Further Essays in Economics
Leon Maclaren

II

CREDIT

Credit is belief, trust or faith in a man. When we say "I credited Jones with good sense," we mean we believed Jones to have good sense, and we trusted in it.

This faith or trust is essential to all trade. No human relationship would be possible without it, and the merchant whose livelihood depends upon success in transactions with others must rely to a very considerable extent upon the commercial integrity of his fellows. In all countries where trade has reached any proportions, a degree of honesty and the resultant faith that men will fulfil their promises must have been achieved; and in such countries the law seeks as far as possible to bring pressure to bear on the individual to compel him to fulfil his obligations.

When a man "gives credit", as it is said, he does not in fact give anything at all; on the contrary, he accepts something, he accepts a promise from the other. Thus where goods are sold "on credit", the vendor gives the goods just as he would on a cash sale, but credit comes into the transaction because he accepts in exchange for the goods a promise from the purchaser that he will pay. Equally, of course, a purchaser may pay the price of goods to a shopkeeper and accept in exchange a promise to deliver the goods at his home. Although not commonly so-called, this is also a credit transaction. It is a purchase "on credit". The giving of credit actually casts a burden on the person who receives it. It is he who has given something, namely his promise - a promise which the law will usually enforce.

On the other hand, "withholding credit" is a refusal to accept a promise. It indicates a lack of faith in the customer's willingness or ability to fulfil his promises.

Now no trade at all is possible without credit. To exchange my watch for the £5, you offer me entails one or other of us making the first move. I must let the watch go, or you must hand over your £5, first. If we so distrust one another that exchange on these terms is impossible, then we might have to resort to a stakeholder to whom we both must hand over before he lets either of us have the thing we expect to get. But then we must be able to trust the stakeholder. Trade is in fact impossible without credit, simply because a simultanceus act of exchange is virtually impossible.

Accordingly in between the two stages of an exchange there is an intervening period which may be measured in seconds, minutes, hours, days or years, during which one party to the exchange having fulfilled his part has to trust that the other will do likewise. I have handed over my watch; I must now trust you to hand over your £5. If we agree that you shall pay next month, then the period of credit or trust will extend over a month. It will easily be seen that the period of credit is infinitely variable, but that if it happens to be very short - while the other man is still in sight, for example - the fact that credit is necessary to the exchange tends to be overlooked.

At the intervening stage, after I have parted with my watch and before you have given me your £5, we are bound together by an obligation which, if it came to the point, the law would resolve. You are my debtor in the sum of £5 and I am your creditor for that amount. An obligation therefore (Latin: obligare = to bind) consists of a credit and a debt. The debt is the duty (Latin: debere) which arises on the promise of the debtor to pay, or to do whatever else he has promised. The credit (Latin: credere) is the right to have the duty performed. Etymologically, it is the belief that the duty will be performed. The law enforces the duty by making the debtor pay - so far as that is possible. It thus resolves the obligation by which debtor and creditor are bound.

The importance of credit grows greater as the division of labour and the complexity of production becomes greater along with the economic advances in civilisation. In a highly developed community production of every sort is carried on day by day. Men cultivate the soil, build factories, and clear cheques through the banking system simultaneously; and all the other innumerable kinds of production are going on at the same time. But the results of all this labour take different periods of time to materialise. As the farmer plants, he may expect to have a crop to sell in six months or more. As the keel is laid, the undertaking concerned in building a liner may expect to have the vessel ready for exchange in a couple of years' time. When they lay the foundation stone, the builders of a factory may hope to have their product ready for exchange in a matter of years.

Moreover, when the ship is built or the factory completed, neither will be consumed at once. The owners of the ship will hope to get good use out of it for twenty years. The factory may last a century.

The result of this disparity between the time taken to produce and to consume different sorts of wealth is not merely that exchange is impossible to carry out simultaneously, but that the period between the two stages of exchange is in many instances likely to be very prolonged. Those building a steamship need to be clothed, fed and sheltered day by day, but they will have nothing to hand over in return perhaps for some years.

There is, of course, no difficulty in meeting this situation in communities where credit has developed as rapidly as the exigencies of complex production demand. Those who produce food, clothing and shelter must give these things to people engaged in production which takes a long period to achieve its final result, and be ready to trust them to go on with their work and have ready at the appropriate time a product which can be put into exchange in return. The builders of steamships and the like are thus debtors and those producing more quickly are creditors for varying periods of time - some of them quite protracted. But so long as all produce and can be trusted to go on producing, in the long run all will have produced value enough so that all is exchanged throughout the community and every debt is cancelled by a corresponding credit.

The alternative is, of course, that if short-term producers will not exchange on credit they will lose as customers the long-term producers. It is not merely the latter who will suffer, for in modern communities no customer means no production; and if those who produce food do not sell it to those who produce steamships, they will have to reduce their production pro tanto.

An understanding of this process of credit is at first sight made difficult by the fact that taking the whole community together, the short-term producer and the long-term producer we have postulated do not in fact directly confront one another and trade together. A man rarely sells his product for the product of his customer. A sells to B and C so that he may buy from X, Y and Z. He therefore takes from B and C not any part of their product but a general claim on the wealth and services for sale in the community a claim usually in the form of money.

On further consideration, this makes the process of credit easier to understand. So long as those engaged in the production of a steamship have in their hands these general claims, they will be able to purchase the food, clothing and shelter they require. They could, of course, create the claims themselves if those from whom they purchased their requirements trusted them and could be assured of being able to pass the claims on again when they in turn wanted to purchase. The next sellers would need to have the same confidence and so on all along the line. This is not possible, nor does it often happen; for in a large trading community, few will know John Smith who started off all these transactions with the claim he has created for himself.

In fact, a specialist in credit grows up by the time the economy has reached this degree of complexity. The banker creates the claims and puts them into the hands of John Smith. Few know John Smith, but almost everyone knows the banker as a man to whom credit can be given; and so long as he never creates claims except in due proportion to the wealth John Smith is producing, there need be no other limit on the amount of claims the banker creates.

The banker of course, must be able to trust his John Smith; and for this reason not everybody will be able to obtain credit. The labourer, where his wages are at the level of the least labourers will accept, is clearly a man to whom only very limited credit can be given; certainly not the credit necessary to build a steamship. Thus in societies based on the enclosure of land any significant credit can only be given to the entrepreneur.

The process is best illustrated by an example. A steamship is to be built. The entrepreneur will obtain an advance from his bank, increasing every few months as the banker is satisfied that the work is progressing properly. Out of this advance wages are drawn, material is paid for, and the claims of all those to whom the rent must go are met. At the end of six months the entrepreneur probably obtains part payment on the surveyor's certificate from his customer who is purchasing the ship. This payment cancels out most of the advance obtained by the entrepreneur from his bank. But the customer will have obtained the funds with which to pay his first installment on the price by an advance from his bank. So the process goes on until the ship is completed and paid for, and the advance to the entrepreneur has been paid off, and in due course the advances to the customer who bought the ship will be paid off out of the earnings it makes.

What has really happened is that the wages, for example, of those who built the ship have come out of the ship. Production is the mother of wages. By means of the credit operating throughout the community, of which the banker is the arbiter trusted by all, those who built the ship have received before they have given in exchange. In essence the transaction is no different from my handing over my watch before I receive your £5.

A lack of understanding of this process has led to the formulation of doctrines such as the notorious Wages Fund Theory, which have attempted to explain how labourers receive their wages before the product of their labour is sold. The theory stated that wages are paid out of capital; the word "capital" being usually used in its sense of an existing stock of wealth. This implied that past production had to be built up into a fund from which wages could be drawn. Examination of this idea shows it to be entirely fallacious.

If a stock of wealth is necessary before wages can be had, how do the first labourers get their wages? Clearly, they produce their wages; and indeed what men produce is always (as to part) their wages. Where a man is his own master - a cobbler, for example - he pays out from the proceeds of what he produces all the costs he incurs in production. He pays for leather, nails, wax, thread and the rest. He pays all those who have a claim on what he produces; his landlord, the Chancellor of the Exchequer, the rating department of the local authority and so on. What is left is his wages, and comes out of what he produces.

Where a man works for a master, he might, as happened in the old days among whalers, take part of what he produces as his wages. The whalers took part of the catch as their wages. If the catch was sold in one lot, they might take part of the proceeds. Their wages still came out of what they produced. So any employer must ensure that his undertaking produces enough to pay off all its debts and leave sufficient for wages and profit. The wages come out of the product.

We may finally test the matter in this way. In societies where men sell their labour, and its product belongs to their master, they are paid at the end of the day or week or month. The master has then had the labour for which he pays. The men have given him credit. As the final outcome of the transaction, he must sell the product which is left in his hand for considerably more than he has paid the labourer or he will not remain in business.

It may be that in the intervening period the master must obtain credit against the growing product of his undertaking, and it is out of this that the wages of the labourers he employs are obtained. It is only the labourer who has advanced anything - his labour - enterely on trust without, security.

Next† Essay