance, short-time and demand promises are called directly, 'circulating capital.'(148)

In the case of unlimited liability (a partnership) the stockholder provides guaranty for the bondholder.(158)

Whether an industrial crises follows a financial crisis depends upon whether persons who have purchased stocks have either not fully paid for them or have put them up as guaranty so that they "occupy simultaneously the positions of debtor and guarantor."(160)

A fall in profits -- and, therefore, an industrial crisis, which is a great fall in profits "follows misdirected enterprise." Taylor attributes this view to Mill but says that Mill "perhaps minimized the danger of miscalculated supply...Professor Patten has properly laid stress on it [the miscalculated supply]. It is an important cause of crisis." It is doubtful whether the "proper central authority" could "determine the proportions of the items of national supply...better...than..a competitive market...inasmuch as the public itself does not know what it wants, until venturesome investors, promoters, and underwriters risk experiments on it. The process of economic life and progress is one of experimentation, adaptation, or, in mathematical language, differentiation." Etc.(162) "Income is nothing unless it consists eventually of things that the owner of credit, the entrepreneur, the laborer, or the artisan wants."(163) "It is [the miscalculated supply], among the other causes of crises, that is especially to blame for the stoppage of sales or the circulation of goods.(163m) "Inharmonious production has much to do with the fall in profits; it is commonly called 'overproduction.'(148)

This study of the "competitive choices affecting the rate of but part of the explanation." "The analysis must be pushed into the environment."(165)

The prominent schools (Clark vs. Bohm Bawerk). BB's doctrine about the rate of interest equalling the "last permissible extension of production" is Clark's doctrine in one of its marginal expressions. Clark's teachings is that as successive amounts of capital are added to a given amount of labor, the surplus will go chiefly to the laborers. Capital will actually produce a smaller physical product. But Clark considered additional blocks of labor in a qualitative sense also.

The study of credit concerns what Giffen (see p. 165) calls "nominal capital," not material capital. Yet the return to nominal capital is ultimately dependent on the return to material capital. The return to material capital should be called profits. "Profits" is a name that bridges the chasm between interest and rent.(166-167)

If we study BB's theory of roundaboutness carefully, we are led to observe that the distinctive part of the capital concept is that it consists of time-credit rather than materials. Production is regarded by BB as the "meeting always of simply of man's natural powers with Nature's."(168) "Control of industry through credit is the fundamental capitalistic fact. This is manifested by the correspondence of credit to the 'production period.' The vital part of this control is exerted on the qualitative margin of production."(149)

Investors' intense desire for surplus increases the demand for resources to be used for current investment, thereby raising the value of resources used for current investment, and causing interest to emerge.(168)

"For five years ahead, the annual rate of discount is the same as for four. But at the former date, the rate of material product on the whole process is larger, if the work is begun now than if the capital lie idle until next year and thereby be involved in a shorter process."(169) This does not prove the (diminishing marginal) superiority of more roundabout production methods, however. It only proves that "it is more advantageous to a capitalist to begin his investment to-day rather than tomorrow."(170)

In Clark's example of a young forest, both labor and capital begin to realize income, "in value and property, from the start, although they are not realizing it in consumption exchange."(172-173) "[Clark] puts material capital on a par with labor."(172). "There is little essential conflict between Clark and v. Bohm-Bawerk.(See Fisher, Capital and Income, p. 247.) The former explains that the laborer who contributes present days' work, is not obliged in order to obtain his wages. After saving has once begun and capital has been constituted, then there is a perpetual flow sufficient to satisfy the community, labor included...[But v. Bohm Bawerk] does not assert that laborers should not should not have the benefit of regular wages, nor that plenty of goods are not currently produced. His contention is, that the laborer's pay is not so high as it would be if he waited until the end of the regular production period, and that the difference between what he receives now, and what he would have received if he had waited, is interest...What v. Bohm Bawerk has distributive potency of Time [rather] than its productive efficacy."(173)

Clark views the capital in the economy as one giant productive machine, or plant. However, such an aggregate view demands further explanation. "The credit current in a community is what lends to that complicated plant a claim to independent existence...It galvanizes the Clarkian automaton into the social instrument that it is....[T]he last investment and that which determines the rate of interest, is" best understood "as an addition of a certain quality to the technical means at the general disposal of industry."(174-175)

"The marginal theory in economics is principally an analysis which discloses where the decisive, competitive contests are located. It is perfectly consistent that...[(a)] the last investment and [(b)] the length of the productive process [simultaneously] determine the rate of interest, because they are independent. 'How much time will the process occupy after the investment?'" "In general,' answers v. Bohm Bawerk, 'it lengthens.'(176)

"Interest, however, is neither expressible nor satisfiable in money alone." Fisher's demonstrated that anticipated changes in relative price generate equivalent relative changes in interest rates on loans of the various items. This result suggests that capital can be defined "as those sources of income whose values are adjusted in order to equalize the rates."(177-180)

"The long- and the short-time rates of interest remain for study..."

Taylor traces the history of Fisher's [correct] idea that and increase in gold first reduces the short-term rate of interest, then raises the rate of interest. The idea was introduced by Giffen, using the Clarkian idea that additional gold is less productive than the original. Giffen recognized that banks would eventually be required to raise the rate of interest in order to decrease the strain on lending. "Gold, the [the Clarkian] machine, lowers interest; but gold, the representative of future values, raises it...Ten years later, Fisher complemented the work of Giffen with the statement of a principle of interest compensation. About the same time, Clark furnished the cement to bind the two propositions, by his really evolutionary theory of specific productivity and of qualitative marginal increments.(182)


Chapter 6

The Valuation of Capitals

The question asked in this chapter is how credit is a connecting link in the causal chain relating to production.(185)

Because gold is guaranty and the provision of guaranty yields income, the theory of marginal productivity can be applied to describe its rate of return. The marginal productivity and rate of return falls as the quantity of gold increases, as shown by Giffen, as if the gold is a machine.(186)

But competition forces the rate of return on gold and the rate of return on credit to be equal. Beginning in equilibrium, when gold first flows into a country, gold substitutes for credit and the increase in loanable funds reduces the short term rate of interest. As time passes, however, the gold becomes the guaranty which forms the basis for new credit. [As credit expands, the rate of interest on gold rises.](187) "This process has been called that of the adjustment or accommodation or compensation of capitals."(186) Fisher's law.(187) Another reason for this name may be that the rise in interest is needed to compensate for the depreciation of the principle.(184) "Capital compensation instead of interest compensation usually obtains in short periods."(186m)

From this analysis it looks as if gold governs the amount of credit. However, the true situation is the reverse. Credit is not a tangible thing and the inflow of gold cannot increase its quantity. If people are not disposed to create more credit, the rates of interest on both gold and credit will already be low. When the inflow of gold further reduces the rate on gold, the low gold rate of "interest will at once force the recent gold supplies out again."(187) In the opposite case, where the two rates are already high, the inflow of gold reduces the gold rate of interest temporarily. However, the great demand for loans causes the gold rate to rise again. If it rises high enough, more gold will flow into the country.(187-188)

The law of the compensation of capitals, whereby the rate of interest on gold comes to equal the rate of interest on credit involves the two standards: gold and credit. But the law prevails in an environment of a third standard: "technical output and commercial outlet (Absatz). This means that the rate on gold and the rate on money must also tend towards equality with the rate of profit.(188-189)

A critique of Fisher's system of political economy: (this is "the claim that interest does not depend on productivity," but on marginal utility (288m) To understand interest, one must recognize that capital is at the same time (1) a means of producing future goods and (2) a means of avoiding present labor.(189) Capital is thus a "middle term between exertion and consumption."(190) In the market economy, this fact is manifested through the interaction of appraising entrepreneurs.(190-191) On entrepreneurial calculation and the assumption if "separate proprietorship at each stage of production."(191) The equilibrium approach to profits, in which profits are "distributive shares arising from luck or monopoly," shows that "[i]f...profits are the normally accrued excess of future values, when they reach the present...then they are a term for realized interest."(192)

"Can it be that the estimates of consumers alone establish the ratio of future to present values, and that the intervening capital markets thus exert no influence on the general rate of interest? The other view is here adhered to, especially since it harmonizes with the gradational organization of the environment of production, as elsewhere explained."(193)

"Professor Fisher says that the moment a business is found more remunerative than comports the market rate of interest, its capitalization is immediately reestimated at the (impliedly) old rate." But this ignores the fact that the rate of interest itself must change as a result of the new profit opportunity. [Thus it is a partial equilibrium view.](194)

Costs do indeed influence the valuation process by means of entrepreneurial appraisement of different capitals.(189-194m)

Interesting definition of costs: "Costs are those intermediate goods which must be valued in intermediate markets in order that the entrepreneurs engaged in their manufacture may exert the independent judgment necessary to influence their price, and to exact, in this way, the largest possible return out of the final product."(192)

Capital is best used to refer in a general sense to the three different levels of markets. The result is "a broader competitive definition: 'Those economic constituents, goods and promises, which equalize the [rates of return] by adjustment of their own exchange values.' By this same elusive conception, it is possible to introduce into the same scheme, both credit and that quasi-credit and quasi-commodity, 'Money'; and also, goods and machines, of which the basic, tangible, industrial element is composed. The law of capital compensation operates to equalize the rates and revalue the principals, as between credit and real tools. It also induces a like approximation between the latter and gold, the standard."(195)

The method used to analyze the effects of an increase in the quantity of gold -- namely, the static method of provoking a change into a system that abstracts from change altogether -- assumes that there is an increase in gold and asks how individuals would react to it. In an open economy, the answer is that, in the long run, the gold would flow out of the country into which it entered (a point made by Mill (197n), since "credit plays the leading part, for it is but the commercial shorthand for the business plans which must precede a forward movement. Money and production follow suit. A statistical inquiry which dispenses with the necessity for separate data of volume of credit, on the ground that it closely follows the vicissitudes of the supply of gold can hardly reach trustworthy conclusions."(196) [Note that Taylor does not discuss a closed economy.]

Taylor represents the relationship between the psychological (credit, money), the intermediate (money, circulating capital), and materialistic (fixed capital, land) environments in diagram 3 (197). "The analogy is essentially biological.(198) The relationships in the diagram are discussed on the next 4 pages. But Taylor points out: "Nothing could be further from the writer's intention than the chaining of thought to a dry schematism."(200) Also see the margin notes on p. 197-201m

Six periods of "interest-and-capital adjustment:

(1) Increase in gold reduces the gold rate of interest and, with it, the credit rate of interest. In this period, gold and credit are substitutes.

(2) Credit is increased because the gold becomes reserves. The rate of interest on credit falls further.

(3) As the compensation of capitals occurs, gold may flow back out. However, if there is a "spirit of speculation," which often occurs, the rate on credit will rise substantially "in order to compensate for depreciation in the nominal capital or credit-principal.(202)

(4) In a longer period (10-20 years or so), the relationship between gold and credit is reestablished, through which gold is the guaranty.

(5) Credit expands to reflect an increase in speculation and nominal capital is swollen as a result.

(6) Credit expands to reflect an increase in perceived profit opportunities (a consequence of progress in production) [which may arise simply because there are profitable opportunities to expand credit](202-204)


Chapter 7

Rent, Profit and Interest

See the conclusion at the end of the chapter -- it adequately summarizes the points at issue, which are presented is a rather obscure way.

Early discussions of rent said that rent is revenue that depends on unmodifiable circumstances. This must be recast in recognition of the fact that "the real economic problem is that of the effects, circumstances, and limitations of the voluntary activity of man in his housekeeping and bread-winning."(214)

Marshall's theory of quasi-rent seems to be based on a recognition of the "real economic problem" since it seems to be the actor's purview that Marshall has in mind. The short run is a short-term decision-making horizon. If this interpretation of Marshall is correct, then he made a useful contribution.(211-214)

We ought to take a similar approach to credit.

Under simplified conditions, "[t]he four values, plant, goods, shares, profits, are in continually disturbed equilibrium. They are endeavoring to reach a stable position; but are implicated in the process of economic progress known as 'competition,' which prevents subsidence of unstable into stable equilibrium. Monopolies appear momentarily to render it stable. But they prove, in the long run, to be only a slower and bulkier form of competition than men had been used to. Industrial depressions, at times, seem to have reduced industry to the stationary state. But competition springs up again, and, with it, revives disturbance of values, and the reactions are renewed."(217-218)

"[I]n the and product must continually be assessed."[appraised](218)

The process of economic calculation, which Taylor seems to call "valuation," requires the appraiser to know costs as well as revenues; although it is nevertheless true that "all of these valuations depend upon consumers, as a source or store of subjective value."(219-220)

"Marshall associates rent with the shortest periods, on the one hand, and with the slowest processes, on the other. The free volitional factors are, consequently, to be found in intermediate periods and processes...In many respects, it will appear that Professor Simon N. Patten agrees with Professor Marshall. Professor Frank A. Fetter thinks that the distinction between rent and interest is shadowy. He has been led to this view, doubtless, by the labors of Professor v. Bohm Bawerk, who has neatly demonstrated that the value of any agent of production is the discounted present worth of the infinite future output attributable to it by anticipation."(223-224)

"There are substantial distinctions between the ascending environments into which economy is partitioned, due to differentiation in the mobility and marketability of both the tools and the product. For this reason, from the dawning of economic analysis, a distinction nomenclature was required. Returns at the bottom were called rents, those along the middle heights profits, and those along the upper regions, interest. It is true that those several revenues are not rigorously distinguishable, for some of them contain foreign elements or share their qualities with others...The association of the surpluses arising in different markets, with foreign constituents, [distracts one] from the legitimate differentiation of the tools of production."(229-230)

"While land adjusts its value slowly to incomes from general industry, it is, nevertheless, the fundamental source of wealth. In the last appeal, returns to farming and extractive industries are more indispensable to prosperity than are others. Rent is, after all, the most important sort of profit."(230)

"In the long run, all incomes, whether price-making or price-made, tend to adjust themselves to a single ration by a reference of products to a central market and by value-equalization of principals and incomes, through the operation of the law of capital compensation."(230-231)

Good quote anticipating the Socialist Calculation debate (p. 231)

The essence of the chapter is summarized in item 12 on p. 231-232.


Chapter 8

Financial Statistics and Crises

"The controlling influence [on credit], in a period of intermediate length, so far as the rise of prices is concerned, is the state of the public mind."(235)

"[B]ank deposits begin to increase before note circulation. This indicates that hoarding has ceased and that money, presumably metallic, is being returned to banks. Further, [bank notes plus deposits] begins to increase before there is any expansion in loans...The business community is rising back into the higher or credit environment"(236)

This is the pattern from 1847-1893, with the exception (France, 1847) in which speculation during a crisis caused loans to increase while prices were falling.(236-238)

Statistics show "in general terms, that speculation, and hence speculative loans, are sustained for a considerable period after industrial loans, the produce of which is applied to purchase of goods, have begun to dwindle."(240)

"It is not so much disappearance of profits which causes declension in the price of the securities offered as collateral for loans, as it is the failure to realize expected profits."(240-241) "It is not even strictly correct to say, the fall of prices is due to disappointment. It is more precisely due to inability to keep engagements. Disappointment is a manifestation of its personal effects."(242)

Doubt about who will bear the loss due to the reduction in value of assets "may decrease the marketability of the claims, to such an extent that their total will be even less than the objective values..."(242)

Discussion of the popular fallacy that crises could be prevented if the government could merely keep prices from falling. "To affect prices without operating upon the collectivity itself, so as to influence its organic action, is as little efficient as to raise steam in a boiler by turning around the dial of the gauge."(243) Very Hayekian and Misesian because of the focus on malinvestment. If the government attempts to raise prices, "[t]hat worst of all forms of gambling, betting on the future value of the circulating medium itself, will surely engross the attention of the speculative community, at the expense of legitimate enterprise." "The effect...of [an artificially-induced] rise in prices...will increase the loss which already constituted the chief element of a crisis. Such an artificial inflation, therefore, augments the disaster...[A] further increase of promises...may greatly aggravate the weight with which disappointment bears upon the creditor class Indeed, the use of government only too often...planned to help debtors to scale down their liabilities generally, under the specious pretext that the obligations were unjustly incurred, or unrighteously swollen." 242-244

"The disappointment does not, ordinarily, come from a falling off in an already established demand, and from a price that is already customary. It follows a futile attempt to stimulate demand where there was none previously, and is ascertained by a divergence from prices arbitrary or tentatively fixed." "[T]he cause of the disappointment is not the fall in prices, but inability to stimulate demand -- a very different thing. Back of the inability lies the attempt; which may be analyzed through all the paraphernalia of promotion, underwriting, stock-market sales, and concentration of provincial deposits into the money centers..."(244-245)

There is a close connection between the "fall of prices, as a direct result of mal-assorted production" and the "fall as an indirect result of balances on the wrong side of the ledger and consequent contraction of loans...They react upon each other cumulatively."(245)

"The rise in prices, then, is due to high expectations of profits. Their fall is due to the undeceiving of investors."(245-246)

See the conclusion on p. 252, which talks about the period 1879-1884 and concludes that promotion, not speculation, raises commodity prices, "that speculation does not directly affect the prices of goods," and "even where the metallic standard is itself admittedly exerting all possible strength for contraction, prices will rise, provided promotion increases, and will attain to a point much higher than the scarcity of the metallic standard would place them."(252)


Chapter 9

The International History of Prices

Traditionally, economists have explained the price level by relating it to the quantity of gold. Recently, "mathematical novators" have deviated in some measure, but they still accepted the "gold the decisive variable. Even credit theorists "have been define the conditions under which credit does not affect prices [rather than to define the conditions] under which it does. Still another course remains open, namely, to replace with credit the gold of the ancient rule, and then to proceed as before...Credit becomes the dependable determinant." Let me explain why this new approach is desirable.(254)

In the short period, the expectation of profits causes a change in credit-capital and then credit-capital causes a change in prices. In the intermediate period, we are concerned with how capital effects prices. This occurs through demand-credit, which manifests itself chiefly through bank deposits and which changes the purchasing power of the community.(254-255)

There is a significant relationship between the rate of interest and the volume of issues of nominal capital. Both are determined by (1) the expectation of profit and (2) the past and current profit. Speculators, who form expectations of profit, ordinarily exert the most substantial effect on the volume of nominal capital, while more conservative bankers, who pay greater attention to the past and current profit, ordinarily exert the most substantial effect on the rate of interest. Yet "the lines between future, present, and past have a tendency to dissolve, and hence fluctuations in nominal capital and the rate of interest will largely correspond. Bankers are gradually convinced either (1) that there is ground for a more cheerful view or (2) that the expansion of speculators needs checking."(255-256)

To the holder of past stocks a rise in the rate of interest means a decline in the value of his securities. To the issuers of new stocks a rise in the rate of interest means that the new issues must "yield more or be cheaper and hence larger in amount than if the loan market had not advanced."(257) [? I think that he supports this argument with his statistics -- see especially p. 270-273]

The rest of the chapter describes the history of prices. Among other things, he makes the following observations:

"The long-time level of prices will remain where the art of metallurgy places the outlay for raising and refining gold. But the almost doubling of them since 1896 could hardly have occurred, without the dynamic vitalizing stimulus of credit."(265)

"...[I]t may be objected that higher prices are a discouragement to gold mining, whereas the recent increase in gold supply is epoch-making. The reply runs that the enormous extension of the banking business and the world-wide increase of deposits and notes have called for a proportional augmentation of reserves...Hence the great rise of prices that has occurred may more properly be said to be due to the increase of credit than to larger costs of production of gold...It is thus perceived that credit may have, according to circumstances, one of two possible effects on gold production, depending upon the level of prices from which the expansion starts. (1) It may raise the value of gold by demand for reserve, or (2) it may lower its value by raising general prices too high."(265-267)

T. discusses a "tabular standard," to replace the gold standard but dismisses it on the assumption that government officials would probably not exercise the extreme prudence and rare uprightness that is necessary for it to avoid the drawbacks of herky-jerky changes in gold supply. He feels that the men of finance have greater prudence and readier courage.(268)

He concludes the chapter: " It is not pretended that the view of causality advocated in these pages is established by the preceding study of financial statistics; but they do not seem unfavorable to it."(274)


Chapter 10

The Causes of Crises

The orthodoxy states that it is "just as possible to enjoy prosperity at one level of prices as at another, for the statement ran that any quantity of money was a matter of no consequence. On their limited premises, the economists were perfectly correct. But theory should be able to explain everything, [including] organic fluctuation of prices."(276)

We have studied the interaction between gold and credit as it effects interest (in the chapters on interest). Let us now study the interaction between these two as it effects the level of prices.(277)

By way of summary, "[C] the purchasing medium commonly used, and...the level of prices is affected by the amount of the purchasing medium...When more gold arrives, there will be encouragement to more credit. Under exceptional crisis conditions, however, gold may superficially be regarded a substitute for credit...But credit receives a more substantial stimulus, when the ration of profits in the community is higher than the rate of interest that obtains upon loans. Then...nominal capital or the capitalization of income is increased, and then loans rise, with the greater 'value' of the security...However, it has been found that an expansion cannot attain a noticeable development, unless the community is in a confident mood, willing to make investments on the faith of future returns, hopeful, and courageous. Fundamentally, therefore, the condition of the expansion of credit is, that the public be one of those psychological phases when it is willing to take risks. The plain cause of the increase is the mood as to investment...excepting in so far as there may be some slight, very short-time effects, from little accessions of gold into the bank reserves."(277-278)

To cling to the quantity theory in the face of credit is "merely tweedledee and tweedledum...The point to be settled is, why is there a certain quantity of credit or of money?"(278-279)

Inflation occurs when, even though goods cannot be sold and the expected prices, the banker renews the producer's note which would normally have been paid when the goods were sold.(279-280)

"The exchange medium is the circulator of the present and the representative of the future goods." [It represents the future goods in the same sense that the credit is an implicit commitment to buy the goods.] If expectations are fully realized and promises are completely fulfilled, there would be some initial inflation which caused later deflation. In a progressing economy, "[t]he continuous fulfilling of expectations about future values would furnish a supply of goods that would deflate their own inflation, for new production periods are continuously opened."(280) "If, however, future goods should not realize the expected values, then...that would be an instance of real inflation."(281) The inflation can be said to result from the overvaluation of future goods.

A lovely example of how a crisis occurs in which a crowd of capitalists bet that the rooms of a warehouse, which open successively in different years, will contain a given value. If they believe the value is high, the amount of promise dollars in circulation will be high. When they are disappointed, a crisis will occur which entails a reduction of the price level, etc.(281-282)

"The lawgiver cannot possibly play the role of the discriminating creditor...Shifty measures of mercy are but palliatives, and unkind, in the long run, to society."(283)

"The usual employment of credit does not involve inflation...This conclusion has often been reached by students of credit. But in a progressive, industrial society, a portion of the credit is kinetic and tends to affect the price-level. This portion can be estimated only through an appreciation of the evolutionary circumstances which, in an advancing type of economy, call for rhythmic efforts, and all that they mean for human foresight and inter-relationship. The task is to understand how credit, with or without additional business, may fluctuate in reference to the valuations of goods brought into exchange...Under a credit system, one needs never be concerned lest there be not enough money available to transact business."(283-284)

"Credit may be looked upon, graphically, as "future goods." Upon the values and quantity of these promises depends the level of prices...The promoting and speculative industry creates the "future goods" that are to form the basis. The current rate of interest is the result of the past rate of profits, which recorded experience as to the returns that are to be obtained from investment and production." It might be thought that "the expected rate of interest would be determined by the awaited future rate of [profits]. But this is not wholly so. It depends, not only upon the amount that is promised to be paid in as dividends, but upon that at which the capital is estimated, because the rate of interest is the proportion between the two quantities." Speculators are responsible for estimating capital, which is an accrual to principal, not a rate of profit. Increases in principal can be discounted at banks. [T]he banker only lops off the old rate of interest or a little above it, whereas the speculator, having turned the rest of the future profits into principal, realizes for himself in exchange or sale."(285-286)


Chapter 11

Money and Credit as Mutual Substitutes

"[T]he law of prices...affirm[s] it as one of the power of promises relatively to the barrier of the standard of value."(288)

Taylor anticipates critics who do not understand the relationship between gold and credit.(288)

An important fact that will enable one to remember the proper relationship: "[W]hen prices fall, one important reason is that the time is come when credit is brought into an active comparison with gold. When the subsidence begins, men are actively questioning whether the credit is worth wo much as the gold."(289)

The banking school assumed implicitly that "credit is always being brought into comparison with gold." This assumption is exaggerated and misleading.(289) It is true that as credit expands after a period of being constant, there would be some inflation, since the expansion of credit is based on expectation of future values, not past values. This inflation would cause international gold dealers to shift some gold around. But the small amount of inflation would not affect the ordinary trader. "He will continue to accept a bank deposit more readily than coin.(290) [H]owever, when the time of crisis comes...then demand for the guaranty fund rises quickly and becomes universal and impetuous."(291) At that time, gold passes as a temporary substitute for the customary medium, credit.

"The theory of average prices is an alternating one, which states that, under usual conditions, the immediate element in moving the level, sometimes upward and sometimes downward, is credit; that, in period of stringency gold comes in as a more active influence; and that there is, thereafter, a moment when what might be called the 'natural' values of gold and credit correspond."(291-292)

The shift to gold during a depression may be said temporarily to bring back a primitive environment. It indicates dissolution of the system of contracts, by which which all production is normally cemented together. Merchants cannot easily predict their sales. They seek gold to be assured that they have can purchase supplies. In earlier times, the functions of a medium of exchange and being a standard were performed by the same item -- gold. With the development of the credit system, however, credit came to perform the function of the medium (and standard), while gold retained its function as a store of value. "Occasionally, it may properly be said that the standard is an alternating one: at times it is credit and at times, gold."(294)

"[P]olitical orators [often claim] that credit is always substituted [for money] so as to make up for a deficiency of gold...[This is] an error. Credit depends upon gold supply, and then not in a way to encourage substitution. The spread of conveniences of a credit economy looks like the substitution of credit for money, but it is a very different thing."(295-296m)

David McKinley has argued that there is a propensity to substitute gold for credit based on the relative marginal value of each. McKinley concedes that what is involved is the substitution of one institution for another and that, as a result, the substitution is may be insufficient to prevent the fluctuations of prices.(296)

This argument is wrong because "[t]here is, in history, no such thing as the compensatory substitution of credit for money...Modern industry and commerce could never have been carried on with gold, because they require credit contracts to maintain the framework of affairs steady and solid. The creation of additional credit is a permanent improvement in the approved methods of doing business. Dynamically considered, it is a replacement only if that be understood as depending on more highly developed financial habits, and not on a momentary, habitual adoption, under old usage...To-day, the additional credit is performing a separate function of exchange, and the money is performing a special duty of guaranty in the reserve, and of storing value for that purpose...The theory of substitution thus holds only within a limited area and is in danger of abuse when used for political argument. [For example, s]ome manufacturing corporations paid their workmen in gold, for a while, after the crisis of 1907."(296-298)

"In times of prosperity, the circulating medium is future goods" (credit).(299m) The "future goods circulate present goods, including gold.(299) In times of crisis [the circulating medium is] past goods."(299m) "[G]old, the past, the realized good, circulates promises and wares."(299)

The different functions of money have been identified by many authors. But the public ordinarily thinks that each form of "money" performs all the functions. Yet credit and metallic money perform different functions. "[T]he prime fallacy of inflationists has been precisely the inability to grasp and hold the truth that the paper and the real money have, in the long run, parted company and are actually rendering complementary services." To the extent that inflationists succeed it is due to the "moral obfuscation which says: 'If this piece of paper is money, it ought to perform all the functions of money.'"(300-301)

Consider the problem of finding "a theoretically absolute level of prices, unaffected by credit fluctuations."(302) Gold is not acceptable because it "is everywhere deeply affected by the state of credit [and thus] it is impossible to estimate where it would stand under the hypothetical abstraction."(303)

Discussion of the English Bullion report of 1810.(303)

If there are competing currencies denominated in gold, gold flows may prevent deviation of prices in one currency deviating in terms of gold from the prices of another currency. However, it is impossible to assert that there is any absolute amount of gold that determines average prices.(303-304)

"It is just as 'natural' for general prices to fluctuate as it is for the relative exchange value of different commodities [to do so]."(304)

"It is not to be inferred [however] that it is not desirable to grasp measures to minimize value-fluctuation of promises, if that takes place in an inordinate degree. The same motives, however, obtain for regulating the relative value of potatoes and overcoats. Moderation is the test of sane administration..."(304-305)

"The value of the metallic standard fluctuates in unexpected ways, -- it forms no practically ascertainable base-line from which measurements can be taken...There is nothing harmful in a moderate fluctuation of prices: it is a symptom of dynamic activity."(287)


Chapter 12

Notes and Deposits. The Organic Idea in Financial Legislation

Up to now we have assumed free competition in banking. "Governments interfere in the private credit system partly by their issues of paper money and partly by regulation of banking."(307)

One argument in favor of government issuance of paper money is that it saves interest which the government would have to pay if it borrowed.(309)

Newcomb argued that the issue of paper did not offer an advantage of outright borrowing so long as the borrowing would cause the reserves of banks to consist of official paper. But Taylor sees the use of paper money as one of many diverse ways of tricking the public "in order to avoid the appearance of an over-issue of any one kind." This is just as effective as that resorted to by promoters of private schemes.(311)

There are two major disadvantages of government paper money. First, it caters to the popular misconception that whatever "can be made to work as a circulating medium...[must also] be an efficient and trustworthy standard of value." A second disadvantage is that it reduces the ability of banks to expand and contract credit in response to the speculation and promotion, i.e., in accord with the contracts that people make and break. In other words, it makes the currency inelastic.(311-312) A third disadvantage is discussed on p. 316

The fallacy rests wholly on the failure to appreciate the congeries of contracts that accompany the various guaranties that are the foundation for credit. To substitute government paper money for credit would require the government to direct "every particular act of production, down to the smallest...from a central bureau."(313)

Besides administration of justice and property rights, certain projects are perhaps appropriate for governments to carry out. Examples are light houses and various public goods construction projects. But these projects are likely to be carried out during a depression, at which time their financing interferes with the alignment of credit contracts that follows a period of mal-investment. "If the nation seems to pay for these good things with paper money, that must be redeemed, some time or other, by means of taxation. The replacement of a system of payment by means of taxation for one by means of sale and liquidation with organic credit, is like the mixing of oil and water. The movement of official credit does not correspond with that of private and is a decidedly disturbing factor."(314) The movement of official credit, as opposed to private credit, discourages liquidation and encourages speculation.(314m)

There seems to be an excellent discussion of how gold should be exported during a crisis but how the govternment money stops this from occurring.(314-315)

"The recent development...of the theory of subjective values, facilitates the deduction that money does not represent present but does future goods, and consequently the inflationist's argument, so far as it is founded on a false quantity theory and neglects the natural, organic genesis of credit, in unexecuted contracts, falls to the ground."(316)

A third disadvantage of govt money is that the burden of payment, when the day of reckoning arrives, is much greater than the benefit.(316)

"[A]n issue of paper money is a confession of bankruptcy on the part of the government."(317)

We now turn to govt regulation of private credit, specifically to the regulation of banks.(317)

"A law is a compromise between the popular error as to what the facts are and what would otherwise be the logical conclusion from the facts themselves."(318)

T. praises McLeod in England and Dunbar and Laughlin in U.S. for teaching that "business makes money." But public opinion is a tough thing to change.

"The banker is popularly supposed to be a dealer who takes persons' money on deposit, that is, for safe-keeping, and loans it out again...Observation shows that there is no more than the slightest grain of truth in that idea."(319) "[W]hen a form of speech is once rooted in the language, it is almost impossible to eradicate the fallacies that may cluster about it."(320) "Although banking business has been developed, in practically its present form, for two centuries, the popular theory is still that of the money changer on the Rialto."(320)

T. expresses a view that the academicians are fighting a difficult battle. They know the truth about banking and have disseminated it. But their students too easily forget. And many people are not students in the first place.(320-321)

"The proposition for the state to indorse bank deposits is repugnant to the principle of private enterprise. But the modified proposal to encourage banks voluntarily to organize themselves into a guild for the defense or insurance of their notes and deposits, may be a reasonable one, in the present state of public opinion on finance and in the present tendency of business and classes toward separatist organization."(323) [Why not prevent branching?] But public opinion will probably cause governments to act otherwise.

T. now discusses "two main reforms to work out in banking legislation": (1) making the currency elastic and (2) recognizing that notes and deposits are identical.(323)

He praises the Bullion Report on its recognition that (1) financial legislation is interference, (2) that "business makes money" and (3) that deposits and notes perform the same function.

Peel's Banking Act, bolstered by Ricardo, put the Bank of England on the gold standard. By emphasizing the simple relationship between the quantity of bank notes and inflation, it failed to get to the more complex relationship that involves credit. As a result it helped promote the myth that by controlling bank notes, a government could control inflation. The act's proponents claimed to have based the act on the Bullion Report but they clearly failed to heed the essential message of that report. The main result of the act was to cause a shift from notes to deposits, which the act also failed to anticipated but which the Bullion Report recognized.(325-326)

Peel's Act did have a beneficial effect of alerting people to the guaranty function and also recognized that inflation results from credit. Subsequently the Bank of England attempted to prevent crises by restricting the issue of notes alone (as opposed to allowing the shift back to gold). This led it to be caught without sufficient reserves against deposits, until it learned its lesson from experience.(327)

The early banking acts, 1781 and 1816, are not relevant to the current discussion. The 1863-1864 acts were a backward step, since they only allowed the guaranty fund to be used to redeem notes and not deposits. On the good side, it did allow deposits to be expanded indefinitely; but this was probably because the lawmakers did not understand the significance that deposits would assume. It seems that the "'banking principle,' not viewed as a doctrine about the causes of inflation, but as one which puts promise and guaranty fund in their proper relations to each other, is now gaining the upper hand of the 'currency principle.'"(327-328)

The Act of March 14, 1900, aimed to secure the gold standard by increasing the treasury reserve against government notes. A better plan would have been to abolish paper money altogether. There was some recognition of the significance of currency elasticity.(331-332)

P. 333-337 discusses the evolution of corporation law, of which banking law is only one part, as a series of blunders which education in political economy might correct. Among the many gems are:

The removal of shareholders from corporate responsibility was partly the result of the recognition "that many of the subscribers were women and minors, persons that were not supposed to be fully competent in business matters, and therefore deserving of the protection of law."(334)

The result was "bad management, incapacity, flagrant abuse, and peculation."(334)

"But modern legislation [does not aim] to remove the cause [which is absence of responsibility]...[Instead, it builds] "an elaborate system of palliatives,...'checks and balances,'...inspection,...registration,...sworn prospectuses,...prescribing the substance and form of the organization, and the duties of the officers,...official valuation of the assets, and finally,...administrative consent to indebtedness and to nominal increase in capital."(335)

In banking, legislators have tried "to cure the results of bad theories of paternalism with more paternalism..."(336)

If legislators "had recognized from the first, that incorporation was primarily for the purpose of production, and that, when it comes to a question of responsibility for wrongdoing (a department of distribution), there is no such entity as a corporation, perhaps they could have given a better turn to the law."(337)

"The public, however, now pays more attention than formerly to the universities, and less to legislatures."(33)


Chapter 14 (last chapter)

Justice for Debtors: Idealistic Standards

About the ideal standard for deferred payments. Related to the index number problem.

August 5, 1996

Gunning’s Address
J. Patrick Gunning

Professor of Economics/ College of Business
Feng Chia University
100 Wenhwa Rd, Taichung

Taiwan, R.O.C.
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